The Buck Stops There?

Today’s guest blog on the impact of foreign-currency fluctuation and inflation on outsourcing contracts comes from Chris Kalnik, a TPI partner who leads the Financial-Analysis practice.

The sourcing industry is pushing service providers to act more like partners than labor-cost savers. That fact, coupled with some undeniable global macroeconomics, suggests we shouldn’t be surprised that the providers are seeking more equitable treatment when it comes to shouldering currency and related risks.Lately we’ve been noticing that outsourcing clients and providers are having a hard time reaching agreement on the acceptable impact of foreign-currency fluctuation and inflation. The U.S. dollar’s continual drop over the last year, coupled with wage inflation in India, has exacerbated this situation. The result: Service providers want clients to assume more of the risks associated with these elements.

 The common practice has been not to allow for price adjustments for foreign-exchange fluctuations in outsourcing contracts – the rationale being that service providers can hedge currency exposure. But as the dollar continues to weaken against India's rupee and other currencies, Indian and other providers are pushing back. For example, the head of pricing for a large multinational provider recently told me that the company has begun explicitly building the risk of further dollar deterioration into prices, and unless the client is willing to share this risk (both upside and downside), the prices it pays will be higher.

For inflation, the commonly accepted practice has been to allow for price adjustments based upon fluctuations in the receiving country (usually the U.S. or in Europe). This is done by measuring inflation via the consumer price index or other, similar, broad-based, government-published indices.

But with most of the offshore delivery centers located in developing countries with relatively high labor cost inflation, service providers are pushing for contract rates to be adjusted for inflation based on the state of play in the countries from which services are being delivered. While high turnover rates in these same delivery countries helps to ameliorate some of the net labor cost increase, the providers are still experiencing higher cost pressures than they are able to recover from the traditional inflation.

I predict that we will continue to experience more negotiation pressure on these fronts, and we may well see contract terms and conditions whose final negotiated outcome is different from what it has been in the past.

Comments

[Dinesh Goel]

Absolutely Chris. These risks to pricing have become certainly more real as well significant in quantum of late. At the end of the day, my belief is the terms will reflect the hunger for the business by the service provider in a competitive situation since the principles of such adjustments are not hard to understand for either the buy or sell side. The bottomline is the pull of negotiations lever. Service providers will certainly price the risk in their pricing if client demands no adjustment to price on any of these counts.

[Subir Dhar]

Hi Chris,

I agree with your thoughts on the issue of continued decline of USD in the recent months, and the need to relook at pricing of contracts.

At the same time, one should also look at the behavioural aspects of the situation.

I have managed procurement contracts, and I always believed in helping out contractors/service providers who have responded positively to the needs of my organization during difficult periods, and built an atmosphere of mutual trust.

So if I were to analyze the situation of falling dollar - I would see how the service provider "behaved" when the dollar was continuously rising vis-a-vis the Indian Rupee. If the service provider was agreeable to passing on some of the benefits to client, I feel that the client should adopt a practical approach to consider the cause of the service provider.

On the issue of Inflation:
One good practice can be to have an understanding of the cost structure of the service providers and agreeing on the adjustments that will be made to the rates, and the basis (any Government Data).

One should note that the impact of wage inflation (linked to Consumer Price Index) should apply only to the labor component of the billing, and not to the total billing. Secondly, while the labor costs go up, the costs associated to technology (costs of desktops, telecom links etc) do come down.

Regards

Subir Dhar
Bangalore