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In Outsourcing, Less Expensive May Not Be Cheaper
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My Mother always told me that cheaper is not a statement about price but rather a comment about quality. In the outsourcing world, cheaper has always been measured as lower unit rates, whether for application developers (dollars per FTE) or computing power (dollars per box or CPU minute) or for a broad range of BPO services (price per employee per month (PEPM) or dollars per claim). There are many advantages to the fixed unit rate form of contracting that has developed in the outsourcing industry. It provides a pricing mechanism that is easy to understand and fairly (though not completely) flexible to adjust for changing volumes and business circumstances. It also puts an incentive on efficient supplier operations and provides a convenient metric for benchmarking against other suppliers or other alternatives.
However, at least in the IT arena, it does not provide much of an incentive for the efficient use of the resources being consumed. In most cases, the supplier asks the customer how many “widgets” it has, and develops both a unit price and a projected price over the contract term based on the number of customer-identified units. So long as suppliers were able to offer year-over-year reductions in unit prices and unit prices materially lower than a potential customer’s comparable unit costs, everyone was satisfied. Moves to offshore or remote support locations (so-called labor arbitrage) have been a key driver over the last ten years in producing constantly lower unit prices. Similarly, supplier investments in tools, enhanced training, common processes and other forms of forms of standardization have continued to drive supplier unit costs lower.
Within the last two years, we have observed a leveling off in the rate of supplier-offered unit rate reductions. It appears, at least for the near term, that the rate of productivity increases reflected in lower IT unit rates is not as great in years past. This is best seen in a number of very recent proposed IT outsourcing transactions where the supplier’s unit price is not much less (or not lower at all) than the internal customer’s cost to deliver a comparable service. But, even in these cases, customer IT management, as well as a customer’s business management, still view the total cost of providing IT services as much too high. How can this be? How is it that a customer’s unit cost to deliver a service is not much greater than the outsourcer’s price to provide the comparable service, but all users of the IT service still view the cost of the service as too high?
