by Stephanie Overby

Why your outsourcers’ cost of living adjustments don’t work

News Analysis
May 03, 2016
CareersOutsourcingTechnology Industry

Cost of living increases are intended to keep IT outsourcing staff happy and working hard on your account. However, only a fraction of the money makes it into the pockets of those workers. Here are three ways to fix that.

Scissors cutting money for budget slashing
Credit: Thinkstock

For years, most large outsourcing contracts have included standard provisions for annual pricing adjustments based on consumer price indices and other economic indicators. These cost of living adjustments are intended to normalize services fees with economic conditions over the life of long-term deals. The impact on pricing can be significant—in the millions of dollars for a large deal. A $50 million annual services contract with a 2.75 percent cost of living adjustment could mean a $1.375 million increase in annual fees.  

In theory, cost of living adjustments help service providers reduce attrition by ensuring that employee salaries keep up with market trends. Staff retention benefits providers and allows clients to avoid the disruption of employee turnover.

That’s particularly important today as IT organizations look to outsourcing providers for high-demand emerging technology implementations such as data analytics or robotics. “The technology is changing so fast that workforce strategies and finding people with the right skill sets and experience in these areas is becoming an increasingly high priority,” says Michael Markos, managing director with outsourcing consultancy Alsbridge. “And in many cases, you have specific provider resources who acquire the operational intelligence needed to understand a customer’s unique environment.  That value is very difficult to replace.”

But while cost of living adjustments seem like a straightforward tactic to tackle the problem of talent retention for buyer and supplier, they often don’t work as intended. I many cases, only a fraction of the resulting price increase actually makes it into the pockets of provider employees. Instead, the provider account teams build the adjustments into their business plans and apply them to boost margins throughout the duration of the contract. “For example, what often happens is a key team member gets a raise and then leaves the firm for another position. That employee is then replaced by a lower cost resource, with the difference simply going to the provider’s bottom line,” says Markos.

Another issue is determining the true effect of the cost of living increase and factoring in offshore and onshore resources moving on and off an account. The economic indicators on which these provisions are built can be esoteric. Recently, consumer price indices have been volatile; offshore indices have revealed a higher rate of inflation than their onshore counterparts, decreasing the benefits of labor arbitrage over time.  “That has an impact on deal value,” Markos says.

These three steps will help CIOs ensure take these cost of living adjustments have their intended effect of reducing attrition rates among service provider staff:

1. Build specific metrics into the contract to accurately assess turnover.

If staff retention is the goal, IT leaders can create a contractual model and specific metrics aimed at ensuring that these increases are actually used to keep key members on the team. It’s easy to just tack on a 2.75 percent increase annually and be done with it, but it’s not always effective.

Staff retention must become a part of the service level agreement structure. “It’s a bit of a challenge because managing outsourcing relationships is about managing services and, ideally, about managing outcomes,” says Markos. “But of course at some level it’s the people involved who deliver the services and the outcomes, so there needs to be some focus on keeping the right people in place and giving them an opportunity to grow.”

2. Link cost of living adjustment to provider employee benefits.

IT service buyers can tie the cost of living contract terms more directly to increased compensation and benefits for those staffing their accounts. “It’s important that the incentives go beyond salary increases and include positive recognition, career growth opportunities, and a long-term career track — things that create an incentive for talented people to stay put,” says Markos. In some cases, a simple raise can actually be counterproductive; an increase in compensation can be a trigger to job hunt because it makes the candidate appear more valuable.

IT leaders should also pay attention to the details of how increases are distributed. “The other key factor is to normalize for factors such as attrition and new people coming on so that you’re not giving a bonus to a new hire just coming onto the account,” says Markos. “And with automation increasingly being integrated into outsourced solutions, you want to avoid getting into a situation where you’re paying salary adjustments to robots.”

3. Identify key team members who deliver critical value to the relationship.

This may not be clear unless the provider and client have had detailed conversations about the long-term objectives of the relationship are the strategic value the provider team will be delivering. “It requires an investment on both sides, and it’s not just an investment of money, but an investment of time to understand specifically how value is being delivered, who is delivering that value, and what’s important to the people delivering the value,” Markos says.

Once both parties are in agreement, the client can identify the most valuable players on the team and create an incentive structure designed to keep them on board. “You might identify five key managers and five key technology experts you want to retain.” Markos says. “you build the incentive program to keep those key contributors on the account, and then measure how effective the program is.” If it works, both parties benefit from the retention of top talent.

“Everybody talks about the importance of developing outsourcing relationships into strategic partnerships that deliver value and are a win-win for all parties,” says Markos. “This is a very specific and tactical way to address that strategic objective.”

Providers should be open to these kinds of discussions and arrangements. “Providers spend a great deal of money on recruitment and retention, so ensuring that COLA increases are applied to keeping the team in place can be seen as an investment that delivers value,” Markos says. “The key is to take a long-term perspective rather than a short-term view.”