Indian IT-BPO industry moving towards complicated Outcome based pricing model

For years Indian IT-BPO industry relied on the labor arbitrage wherein Indian software companies provided information technology and business process services to American companies at a fraction of cost due to the huge supply of inexpensive engineering talent and English speaking graduates that led to the building of US $108 billion ( Rs 6.4 lakh crore) IT industry in India. The industry has seen a double digit growth and generates employment for hundreds of thousands of engineers and graduates every year but the Indian IT-BPO industry has been maturing for the past few years seeing slowdown in growth and reducing employment opportunities for engineering graduates and other graduates too.  Industry relied on traditional Fixed Price and Time and Materials pricing model for years and built up huge employee base in India and other locations across the world. Lakhs of employees work for the top Indian IT companies like TCS, Infosys, Wipro, HCL Tech, Cognizant Technology, Mahindra Satyam, etc. and it is becoming difficult for the Indian companies to manage such huge workforce as the number of employees increase so do the cost associated in managing, training and retaining also increases which literally destroyed the labor arbitrage that Indian companies relied on for years.

These days often clients of Indian IT Industry complain that India is no longer a low cost destination for IT-BPO services and the emergence of countries like Philippines, Poland, etc. as low cost destinations compared to India is also affecting the future growth potential of the industry. These challenges forced Indian IT-BPO industry to move towards outcome based pricing model, wherein clients link billing or payments to business outcomes and the principle is simple, Indian IT companies will be paid a share of portion of the revenue generated or the cost savings that have been achieved by the Indian vendors for their clients. This is a highly complicated and risky model compared to the traditional model where in clients are charged based on numbers of hours worked by engineers on a project or fixed price per employee. In the initial years of IT-BPO outsourcing cost reduction and cutting were the primary objectives of the most of the American companies which most of the companies have successfully achieved and now moving towards more complex business process centric spending from the simple IT spending which also forcing the Indian IT-BPO companies to adopt the outcome based pricing model.

Also the changing global macroeconomic environment, globalization, increasing reliance on emerging markets for growth for most of the American companies is one of the factors. Intense competition between the Indian IT-BPO companies of all sizes be it small, medium and large and the multinational outsourcing companies to adopting the low cost delivery model by setting up operations in India and other low cost destinations also led to the increased adoption of outcome based model as a differentiating factor for both top line and bottom line growth for the Indian companies. Indian IT Majors have since past three years have been talking about various nonlinear revenue initiatives that includes outcome based pricing model, analytics, social media, consulting and mobility technologies as key strategic areas that will drive future growth. Non Linear revenue model is where the relationship between employee headcount growth and revenue growth will be not there. Outcome based pricing model which many industry experts call a natural progression for Indian IT-BPO industry as the industry matures have been seeing a slow adoption.

Outcome based pricing models are highly complex and complicated model and lack of experience both on the client side and vendor side is one of the major reason for slow adoption. For this model to work the clients should move on from basic cost cutting initiatives to more business process centric initiatives the outcomes of which will have a direct effect on the client revenue and profit growth. Both the client and vendor should have significant experience in outsourcing delivery models and matured internal organization structures, systems and processes that facilitate this model of pricing. Indian IT companies must recruit and develop highly skilled engineering talent with excellent domain expertise and also have Managers and domain experts specializing in range of industries and verticals who also must have deep understanding of clients’ existing systems, identify gaps and pitching improvements accordingly. India definitely lacks the skill sets in terms of domain experts and consultants in range of industry verticals like BFSI, Manufacturing, Retail, etc.

Another major issue has been the difficulty in measuring the outcomes, tracking and reporting such outcomes. Service Level Agreements and business outcomes that are to be achieved in terms of quantification and impact are often difficult to agree upon and which will increase the inherent risks involved in failing to measure and report such business outcomes. There is chance of increasing disputes, legal litigations and financial penalties may also increase which will be having a huge financial impact for both clients and vendors. So one important everyone should understand is that outcome based pricing model is not suitable for all outsourcing activities and if client is looking for a basic cost cutting initiatives it is better to stick with the traditional pricing models like fixed price and Time and Materials Models. Industry experts believe that high end  activities like Analytics, cloud Computing, Consulting, Mobility, Social Media, Strategic Sourcing related processes are best suited for outcome based pricing model. Both clients and vendors are adopting more hybrid pricing models that include both the traditional models and outcome based pricing but majority is still traditional pricing model with 70% of billing related to commodity processes and 30% outcome based pricing for strategic functions that involves analytics, etc.

In an interview with The Hindu, Executive Director and Chief Executive Officer T. K. Kurien of Wipro had said “All the companies in the industry are still learning. But maturity in this area depends partly on us and partly on customers. But if I had to take a bet, I would say that five years from now 60-70 per cent of the market would be outcomes-based. We are experimenting and I am sure we will make mistakes. But we are ready to takes risks.” This is the case with all the major Indian IT companies that are experimenting and learning to adopt the outcome based pricing model thus increasing both the revenues and profits.