News Analysis

Hasty recession-era outsourcing deals will collapse this year

Outsourcing deals signed in haste during the economic downturn could be at risk of falling apart this year as businesses prepare for the upturn.

When the world economy was plunged into recession following the credit crunch, businesses quickly signed outsourcing deals to cut their costs.

But many of these deals will not now go the distance, and as economies recover, many could come to an abrupt end, says Professor Leslie Wilcocks of the London School of Economics. When the economy improves, these deals will no longer be right for the business, he says. "A lot of the quick and dirty outsourcing contracts signed during the downturn will break up towards the end of this year."

As a result, there will be an increase in disputes and contract renegotiations says Kit Burden, partner and head of technology and sourcing at legal firm DLA Piper. "Deals done in haste in 2009 will be repented at leisure in 2010, with a potential rise in the number of formal outsourcing-related disputes before year-end."

Lee Ayling, director at sourcing consultant Equaterra, says that many outsourcing deals will be up for review anyway. "There is usually a point in a contract where people look at it again, and this is about that time for many contracts signed in the past two years. Add to this the impact of the recession and a lot of contracts will not be seen as delivering what they were supposed to."

Robert Morgan, director at Hamilton Bailey, which advises outsourcing service providers, says a lot of the cost-cutting deals signed during the credit crunch were application maintenance agreements with offshore suppliers. "They are in trouble because companies did not take all the management overheads fully into account." This includes costs such as flying over to India.

Offshore cost-cutting deals are losing their appeal since changes to VAT introduced on January 1. Financial services firms now pay VAT at the place a service is used rather than at the source of the service. In other words, a service originating in India has increased in cost by 17.5%.

But Morgan warns that it may not be easy for businesses to renegotiate or cancel offshore agreements. "The Indian suppliers are usually very reasonable and even though they have clauses they tend to let their clients off easier. But the tier-one US and European suppliers are tough and will not let them off easily."

Equaterra's Ayling says the nature of the Indian suppliers' businesses makes it easier to change contracts. "Because many of the contracts are offshore software development it is easier for them to put staff on other projects."

Mark Lewis, partner and head of outsourcing at law firm Berwin Leighton Paisner, thinks it might take until the end of this year for businesses to identify whether deals are still appropriate. "There were quick and dirty deals done in late 2007 and many of these had the cost savings hardwired at the front so they get the benefits instantly. It is too soon to say whether they have delivered."

He adds that although the deals were done in haste they did have the right level of corporate backing. "Where deals have been done quickly there has been a lot of CEO and CFO involvement and I believe it is only at the end of 2010 that you can see if these deals have gone badly wrong."

The combination of the recession and outsourcing agreements reaching their review points will increase contract renegotiations. Suppliers will be involved in talks with numerous clients in the same boat and will be under pressure, so CIOs could face tough talking.


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