The price war begins

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At the start of the year the NOA predicted that vendors within the outsourcing industry may find themselves in a price war, both with each other and with end users. It appears that this prediction is now coming into fruition.

Gartner has released its report, “Potential Impact of Economic Downturn on IT Infrastructure Outsourcing Prices, Q109”, which forecasts that IT outsourcing services will drop between 5% - 20% through 2010. The recession has led to IT budget constraints, intense competition and contract renegotiations, which are all factors that Gartner believe are contributing to the reduction in prices.

In 2007 the NOA commended the growing trend of end users shifting their focus from cost to service quality and added value. It appears that, as the recession deepens, cost will once again become king.

End users are looking to renegotiate their contracts and the focus is firmly on reducing prices. Suppliers will end up caught in a price trap. If they reduce costs significantly the users will question the supplier’s current/initial rates, if they stand firm then they risk being significantly undercut by competitors.

Indian outsourcers, still recovering from the Satyam debacle and Mumbai attacks, may be worst affected by this competitive price war. Emerging destinations will capitalise on an unstable rupee and look to offer more westernised services at better value. Recent reports of Indian service providers looking to relocate to cheaper destinations due to rising costs, may also fuel speculation that India will not be as best placed to compete in a price war as it once was.

Despite the lure of driving down costs for end users, this can be a dangerous game. By focusing solely on reducing costs rather than maximising the potential benefits the supplier can provide, end users are putting additional pressure on suppliers to lower their bid to an unprofitable level in order to secure the business.

However, it should come as no surprise that suppliers attempt to claw back their initial losses as time goes on. No supplier wants to sell like this, but competitive bidding processes such as these leaves them with no alternative. Suppliers will use constant change requests and other variations to extract extra revenues from the contract without the scrutiny of a procurement process or comparative pricing mechanism.

The outsourcing relationship may also be in jeopardy. The NOA has always stressed that suppliers should be treated as business partners and not just cost cutting entities. Pushing suppliers to reduce costs significantly could result in a bitter feeling for both parties. Vendors will be concerned and shrinking profit margins. Users will become increasingly frustrated at a reduction in service.

Despite this, a competitive market is always a healthy thing for everyone involved in the industry. It will push suppliers to develop innovative service offerings, which give value to the end user without sacrificing large chunks of revenue. However, it is imperative that users don’t push suppliers too far.

By all means, end users should look to renegotiate a contract that works well for both parties. But they should not simply demand vast price reductions; after all, it will ultimately be the end user who will be in their client’s firing line if standards are not up to scratch, not the suppliers.