Too many buyers ignore the importance of currency fluctuations in their offshore outsourcing arrangements, both the risk and reward that changing valuations may bring. But the steady fall of the rupee this year -- India's currency hit an all-time low on Aug. 6 -- has shed light the significance of foreign exchange rates to offshore deals. And, based on year-to-date depreciation, this year is almost certain to be the third straight year of rupee depreciation against the U.S. dollar, says Alan Hanson, senior vice president with offshore outsourcing consultancy Neo Group.
That's made offshore support significantly less expensive for Indian suppliers particularly, as well as multi-nationals who provide services delivered in India. When they receive their income in U.S. dollars and pay their expenses in Indian rupees, their margins increase. "While suppliers may say that they hedge or that the valuation moves in both directions over time," says David Rutchik, partner with outsourcing consultancy Pace Harmon, "there's no question that they are receiving a windfall in this situation."
But there's no reason that IT buyers can't benefit as well. Indeed, customers ought to leverage the rupee's depreciation to get better pricing, says Hansa Iyengar, a sourcing and vendor management analyst with Forrester Research. But before you head to the negotiating -- or renegotiating -- table, there are a few things to keep in mind.
1. Know your power. "New customers negotiating large engagements would have more leverage than a new client negotiating a smaller engagement as scale matters when it comes to the vendor's top and bottom lines," says Iyengar. "Existing customers, especially key clients where the vendor is involved in multiple mid to large size projects across several departments, would have more leverage here."
2. Consider not paying in U.S. dollars. Just because the supplier prefers to be paid in American greenbacks doesn't mean you have to oblige. Customers should make the best choice based on internal company dynamics, particulars of the transaction, deal structure, and currency impacts, says Rutchik. "One option is to pay in local currency, depending on where the company does business, or to pay in dollars that are tied to local currency," Rutchik says. "Of course, this option could present a risk as the rupee's value could swing back in the other direction."
3. Look for good renegotiation opportunities. Routine maintenance and support is an area where downward negotiation is more feasible than a critical application development project. "A critical application would necessitate the use of higher-skilled resources or experienced staff," says Iyengar. "The vendor may feel cornered if there is too much cost-pressure and could cut corners by bringing in less qualified staff causing downstream quality issues."
4. Avoid agreeing to cost-of-living adjustments. These increases, common in offshoring contracts, are often 8-10 percent. "Even though inflation is tied to wages, providers are paying resources in a devalued currency so they're getting ahead of the game with significant margins," says Rutchik, adding that vendors are increasingly agreeing to leave out the COLA clause.
5. Be reasonable. There's no formula for renegotiating price based on currency valuation. "A good approach would be to talk to the vendor about it since a depreciating rupee also means increasing inflation," says Iyengar. "Compromise at a point where the vendor also has a little wiggle room. At the end of the day, the vendor also has a business to run.
6. Consider foreign exchange fluctuations at the start of a deal. "By strategically using currency-driven deal structures, we've seen clients repeatedly save millions of dollars on their outsourcing contracts," says Rutchik. "Some of this is in the form of providers giving clients seven-figure credits based upon the valuation of contracts that factor in currency implications."