IT Outsourcing: How to Save Money After the First Year

CIO — You can't blame IT outsourcing customers for breathing a sigh of relief as they enter the second year of an IT services contract. The transition is over and steady state begins.

But something else begins to occur in year two of an outsourcing deal. Your prices can become drastically out of sync with the market, especially today. IT outsourcing prices have been dropping an average of 15 percent a year, according to outsourcing consultancy Alsbridge's ProBenchmark unit, thanks to outsourcer price cuts, aggressive use of offshore infrastructure management, hardware price declines, better management, and increasing use of virtualization. In some industries, such as retail, outsourcing prices have been dropping even more dramatically, says ProBenchmark's director of outsourcing and benchmarking services Howard Davies. (See chart of annual unit price declines for specific IT services below.)

For IT outsourcing customers who began their contracts with above-market rates, the disparity between what they're paying their providers and current market rates is even greater. "We had one client who saw a 40 percent reduction in server pricing for a deal that was two and a half years old," Davies says.

Some outsourcing buyers wait until the end of the contract term is approaching to benchmark their outsourcing prices because they don't want to create a contentious relationship with their outsourcer while work remains to be done. But given the current competitive outsourcing market, says ProBenchmark Director Chris Pattacini, most providers are anticipating more benchmarking from their customers.

"[They] know they are going to be under pressure to keep pricing in line with the market throughout the deal," he says. "It is important [for IT outsourcing customers] to benchmark early to set expectations with the vendor."

While outsourcers traditionally back-loaded their costs on their bigger, transformation deals (losing money in the early years and making up for it later), Pattacini says vendors today are savvier about segregating their costs. So customers need not worry as much about cutting into their providers' profit margins with reasonable price adjustments or other concessions.

"As the market shifts to more standardized delivery models, including cloud [computing], there is a clearer delineation between transition and transformation costs and operational costs," Pattacini says. "Most vendors today understand that the transaction will get benchmarked at some point, and therefore more carefully separate out one-time investments."

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