The Common Gotchas in Outsourcing are Well-Known, But Do You Know How to Handle Future Pricing?

The Outsourcing Center recently ran an article on the 5 “gotchas” when negotiating an outsourcing agreement that pretty much covered the same-old, same-old, when it noted that, if not carefully structured, the following five areas of an outsourcing agreement can not only drain value from your business case but decrease the probability of having a successful outcome. Specifically, without a good focus on the

  • Statement of Work (SoW),
  • Service Levels,
  • Delivery Locations,
  • Termination Language, and
  • Future Pricing

if things go bad, your agreement, and any value you expected to derive from it, can go to hell in a handbasket very, very fast. Why?

  • A poorly defined SOW can allow the service provider to take shortcuts and avoid doing intended responsibilities.
  • A poorly defined Service Levels agreement can result in worse, instead of better, customer service.
  • A poorly defined delivery locations clause can allow the provider to deliver from anywhere, and all of a sudden instead of being serviced from Poland, on CET, you’re being serviced from Nepal on NPT and you’ve just gone from UTC + 1:00 to UTC + 5:45 and forget about reaching anyone during a standard North American working day.
  • A poorly defined termination section can result in your inability to pull the plug if service gets bad.
  • And a poorly defined future pricing section that allows for year-over-year increases based on “labour rate increases” could have you taken to the cleaners if “labour rate increases” are not appropriately defined.

But in the future pricing discussion, the article did a great job of pointing out three specific areas you should look out for (and what you should do about them).

  • Year-over-Year Pricing
    In general, unless the service being provided is very labour intensive and requires highly skilled labour, prices should decrease. In a call center, average cost per resolution should decrease year-over-year. In a back-office processing outsourcing arrangement, the cost of processing an invoice should go down year-over-year. Etc. The provider should get more efficient over time and pass on some of those savings to you.
  • Cost of Living Allowance (COLA)
    If the agreement is long-term, it’s ridiculous to think that any provider will totally lock in pricing for services when labour rates are often unpredictable. You have to include a cost of living allowance. But you don’t have to make it almost discretionary. The COLA should be tied to a well-known and accepted government or public index (such as one provided by a major organization like the ISM), the specific services to which the COLA is permitted should be defined, and the percentage of the unit cost that is subject to COLA must be defined as well. (Remember, if you’re paying by invoiced processed, part of the processing costs are technological, and they should decrease year-over-year.)
  • Variance Pricing
    As the article notes, many outsourcing contracts contain variance pricing based on resource usage. An assumed number of resources are built into the annual price, and then adjustments are made up or down based on actual monthly usage. You need to watch how that will work for your organization. Some providers will start off with a lower base price to meet an initial price point or undercut the competition, but then have a relatively high additional resource charge (ARC rate) for more volume. The cost of additional resources should be flat in the worst case, and decrease if requirements increase considerably (as the profit margins the outsourcing provider should need to make should decrease with volume utilization).

So pay close attention to your future pricing unless you want your projected savings to turn into actual losses.