Pricing Models and Choice of IT Service Providers

Among the various pricing models in vogue with the offshore based IT services providers, the key ones are time and material (T&M) and fixed price (FP) models. While there may not be complete data ( or at least I have not seen), on which ones rule the most --- my personal take is that T&M contracts should be accounting for almost 80% of the contracts if not more. The rest are mostly fixed price. There are some others like device based unit pricing, outcome related pricing which may be there in pockets but mostly T&M rules the chart.

This also shows the nature of engagement --- the customer owns the risk in such contracts -- and probably s/he don't mind it as the nature of work outsourced is chopped and packetized to ensure it follows the technologies, processes and skill requirements that already exist. However as corporations move to a managed services environment, if you can rely on your provider, then to help them realize the full potential of their innovativeness and cost-efficiency, one needs to look at pricing models like fixed price, utility based, transaction based or, outcome based. However, the difference across these models (apart from how you assess the charges and the risk ownership) is also the degree of control you, as the outsourcing enterprise, would wield. So, not only does it require a mature, stable and innovative partner with a track record, but it also needs the outsourcing enterprise to agree to let go control, to varying degrees to completely benefit from outsourcing.

It is not uncommon to see most CIOs embark on a roadmap starting with T&M model, with a stated objective to move to other more deeper models gradually, but somewhere down the road that does not happen -- often fuelled by the outsourcing enterprises' staff's need to retain control or due to the lack of leading-the-curve trait shown by the chosen provider. And then, between the choice of going for a new partner in the hope that it will be different or to continue with the current one but with a lower degree of involvement ( and no transition and a whole lot of other stuff to face) organizations often choose to continue with the chosen provider.

So, it is also important to choose a service provider carefully in the first place before you let them in. It is much more difficult than shifting to a new desktop manufacturer ( which in itself is not easy either!) when it comes to changing service providers for IT services.

Service Provider Consolidation

Many large enterprises over the years find themselves with mulitple IT outsourcing partners who were brought on board at different points in time for different pieces of work. Some times, it is a collated view of opportunistic out-tasking where the cheapest bidder gets small chunks of work till it emerges that the total cost of managing several contracts and service providers, outweighs the benefit of lower cost in siloed contracts.

Among large companies with substantial growth and those with multi-national business spread, it soon becomes apparent that having fewer partners incentivizes them to bring greater value not just with cost but with the quality of work. Clearly, if a customer contributed $5m of revenue, the focus woud be differnt from what it would be if the customer contributed $100m of revenue. It would get greater senior executive review and the outsourcing company would go further to ensure these revenue streams are protected and grow through a partnership.

This, in a free market situation, also acts as an entry barrier for smaller IT outsourcing players ( and actually in any industry with vendor consolidation). .That is why most large companies mature to outsource to few and large IT outsourcing providers only.

In fact, looking at the state of vendor split, size, number of outsourcing providers for an enterprise can actually also reflect on the relative maturity of these organizations in the outsourcing space. Each company has its own journey, driven by its strategy to outsource and its size.

Domestic IT Services Market in India

Offshore based IT Service Providers from India have interestingly a very modest to negligible play in the domestic IT services market in India. With the exception of those which have a hardware based business in India for couple of decades and who do primarily hardware sale and systems implementation, most of the bigwigs have very little revenue coming from India. For those who have, it is in single digits or roundabouts of their total global revenue. Reason?:


- Core value proposition, including but not limited to labor arbitrage does not apply to customers who can also get work for as much as they do
- Access to competent and skilled resources for customers
- Lack of technology maturity in the domestic technology market
- Rampant insourcing in the industry in general
- Long, low value sales cycle. In comparison the same efforts would yield more and higher value (revenue and profit) business in US and Europe

Having spent few years of my earlier life selling in the domestic market, the experience of selling is also different where the customers' buying behavior is much different and not so sales friendly.

Things are changing, moreso with some of the large government or government backed IT spending initiated in recent years. There are also some large and early companies who are looking at total outsourcing

Why Didn't Recession Boost Offshore Services Revenues?

The common speculation that outsourcing and specifically offshoring of IT services would rise dramatically in the recession remained just that -- speculation! In fact in the last two quarters, barring some exceptions, the offshored based IT services companies also saw their revenues from new deals fade just like other industries were hit with recession. This is surely merits a study to understand why this is happening. It looks obvious that an industry thriving on reducing operating cost would only benefit in a situation where bulk of their customers (in US and Europe) move to an environment of severe crunch.

What could be the reason? While an empericial study led by interviews on both sides (customers and service providers) can share some data backed insights, following are some guesstimates based on my interaction with people in the industry:

- Outsourcing and offfshoring activities generally require time to execute through a well defined procurement process if it has to be done at a large scale ( to derive larger value of benefit). Hence this was not considered as an exercise to reduce operating cost since the horizon of initiating, getting a new provider and finally breaking even would be over 24 months --- a time horizon much farther away than the urgency demanded.
- This increase in revenue would have come most from companies who had shied from offshoring in the past and would gain most by unlocking this latent chained value in their operations. However these same companies also shied from offshoring now, which would have resulted in further unemployment in their country. This was not a desirable PR move given the focus on increased unemployment due to recession.
- Many of the companies did outsource but not to offshore based service providers. They outsourced to local American or European IT services companies who offered labor arbitrage close to what the offshored based players offered by having India based centers to deliver work. So, while the offshore based players may have resulted in a marginal better value, enterprieses took a stance to outsource to in-country companies which helped without any negative PR of jobs going to companies from other other countries. Of course, at the back-end these US/Europe based companies leveraged labor in other countries.

Clouds In The Sky

After a long time in the industry has a technology come which people are so excited about – everyone trying to define it and everyone trying to explain what they think it is. It is surprising that still, most articles on Cloud Computing start with defining what the author considers constitutes cloud computing. 

Most however seem to agree that a cloud enabled infrastructure enables:

• Dynamic provisioning
  
• Scalability and flexibility
  
• Universal access
  
• Computing cost as opex with little or no capex expenses
  

What is not talked as much as the hype on the cloud but is bound to get relevant as people get into enabling it for their enterprise are aspects related to:

• Security on the cloud ( yes, there are people already talking of it) is something which needs to be considered at all levels from application layer to infrastructure layer
  
• Very high dependency on the WAN bandwidth for performance of the applications. Until now, for those enterprises with critical applications on computing infrastructure within their enterprise, they were mostly accessing it over a LAN for a large part of the population typically in the head office. Other users would access it over a corporate MPLS network. Now, everyone does the same and while it is possible to get dedicated access and get the same experience, the network charges are bound to go up
  
• The big challenge of application migration where applications will need to move from existing infrastructure in-premise to cloud infrastructure. This will throw up a whole lot of issues where currently running applications for years will need to be unseated and moved to a new environment or even may be get a parallel application environment stood up in the new cloud infra. However as more critical applications start moving on this path, unless these have been recently deployed, challenges will come forth on getting the exactly same environment in the cloud. It is not unheard of, to have critical applications in large enterprises running on hardware or software systems, some of which are end-of-lifed. They continue to run as the cost of finding an alternative or migrating to the new version or system is much higher than running it with higher maintenance for its useful life before retiring them. It may not be easy to re-create environments which require setting up an old out-of-support version of Oracle for a customer who some part of the ERP is connected to an application which runs on this environment. The older the systems and the more customized the applications, the greater would be the barrier to move them to the cloud.
  
• Lack of control for businesses over IT. Now this is something which seems pretty rampant but not discussed so often : it is not uncommon to find businesses running small (or even mid to large) IT departments outside the “corporate IT” for certain applications and systems that they closely work on. In some F500 companies, if aggregated across teams, this is even upto 50% of the size of the corporate systems. In other companies, while businesses use the common services of “corporate IT” they dictate the requirements : “Well, this is a mission-critical application related to blah blah ... and we need a dedicated environment for this application. We cannot have it share computing power with any other application and need a high-end server with ....” With cloud, to some extent, businesses will lose such control and may not be so amenable to have their applications moved to a cloud.
  

Overall the adoption to cloud will happen in a phased manner where enterprises will test the waters or rather test the clouds, with some early applications. That process is bound to take a while, but moving test and QA environments would be a better bet for lot of reasons. That is the subject for another post!

Extending STPI Tax Concessions

15 years back, the Indian government, granted tax concessions (between 5-8%) to enterprises operating under Software & Technology Parks of India (STPI) to give a boost to this (then sunrise) industry. It was considered wise to give this booster shot to help such companies earn more and enjoy a tax concession.

It is now time to decide on either extending or allowing this concession to cease as per the provisions in force. The industry ( which now extends below software companies and includes many ITeS -- IT enabled Services) is rallying to get this extended for another 3-5 years. It will surely help them with a direct impact on their bottomline. If that does not happen, it is likely to adversely impact their earnings by that margin.

While there are no clear clues, it is being widely hoped that the government will extend this concession but negotiate with the industry on the duration. These times of recession are surely not the best to have some more tax outflow but the government has to also look at how this impact tax collections -- which would be a big amount once these tax are brought in force.

For now, the industry groups are waiting for the new government formed to review and come up with a recommendation, but this is surely going to impact most companies operating from India. It is still not clear, if this will impact the pricing levels for future contracts, but surely, it does not help the service providers much and they will then need to take a call if they fork out this extra money from their coffers or try to increase their billing rates marginally -- or most likely as it will be : a little bit of both

Production and Non-Production Support : Experience Matters

One of the other challenges in maturing (and this one in the IT services space) has been that most of the IT services companies based out of offshore have traditionally been engaging with customers in supporting their non-production environment and have little experience managing production systems. In any bank or a large manufacturing set up the production environment is sacrosanct and critical for uptime and performance. However the rest of the non-production systems like Development environment, Test Environment, Staging Environment are not deemed as critical as business depend on them as much as they do on production systems.

One of the key reasons for offshore based IT services companies having little experience managing production systems is that most of the offshore based IT service providers grew on a staple business diet of application development and maintenance. This resulted in these companies developing expertise, best practices and propositions in this space. However almost all of these activities are centered around the non-production systems. When their application (or an enhancement) development, test, QC activities are complete, these were typically handed over to the onshore based service providers who would be running the customers’ production systems for deployment. Offshore based IT services companies have had little opportunity to get into the production environment due to this and probably made little effort as that space was being dominated by the strong, traditional outsourcing service providers. It was easier to get the bucks coming in doing the application development and maintenance work, as they had cracked that part of the puzzle but these companies did not venture out in the production environment space.

This has come haunting these companies when they eyed the IT infrastructure services space. In this area the customer requires companies to manage their IT infrastructure environment, most of which is in the production space. In this space, the offshore based IT services companies have had little past experience and understanding of the underlying complexities. Also, the maturity of the IT systems in the local domestic market and those in US and Europe are not the same ( the latter being more mature and evolved over a longer period of time).

This is where, often in opportunities which involve support of production systems, traditionally onshore based providers have an edge as they grew in that space. Offshore based service providers are now inching towards this space with some having made more stride than others --- but clearly this can be generalized for the class as a whole.