The outsourcing contract is critical document in
an outsourcing relationship which typically contains:
scope of services, assumptions, deliverables, pricing, intellectual property
and deliverable ownership, contract duration, service levels, customer
responsibilities, Vendor responsibilities, conflict resolution, and termination
process. There were 472 outsourcing deals struck in the third quarter of
2011 compared to 516 transactions in the second quarter of this year according
to Everest Group. Indian IT Vendors constantly write contracts with clients
every quarter. Indian ITO vendors contracts are based on two types of pricing
Time & Materials based pricing and fixed Pricing. Most clients still
negotiate for T&M or Fixed Price contracts with T&M contracts more than
51-58% of total revenue and rest is fixed price contracts.
Fixed-price projects to mitigate the impact of the rising
rupee and wage inflation on their profitability.
Time & Material (T&M) Contracts are the major type
of contracts done by the Indian IT Vendors. In the initial days of outsourcing
of work to Indian Vendors the outcomes were unknown and both vendors and
clients were not sure how effectively the work will be done by the resources
provided by the vendors. They were not sure about the time and resources
required, hence the T&M contracts were the best options. Clients wanted to
have control on the resources and track vendor resources including the approval
and clearance of time-sheets and the risks totally existed with the client. In
the T&M contracts the risk lies totally with the clients. People are thrown
at the problem and are billed on hourly basis and there are instances of
unutilized resources in this scenario. Projects can be easily ramped up or down
according to the clients needs easily. These contracts are best suited when the
relationships between the clients and vendors are just starting fresh and the
projects or process are new with no significant view of the outcomes and their
impact. As long as uncertainty exist T&M contracts will be there and
despite the fact some experts believe the golden age of T&M contracts is
going to end in next ten years.
Fixed price (FP) contracts are clearly defined and
deliverables agreed between client and vendor. Standard IT procedures, periodic
reviews of performance and phased billing are other features of FP contracts.
Risk is shared between the vendor and clients and vendors have to invest in the
relationship and technologies required. This is a rigid model and mid way
changes are difficult to make. Clients have to be very careful in choosing the
best vendors for significant ROI and the vendors too have the scope on investing
on the infrastructure and technologies as they are well aware of the client
needs. Both clients and Vendors have to invest in building a relationship.
Fixed price contracts are being favored by the Indian ITO vendors as they can
efficiently complete the work using lesser resources and do it without much
interference from the clients. In the past four years Indian vendors are trying
to increase the Fixed price contracts percentage to total revenues as the
client IT budgets/spend are being tightened due to the financial crisis, debt
crisis and economic slowdown. Indian IT vendors looking to maintain 40-40% of
total revenue through fixed price contracts. Fixed-price outsource contract attracts the customers due to immediate
cost reduction followed by 3-5 years of cost control. Fixed-price projects are
also more short term in nature, while the time and material are long-term
contracts that give longer revenue visibility for companies
Tata Consultancy Services Limited
TCS has a higher ratio of fixed prices contracts
in
comparison to the competition and suggest TCS is undertaking more complex and mission
critical end-to-end engagements.TCS has been looking to maintain the fixed price
contracts in between 40-50% which they feel is optimal. The recent recession and
financial crisis has tightened the client budgets and spends which forced to
look for more fixed price as it helps them in controlling the resources and do
the work more efficiently.
TCS also
increased the working hours of employees so that they can increase billable
hours for T&M contracts. Fixed price contracts also have higher pricing
compared to T&M and carry risk for the vendors. Fixed price contracts have
to be signed constantly as the existing contracts get completed overtime and if
there are no signings for some time then the overall revenue gets impacted. TCS
in 2011 is facing such situation where they have seen fall in fixed price
signings but confident to overcome as they have good pipeline. Margins also
increase with fixed price contracts.
Infosys Limited
Infosys has
successfully increased its fixed price contracts since 2008. Financial crisis
and subsequent recession forced Infosys to start look for ways to curb the slow
revenue growth. The US
clients have changed their offshore outsourcing strategy and this prompted
Infosys to look for fixed price strategy. But Infosys still have major revenues
coming from T&M contracts as most of its clients want to stick with T&M
and there are risks involved in fixed price like if the scope of a fixed
price bid is unclear, it can lead to cost overruns. The share of fixed price
contracts for Infosys in 2010-11 stands at 42% as compared to 28% in 2005-06. Infosys
focused on shift to fixed-price contracts as part of the bigger effort to
de-link revenue growth from manpower growth and move up the value chain. In
long term, Infosys expects the proportion of fixed price bids going up.
Wipro Limited
Over the last 2-3 years, Wipro have increased
focus on fixed-price contracts. Wipro has been able to increase the
proportion of fixed-price contracts to 45.7% in FY11 compared to just 34
percent in FY-09. Fixed-price contracts ensure better realizations compared to
time and material. Wipro is also
is
aiming to break the “linearity”, or revenue growth linked to the number of
people added, and earn better prices through fixed-price contracts. Wipro was
also forced to look for more fixed price contracts to overcome the recession.
Wipro has in the past couple of years have been signing more fixed price deals
as these deals provide revenue visibility and reduce the pricing pressures.
HCL Technologies Limited
HCL Tech have increased
its fixed price contracts to total revenue percentage in 2011 to 42% from 30%
in 2006. HCL had move to more fixed-price contracts as it offers more certainty
in contract execution and revenue. Fixed-price contracts require greater
planning in terms of resource allocation and utilization and definitive
timelines of implementation and were more relevant in the turbulent times where
clients of HCL are demanding output/outcome-based pricing with service-level
agreements. In the last two years HCL has seen good traction in the fixed price
deals and it is planning to do more such deals in future.
Discussion Points:
- Are
the Indian ITO vendors doing well on the Fixed Price contracts front?
- How
comfortable are clients with Fixed Price contracts and how to manage risk?
- What
will happen to T&M Contracts in future?
- What
is the optimal balance for T&M and Fixed Price contracts?
