Credit crunch fundamentally changes economics of outsourcing

The credit crunch is undermining the economic model of outsourcing, with discounts offered in the early years of a contract disappearing in the face of the recession.

An analysis by Compass Management Consulting of more than 125 outsourcing deals found that discounts usually offered in the early years of an outsourcing deal are no longer available, and the financial crisis is having a dramatic effect on the pricing of long term outsourcing deals.

In recent years, outsourcing providers have made long-term deals attractive by offering "significant discounts" for the first year of the contract. This initial discount is recovered in the later years of a contract, when charges can be 30 percent or more above a comparable internal market rate, Compass said.

Outsourcers are "unwilling or unable to fund losses" by offering discounts to enterprises during the early years of contracts, the consultants group said.

"Outsourcing is no longer a source of working capital for corporates nor a vehicle for financial engineering. 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," said Andy Gallagher, consulting director at Compass.

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