5 tips for surviving outsourcing inflation

Outsourcing’s business value has long centered on labor arbitrage. While outsourcing partnerships have become more strategic, getting costs down remains a significant draw of the sourcing model. But outsourcing costs have been driving higher for months. A chief factor in this is an unprecedented talent shortage.

“It’s hard to get people, and it’s hard to retain them,” says Amy Fong, partner in Everest Groups’s sourcing and vendor management practice.

In many ways, the challenges of outsourcing today mimic the material supply chain issues that companies have been dealing for the past two years — albeit it with a twist: Here, we’re talking human resources, which can be much more complex and nuanced to predict and manage.

According to a recent Everest Group poll, 39% of respondents say their outsourcing prices have risen more than 10% over the past year; and almost half (48%) say they have increased 10% or less. No one said their IT services costs had gone down.

“We have been in a state of increasing costs and talent shortages for at least six months,” Fong says, “and we’re still at a point of uncertainty. Many economists are forecasting a recession.”

All this suggests CIOs may be at an inflection point that will require rethinking their outsourcing strategies. “You need to think about what’s appropriate for the long term and how you build in flexibility in the short term in case things level out,” Fong says.

IT leaders may want to choose a new location for IT services or bring in a new supplier. Or they may want to factor in pricing before locking themselves into a three- to five-year contract. The industry is unlikely to mint an extra million people in the IT workforce in the short term. High-demand skills will continue to be in short supply.

Now is the time to create a playbook for managing outsourcing costs in new ways that build in flexibility. IT leaders should consider various scenarios and understand how their workforce plans might need to change as they encounter various demand and supply imbalances, Fong says.

Following are five tips for wrangling outsourcing costs and making the most of your outsourcing relationships as prices rise.

Consider your commercial model mix

There are a variety of methods available for contracting IT services today, from the tried-and-true approach of paying by time and materials all the way up to outcome-based deals, in which the buyer pays only for the end result, placing more risk and cost management concerns on the supplier.

With IT services costs rising, it’s important to be discerning when selecting which model to apply to your outsourcing IT portfolio. Steady-state processes and services can still be handed over using a managed services model, Fong says. But early stage projects or those where high-end skills are paramount may require taking a cost hit on a time-and-materials basis if it ensures higher quality talent, she says. Because of this, IT leaders may find a mix of models with a variety of providers will be the best approach to controlling costs while maintaining quality.

David Rickard, vice president of business process services at Everest Group, says here, more is more. “When we’re looking at organizations seeking to bring transformation to the organization, they’re starting to think about who are the specialists in the technology stack, who are the functional or methodological sub-providers that we should be thinking about, and — if we’re in in a specific industry or a particular function — are there specific providers we should be working with as well,” he says.

For more generic work, the choice may be different. “Consolidating with providers that you’re already working with can give you an opportunity to start to push for competitive pricing or changing the commercial models because you’ve got an established relationship,” Rickard says. “It’s all about context.”

Location, location, location

The IT talent shortage is a global phenomenon. Worse, in the IT services industry, some large providers are seeing attrition rates double to 30%. “Your providers might be losing one third of their people on a regular basis,” Fong says. “That’s a big cycle through of head count.”

Onshore geographies have been especially vulnerable due to broader demographic trends, including an aging workforce population and immigration issues. 2022 has seen the US and Western Europe facing the greatest hiring and retention challenges in IT, according to the Everest Group, but India and Central and Eastern Europe aren’t far behind.

COVID-accelerated digital transformation efforts are also straining supply. Lead times to hire and acquire across a variety of digital skills, including cloud, data services, and cybersecurity, have extended as much as four to six months.

Attrition and lead times may be leveling out, but IT leaders seeking cost competitiveness need to reassess where they send their IT services work, Fong says.

“Locations that we’ve always relied on may not necessarily be the ones that we can rely on in the future,” agrees Rickard, adding that changing workforce demographics are poised to impact popular outsourcing geographies, with the growth of working-age populations set to stall over the coming decades in counties such as Brazil, Colombia, and Costa Rica and to decline in places such as Czech Republic, Poland, and Lithuania, which are great sources of tech talent today. Now may be a good time to double down on India because that’s where the talent is, Rickard says. “It’s all about managing the impact now, but also thinking about what long-term strategy they need to be deploying,” he says. “We are also getting inquiries right now around Africa, which is a massive source of potential talent as we look forward.”

Cost analysis is an ongoing initiative

There’s been a significant increase in FTE prices offshore since the first half of 2021, according to Everest Group, with the highest increase in next-gen skills in IT infrastructure and applications. The curve has been even steeper for onshore roles, says Fong.

It’s more important than ever to benchmark your costs against the marketplace. “We’ve seen examples where people think they’re paying a good rate, they negotiate, and they’re really proud that they get a 10% reduction or keep it flat,” Rickard explains, “but actually they’re paying way above the market and that’s why a provider can give them an attractive rate.”

IT leaders should also evaluate total cost of ownership versus rates on a card. “Often, the rate card may be attractive, but there are lots of add-on services, operational costs, or relationship and account management costs to add in,” Rickard says. “It’s really about understanding what’s the total cost of that operation.”

Most outsourcing agreements include a cost of living adjustment (COLA) clause, which were largely ignored during COVID. IT leaders should keep in mind the value of any COLA clause with a fixed increment tied to the Consumer Price Index or a cap and collar in which you agree on minimum or maximum increases. “Organizations are realizing these clauses are there to protect both sides so people can plan and forecast around that.”

IT leaders should also understand that wage increases should not lead to equivalent price increases. A 15% increase in wages should have, at most, a 7% to 9% impact on price, Rickard says.

Another sneaky driver of increased costs is role inflation. To retain employees, many service providers have been offering junior resources early promotions leading to rising costs for customers. Typically, outsourcing deals are staffed with around 80% lower-level IT professionals and 20% senior roles. Even a slight shift in those ratios can lead to a 6% increase in overall costs for a customer, according to Everest Group analysis.

IT leaders should review their suppliers staffing ratios to look for any increase in senior roles. “There could be a genuine reason to staff more senior resources, such as service delivery concerns or project complexities,” says Bhanushee Malhotra, practice director in Everest Group’s sourcing and vendor management practice. “But putting junior resources in your senior bracket has been becoming a norm, which shouldn’t be the case.”

Understand your end-to-end workforce strategy

In the past, there was limited visibility of how IT sourcing and contingency staffing fit into the larger workforce strategy — particularly among procurement offices. Now, everyone must understand IT’s workforce needs, both now and in the future, to manage costs. “We’re not talking about buying widgets. In the services world we’re talking about people human capital,” says Fong. “It’s important to think about how all these different parts of the workforce fit together.”

When IT faces hiring or retention challenges, or institutes a hiring freeze, it’s likely that outsourcing and contingency staffing will increase to meet short-term needs. “They have big projects that they can’t add head count to and therefore they may need to bring on another provider” or other contingent workers, says Fong. “These are very interconnected sources of talent that everyone should be thinking about.”

IT leaders should work with HR and other sourcing stakeholders to strategize end-to-end. That will involve assessing future demand based on business needs and external scenarios, understanding the existing supply profile and key gaps, evaluating talent sourcing options, matching supply and demand on an iterative basis, and monitoring the situation on an ongoing basis. “It sounds a lot like the demand planning process for manufacturing; it’s just that we’re talking about people,” says Fong. “And people are much more nuanced and difficult.”

Go beyond cost savings

Regardless, IT leaders are still likely to deal with increased IT services costs, at least in some areas. Because of this, it’s important to shift the outsourcing narrative to business value, as IT outsourcing can deliver business benefits beyond cost savings. “There’s risk management. There’s making sure there’s an adequate supply at all times. There’s maintaining those relationships with suppliers and driving the constant flow of innovative ideas,” Malhotra says.

IT and procurement leaders should integrate more qualitative benefits into their outsourcing scorecards. It’s important “to take credit for all that you’ve done to get through the last couple of years, whether it’s ensuring that your supply was available at all points of time or just creating the right type of impact in the organization,” Malhotra says.

At a time when IT may be struggling to hit cost savings targets, it’s even more important that outsourcing arrangements continue to deliver in other areas. Being transparent about the increase in costs as well as the continued benefits IT service providers are delivering is paramount. “We all know we’re in inflationary times,” says Fong, “so having these hard talks up front is really important.”