ITO Pricing Grows More Complex as Labor Arbitrage Becomes Less Relevant

Generally speaking, the desire to perform operations at a lower cost than you incur performing them in-house is a primary driver of information technology outsourcing (ITO). But how much costs are reduced, and even how cost reductions are tallied, can vary greatly depending on a number of variables.

Marc Tanowitz, principal at outsourcing advisory firm Pace Harmon, agreed to review some of the most crucial ITO pricing variable with Nearshore Americas.

One of the most basics is whether outsourcing is performed onshore or offshore.

“The underlying mechanisms of onshore and offshore outsourcing are the same, but there are nuances that create differences,” said Tanowitz. For example, while the basic cost of labor tends to be much cheaper offshore, there are a number of other factors that can make a comprehensive onshore-offshore price comparison more complex.

Shore Selection

“Hard costs including real estate, telecommunications, security, visas and travel tend to be much lower in the US,” said Tanowitz. “But depending on the amount of labor involved, it may be cheaper to go far away. And some people consider labor arbitrage a dead metric.”

According to Tanowitz, one factor that can skew labor cost savings calculations is the fact that studies have indicated it can take from 1.5 to 2.5 offshore IT developers to do the work of a single US developer. “It can take an awful lot of rework, knowledge sharing and cultural understanding to get an offshore workforce to be as productive as an onshore workforce,” commented Tanowitz.

In addition, there can be differences in how selecting a nearshore ITO provider based in Latin America or the Caribbean affects pricing compared to selecting a farshore ITO provider based in a locale such as India or China.

“The closer outsourced resources are in terms of time zone and geographic proximity, the easier collaboration is,” said Tanowitz.

Who’s Your Buyer?

Another factor to take into account when comparing the prices of different ITO provider is who in the organization is actually buying the outsourcing services. “In today’s marketplace, not all IT-based services are bought by the IT department,” said Tanowitz. “The IT department is comfortable outsourcing resources using the ‘factory’ model.”

However, Tanowitz said that other areas of the company are more concerned with the end result of ITO as opposed to the technical details. “For example, a financial executive buying outsourced AP processes managed with a technology tool is more concerned with how you process invoices and how matches are made, and less concerned with coding and IT tools.”

In addition, Tanowitz said functional buyers of ITO processes will likely be more comfortable with a “flat” outsourcing model than the model frequently used in India, where one high-ranking person serves as the face of a team of lower-ranking IT workers and developers.

Being ‘Reasonable’ with SLAs

Tanowitz also touched on the impact contractual triggers such as service level agreements (SLAs), key performance indicators (KPIs) and benchmarks can have on ITO pricing. “In contract negotiations, the first reaction of the provider if you want to put SLAs in is this puts them at increased risk, so they have to up their prices.”

However, Tanowitz said a counterargument Pace Harmon uses when advising clients in ITO negotiations is to ask the provider whether they have been planning to make mistakes from the outset. In addition, he advised that “reasonable” fees that put the provider at risk which is “not consequential” are usually the best option for contractual triggers such as SLAs.

The Price of Experience

One final aspect of an ITO deal that can affect pricing is the level of expertise the buyer requires outsourced resources to have. “If the client requires a senior resource, the pricing goes up,” he stated. “The majority of resources working for the typical ITO provider have experience in the one- to-five-year range.”

More experienced workers require a higher salary and are harder to find and recruit, which is factored into the ITO cost. In addition, Tanowitz said higher-level workers display the same type of high turnover rates seen among less experienced outsourcing workers.