Indian Outsourcing Vendors looking to increase Outcome based pricing revenues in 2013

The $100-billion Indian IT sector is bracing itself for tough fiscal 2013 triggered by volatility in developed economies like the US and Europe who are the major outsourcers of both Information technology and Business Processes to Indian Vendors. Discretionary spending and overall IT budgets and spending has been reduced significantly by both the US and European companies which has forced to look at innovation, acquisition led growth and outcomes based business to compete against the dominant multinational vendors like IBM, Accenture, etc. For years Indian outsourcing vendors have focused on cost reduction for clients achieved through mostly labor arbitrage as Indian manpower cost was one third of the resource cost in United States and adopted the 'time and material model', in which companies charge clients based on the number of engineers working on a project and the number of hours they put in. Worldwide spending for IT outsourcing (ITO) services is on pace to reach $251.7 billion in 2012, a 2.1 percent increase from 2011 spending of $246.6 billion, according to the latest outlook by Gartner, Inc. Indian Outsourcing vendors used to have good visibility of the client’s spends and budgets and accordingly provided their revenue guidance and future outlook and also plan their operations. But things have changed forcing Indian vendors loosing visibility of clients budgets and as Infosys CEO S.D. Shibulal said “I think the world is in a new normal. It will continue to be volatile and uncertain. Corporations will have to adjust and become more aware of this and learn to operate in these conditions.”

The renewed focus on business outcome based pricing model is due to the recent advertising campaign launched by mid-tier player iGate in US titled "Conspiracy Uncovered" published majorly in the New York Times, Wall Street Journal and the Financial Times welcoming American companies to switch to 'business outcomes model,' where a service provider shares the risk of clients and gets paid only when they achieve business outcomes. “The arch enemy of big corporations isn't recession. It's the outdated, inefficient time and material model, which forces you to pay the outsourcing services vendor, even when a project fails," claimed the company CEO Phaneesh Murthy. Apart from the Time and Material model Indian outsourcing vendors also use a fixed-price model, where project costs are agreed in advance irrespective of the number of engineers working on it or the number of hours they put in. Time & materials model contribute to 50-58% of the revenues for the Indian outsourcing vendors. Post the $1.2billion acquisition of Patni Computers in 2011, iGate is looking to compete with other big Indian Vendors like TCS, Infosys, Cognizant, Wipro and HCL Technologies and this advertisement is one of the ways in which it is trying to draw attention to the American and European companies. In 2007, TCS ran a marketing campaign titled "experience certainty", which highlighted the message of dependability of its services.

iGate through its ad campaign advising clients to move from fixed price contracts to outcome-based models and it is signaling it as a larger global shift in outsourcing models. But most of the Indian outsourcing vendors particularly TCS, Wipro, HCL Tech and Infosys have been focusing on the outcome based model as early as 2005 when HCL Tech highlighted its focus on this model by signing some deals. Most of the Indian vendors have been offering the outcome based pricing for years and also have traction in this but not as much as compared to the traditional Time and Materials model and fixed price model. Between 2007 and 2009 major Indian outsourcing vendors had even announced during that time they are targeting 30-40% of revenues based on outcome based pricing model in next two three years but this did not happen. Outcome-based pricing, which is based on actual performance, does not follow the linear model which banks only on the number of people deployed for a contract. In 2012, 15-20% of offshore contracts are expected to run on the outcome-based model, in which the vendor gets rewarded for reduction in product costs, increased working capital, volume of sales and improvement in bottom line. Large Indian vendors are depending on the vendor consolidation/churning and mid-cap IT companies are relying on segregation of large deals into smaller ones and most of these deals that will be renewed will definitely have the outcome based pricing revenues.

But all the Indian vendors are treading cautiously in terms of increasing the percentage of the outcome based pricing revenues as there are certain prerequisites for this model to be successful like clear and thorough understanding of the client’s business models, understand the client’s business operation and industry best practices, understand the risks involved in this model like failure to deliver as agreed will lead to clients not paying which directly affects the revenues, a comprehensive contractual agreement between the vendor and the client that should factor in all the risks and all the data, reporting formats, details of the pricing and deadlines/milestones and both the vendor and client should understand the contractual terms and agreements thoroughly and sign off accordingly. Acquisitions done by Indian vendors for the outcome based pricing include TCS acquisition of Diligenta and HCL Tech acquisition of Axon, which highlights that all the major Indian Vendors are looking at acquisitions to acquire new capabilities and strengthen domain specific expertise. What ultimately matters for the success of the outcome based pricing model is strong relationship between the outsourcing vendor and the customer for the successful implementation of this pricing model. Clients are expecting Indian vendors to deliver high value other than mere cost cutting and expect the vendor to work closely with them on improvements that has significant business outcomes. Technology trends such as cloud computing and big data are supported by technologies such as social media and smart devices to create new services are most suited for outcome based pricing models and all Indian Outsourcing vendors have invested significantly on these technologies and offering clients new products and services.

Discussion Points:
1.What is the percentage of revenues in terms of the total revenues should Indian Outsourcing vendors target from outcome based pricing models?
2.What should they do to prepare themselves to offer outcome based pricing to their clients in terms of human resources and technology capabilities?
3.What are the risks involved in this model and how does the vendors have to factor them so as to overcome any significant loses?