Credit Markets Affect Sourcing

Nov. 25, 2008
Manufacturing outsourcing contracts offer fewer discounts, says consultant

Manufacturing outsourcing contracts offer fewer discounts, says consultant.

The continued shrinkage in the credit market is having a dramatic effect on the pricing of long term outsourcing deals, says a new study of contracts by Compass Management Consulting. Analyzing 125 outsourcing deals over the last two years shows discounts in the initial years are no longer available as outsourcers are now unwilling, or unable, to fund losses in the early years of their contracts.

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Outsourcing providers have typically made long term deals attractive by offering pricing structures that deliver significant discounts on the cost of the in-house operation it replaces in the first year of contract. This initial discount is recovered in the later years of a contract, when charges can be 30% or more above a comparable internal market rate.

Fewer outsourcing providers are entering into contracts that have negative cashflow in year one in order to fund a short term discount for their clients. Just as the credit boom transformed the outsourcing sector's ability to fund discounts based on an annuity stream from contracts, the shrinkage of credit will have a transformational effect on the sector. The economics of outsourcing and the way deals are managed is going to change radically in the months to come.

Compass predicts, with the attraction of short term discounts removed from outsourcing deals, providers and purchasers will need to adopt a more precise and co-operative approach to the way contracts are put together, priced and managed. Specifically, companies are seeking reassurance that the price they are paying remains competitive throughout the contract lifecycle and clarity on the areas where they and the provider could collaborate to achieve sustainable cost reduction.