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CIOs adjust terms of IT outsourcing contracts to get lower prices

As companies with IT outsourcing contracts look to take advantage of price drops, they find renegotiations may include reduced service levels. Gartner and others weigh in.

IT outsourcing prices may be on the decline, but companies looking to renegotiate their IT outsourcing contracts should be prepared to lengthen the terms of their deals and sign on for additional vendor services.

So says a new report from Gartner Inc., which predicts that the cost of outsourcing IT infrastructure -- data center services and application hosting -- will decrease 5% to 20% during the next two years. The findings, based on a survey of clients of both domestic and offshore outsourcing firms, reflect what some users and other analysts are finding as well.

Fidelity Investments, for example, outsources business and technology functions including maintenance, quality assurance activities and software development, and is currently renegotiating several of its IT outsourcing contracts, said William Pierce, vice president of infrastructure and Web services at Fidelity.

"We're actually asking for very aggressive timelines here and certain guarantees, and we made the assumption that vendors will try and add costs and fees to the back end of the contract," Pierce said. Fidelity is a 45,000-person financial services firm based in Boston.

What's driving down price? On the client side, increased interest in outsourcing from U.S. companies, plus the need to cut cost from IT outsourcing contracts, Gartner said. On the vendor side, increasing competition in the market should keep costs on the decline as new providers compete aggressively to keep their revenue growth on target while still ensuring margins.

"Everyone is looking now for what they can do for less cost, and there's a lot of pressure on all the service providers to reduce costs for clients," said Richard Matlus, vice president of research at Gartner and co-author of a study on the potential impact of the economic downturn on IT infrastructure outsourcing prices.

As a result, companies pursuing new managed services and those managing existing outsourcing contracts can benefit from this trend.

"If you're an IT shop in this tight economy and your budget has been frozen or you've been told you have to reduce it 10% or 20%, you have to look at every aspect of where to get savings," Matlus said. "Most domestic companies have already gone through cutting and finding efficiencies. Now they have to go one step further."

Christine Ferrusi Ross, an analyst at Cambridge, Mass.-based consultancy Forrester Research Inc., said prices in an outsourcing contract typically drop year over year because the outsourcer gets better at managing systems and requires fewer people to accomplish the same business goal.

In addition, due to the economy, "a lot of clients are saying, 'This is what I can afford to give you,' so that's pushing [pricing] down," Ross said.

Additional pressure for pricing reductions applies specifically to Indian offshore providers, due to the Mumbai terrorist attack, the fluctuation of the Rupee exchange rate vs. the dollar and the euro, and the opportunity to achieve lower-cost outsourcing options in terms of Software as a Service (SaaS) and utility or cloud-based infrastructure offerings, Gartner found.

The recent Satyam scandal factors in as well. "A lot of people are nervous about these companies," Matlus said. "They're going to be under the gun to do something if a client says, 'Reduce your costs or we'll go elsewhere.'"

But companies should expect to be flexible in return for cost savings.

"These pricing concessions will likely come only with stipulations, including longer-term contracts, expanded scope of work, greater fees associated with additional resources charges … or accepting additional contractual lock-in terms," the Gartner study found. "Clients must be ready to make concessions to get these lower prices or greater flexibility."

Providers may suggest other concessions as well. For instance, if a company outsources its help desk function for the desktop and normally require fixes within four hours, the provider might ask if you can wait eight hours or until the next day, Matlus said.

"It makes a big difference to service providers," he said. Renegotiation calls for "that type of rethinking and re-looking at what's feasible and still meets the demands of the business."

Gartner estimates that the average outsourcing price reduction for data center services could be 5% to 15%, and pegs application hosting as high as 10% to 20%.

"We think the reason that percentage is a bit higher is because people are going to be looking at SaaS as a solution," Matlus said. "We'll see more of those access-ready services delivered. We think that will drive lower costs, along with things like virtualization and automation."

At Fidelity, Pierce said the renegotiation process has been interesting -- and complicated.

We're revisiting everything, including the engagement model and where we're outsourcing to.

William Pierce, vice president of infrastructure and Web services, Fidelity Investments

"We're revisiting everything, including the engagement model and where we're outsourcing to," Pierce said, as well as potentially adding infrastructure and other value-added services.

Fidelity currently outsources both domestically and offshore in India, although one of its goals is to broaden its offshoring activities to continue to reduce risk. It outsources with numerous providers and is trying to consolidate to a more manageable number.

Pierce said Fidelity "kind of assumed right off the bat" that it would have to make concessions of its own when renegotiating for lower costs in its IT outsourcing contracts. Consulting services and the cost of infrastructure are two areas in which Pierce said he expects there might be a price ramp-up on the back end of renegotiated contracts.

As such, Pierce advises other IT executives looking to renegotiate their IT outsourcing contracts to have providers compete against each other on price, and to watch out for hidden costs and confirm final prices in areas such as consulting.

Some outsourcers "have the proclivity to sneak in [the costs of] consulting services," he said. "They'll quote you a certain level of expertise and capabilities, and you don't realize that 90% of those people won't be on your project."

Forrester's Ross advised that companies with existing outsourcing deals take a look at their contracts and determine whether they include a benchmarking clause, which provides clients with the right to evaluate and negotiate based on current market prices.

"A lot of times, in any economy, clients focus on what they're paying now and what they need to save," Ross said. "As far as current negotiations, I think where clients can also look is not just at rates and fees, but also at financing options."

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