IT Outsourcing: How to Save Money After the First Year

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.)

Annual Unit Price Declines for Specific IT Services

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.”

Regular price check-ins can be beneficial for both parties. “Our experience has been that clients that benchmark more frequently see trends in market pricing and service delivery earlier, which allows them to not only respond sooner to market trends, but also allows them to negotiate smaller, more manageable adjustments to their transactions, rather than trying to make up for years of overcharging with one large benchmark,” Pattacini says.

What happens after a year-two benchmark reveals that overpricing depends on the customer and its relationship with the vendor. Some CIOs are ready to renegotiate anything that’s five percent above market for a given service because that’s their right in standard benchmarking clauses. But that’s not always the best move.

“In practice, clients need to weigh the expected savings against other impacts or concessions that might arise,” Pattacini advises. “A benchmark helps to frame the opportunity to negotiate—not only on price, but also other elements of the transaction as well. We’ve seen clients forgo a price concession in exchange for other changes to the contract, such as increased service levels, changes in scope, etc.”

Of course, frequent price checks don’t come cheap: They require the time and attention of internal IT staff. Outsourcing customers shouldn’t benchmark simply because their contract is two years old. Instead, Davies and Pattacini advise, they should ask themselves the following four questions to determine whether to benchmark their provider’s prices.

1. Have service volumes or deal scope increased dramatically? If volumes in a certain tower of IT service have grown by 30 percent or more or your deal has been experiencing scope creep, your once-competitive contract may no longer be such a great deal.

2. Does it feel like you’re paying too much? Are business leaders complaining that IT costs are out of line with the market or actively seeking to slash the IT budget? “Organizations that are asking these questions often can benefit from a benchmark,” says Davies, “either to identify savings or to confirm market competitiveness.”

3. Is your relationship rocky? Problems meeting service levels, vendor account team turnover and other delivery issues may be an indication that you’re actually paying too little. A benchmark can help determine if the deal is priced correctly. Price adjustments to help improve delivery may be worth the increased cost.

4. Are the individuals who initiated the deal long gone? If there’s only one person left in your organization who actually knows what’s in the contract, you’re in trouble. “If you are at that point,” says Davies, “it’s most likely that the contract pricing and the contract itself have become so unwieldy that they need to be revisited.”