The Indian growth story has attracted significant attention to a certain extent due to the IT sector growth sector. While earlier, this sector signified the IT services and to a small extent the hardware sector, it now also encompasses the IT enabled services as well. The IT sector growth story is too well-publicized to be recounted here. The growth of the sector has been inextricably coupled with that of the globalization and outsourcing stories. While, the modest beginnings for this sector might have been wage differentials and currency arbitrage, this sector has now matured and competition with other geographies too intense and has evolved into value based and transaction based pricing.
The outsourcing story can be understood as one that started from cost savings, grew into cost and services efficiencies, translated into value added services and is now possibly stabilizing at trusted partnership with the service vendor involved in a limited manner in strategic decision making.
For their part, Indian IT services organizations have also finally started to look beyond their self-constrained boundaries. Their strategy for growth is not limited to just expanding industry verticals that they could serve, it is also to expand service offerings and improve cross-selling opportunities especially with the BPO and KPO services. The recent acquisition by industry leaders like Cognizant of UBS’ Indian captive unit is a case in point. More organizations are looking at increasing their footprint across the entire business process of their customer rather than just focus on a single function (viz., IT).
The evolution of the role of the Indian IT organization also necessitates a change in the way they position themselves with their partner organization and a key ingredient of this is pricing. As an outsourced partner that supports non-critical IT applications, the traditional “Time & Material” contracts served the purpose of everybody. For the client, they could justify the onboarding of an outsourced partner in terms of reduction in rates vis-à-vis an employee or a local contractor. Further, T&M contracts carry low operational risks. Information resides with the client. The client controls all resources. Success or failure of the vendor depends on their recruitment and employee retention capabilities. Initially, the client insisted on all activities being conducted at client premises. As an understanding of the vendor organization and capabilities increased, more and more work started getting transitioned offshore albeit under the T&M contracts.
With time and evolution of trust, the client started to outsource and offshore more of the design work. This also led the client to demand efficiencies from the vendor partner including those to the IT value chain. While premium could be commanded in wage rates for designers, value of the vendor partner was not getting positioned with the customers. An added dimension to the outsourcing policy of the IT organization of clients was the failure of IT projects. In many a cases, the clients wanted the vendor to share the risk of the project. However, vendor organizations were reluctant to do so due to lack of control. This in turn crystallized the fixed price contracts where the vendor would share the risks of the IT projects and correspondingly the rewards. There were many variants to the fixed price contracts – T&M contracts with penalty and rewards based on balanced scorecards and fixed capacity contracts with rewards and penalty being a few examples.
While fixed price contracts positioned Indian IT vendors as reliable and skilled, there is now a need for a different pricing mechanism that could leverage the fact that the same vendor is present in different parts of the business process chain. The vendor could be doing application support – voice, production ticket handling, and installations etc., application maintenance – enhancements, production support, application development, and analytics – report generation and analysis. The vendor needs a flexible pricing mechanism that could leverage its presence across the business process chain. The pricing should also reflect the ability of the vendor to shares the risks and rewards of the IT organization.
One proposal that is gaining currency is transaction based pricing. This would be another form of bundling. The application development in itself could be a fixed price contract, but once the warranty period is over, the transaction based pricing could kick in. As per this pricing mechanism, the IT vendor would receive a fixed price per transaction that occurs through the application being maintained/supported. The analytics could be priced per report produced/analyzed. This is akin to royalties of musicians or authors with all its attended complications of defining, tracking and sharing of information on transactions. This pricing mechanism has an in built control where any development bugs or potential production issues are the responsibility of the IT vendor and provides a strong incentive to the vendor to ensure a quality product from the development stage itself.
This kind of a pricing mechanism would also require a sea change in the vendor organizations’ structure and processes. Currently the BPO, IT services and KPO organizations are separate entities. Further, internal systems need to be enhanced to track billing and project costs.
The transaction pricing mechanism is a radical departure from the current client-vendor relationship. It pre-supposes a strong degree of trust between the two organizations. This pricing mechanism also needs the client to be innovative and risk taking. This increases the operational risk of the organization. The client and vendor would have to evolve risk mitigation techniques beyond the traditional variants of disaster management and redundancy maintenance. Governance mechanisms including knowledge management where knowledge is still maintained and retained with the client need to be evolved.
Evolution of technology and business models would also bring with itself new challenges to the outsourcing client-vendor relationship. Pricing mechanisms are but one-way to control the relationship. Intelligent changes to the pricing mechanisms would help both the client and vendor organizations to bring in efficiencies within their organizations. It also has the potential to bring in innovations not just within their relationship but also change the IT services landscape.
