Is it time to revisit your sourcing models?

Only those who understand their supplier costs can negotiate from a position of strength!

During my day-to-day work, I have come to notice that tensions are often building between customers and their suppliers, especially in the more traditional offshore locations, but what is it that is actually causing these tensions to occur? From my experience, I know that customers are pushing hard on service levels to demand the best services at a minimal cost. They want to keep charges low, they don’t want to suffer from indexation (like so many outsourcers are), but yet still demand the crème de la crème of resources.

The problem is that procurement negotiates the deal on price rather than quality of resources and therefore the person receiving the service gets the brunt of the poor quality; the supplier can’t afford to deliver their best people at the price the customer wants to pay.

For example, a large slice of India’s original attraction as an offshore location was based around the substantial labour arbitrage benefits available to customers. Mutually, between 2009 – 2011, the Indian listed suppliers were able to convert contracts into the widely reported 20% plus net margins, to keep their own investors happy. It was one of those rare win-win scenarios where savings were good and shareholder returns predictable.

However, recent reports have India’s Consumer Price Index (CPI) currently running at 8.3% (correct as of May 2014). Add to this the predictions that IT professionals in India can expect an average 11% pay rise in 2014*, with no indication that this increase will plateau in the upcoming years.

The strong graduate schemes in these countries are still in place and are churning out quality resources as they always have. However we’re witnessing a new era where these graduates are not enough to meet demand. Suppliers are instead topping up their resource pool by poaching personnel from their competitors, creating a very competitive and disloyal business environment in the effected countries.

For customers using, for example suppliers with a strong Indian presence, this has to be a cause for concern. For the suppliers there is real potential that the people element of their cost base will have to increase if they want to retain key personnel; in 2015 maybe by more than double the 11% increase predicted for 2014. They remain under frequent and intense pressure to absorb the risk of these increasing personnel costs under capped day rates; capped in local onshore currency adding a further risk of fluctuating exchange rates. All this is going on while the customer is stressing the need for continuity and committed access to key resources. This leaves little opportunity for the supplier to match cost increases to cover quality employee wages, with a comparable increase in fees to the customer. Suppliers know that if customers feel the increase in service charge is too high, they have the option to source from lower cost geographies.

Looking further afield, this exact movement can be followed to other countries. A positive increase in the exchange rate between the UK and South Africa, coupled with good language skills, cultural alignment and a largely similar time zone is making this location more attractive than ever. Sign the contract in GBP and you’ll benefit from an exchange rate of 18.4 compared with 12.6 back in 2010 (correct as of July 2014). Their CPI is running at 6.2% for 2014 and there is no prediction that the same pay increases are on the horizon.  

With the macro-economic landscape in mind, it is perhaps time for companies to review the terms of their contracts. A close look at whether some of the tight controls on indexation that we’ve witnessed can be lifted, at least for those key resources that the supplier is fighting hard to retain. Or perhaps it’s time to open up the offshore options to allow suppliers to go omni-source in terms of locations.

Knowing if you’re paying the right price at the outset should also form part of the dialogue. But where procurement have done their best work, there is the chance that your supplier won’t be able to sustain standards, accept capped pricing and still keep the shareholders onside! Would you?

If this post resonates with you and you wish to discuss or comment, please do get in touch.

 *The Times of India