The partial federal government shutdown has raised the once-unthinkable prospect of the US defaulting on its debt. If the stand-off between the Republicans and the Democrats is not resolved before October 17, the Treasury will run out of cash, debts will go unpaid, trust in the US financial system will plummet along with the value of the dollar, and the world will find itself facing another severe economic crisis.
Most analysts say there is too much at stake for either party to allow this to happen, but even if a default is avoided, the US may be considered a less stable place to do business. Would this encourage global outsourcing or would providers be hit hard by a falling dollar? Nearshore Americas gets the lowdown from Stan Lepeak, director of global research for KPMG’s management consulting service group.
Nearshore Americas: In your opinion what is the likelihood of the US defaulting on its debt?
Stan Lepeak: I’m not a politician but personally I think it’s not that likely, or if it does happen it would be a very short period of time. I think it would be way too disruptive to both the political and economic environment to allow it go on very long. I think there’s a lot of brinkmanship going on but it’s likely to be resolved. I think it’s a case of “who blinks first,” so to speak.
NSAM: If the nightmare scenario were to happen, what would be the immediate effects on the global outsourcing industry?
SL: I think the immediate effects would be pretty nominal, given the nature of outsourcing. It typically involves longer-term contracts and pretty defined pricing for example, but I think it could be disruptive for firms looking at a renewal, or if they’re pursuing a new deal and they’re right in the middle of negotiations. I think it would primarily be a delaying factor to the confirmation of the deal or the completion of the renewal, but I think at least in the short-term there really wouldn’t be much impact because of the long-standing nature of the contractual relationship.
NSAM: If the price of the dollar were to drop significantly would this crush outsourcers business models?
SL: Yes, assuming it were a long-term drop and not a short-term drop. Just given the volume of US currency out there in the world certainly a drop would be problematic, but I think the likelihood that it would be a long-term drop is questionable. Outsourcing is all about saving money and obviously a drop in the dollar is going to impact that but it’s also about access to talent, getting skills that you don’t have in your local market – which is certainly the case in a lot of parts of the US – diversifying the workforce and working out particular issues and problems.
A drop might strain the economics of it, but I don’t think it would mean that firms would say, “well, because of the drop I don’t have the resources to do this,” or even if the dollar drops by a large percentage it still could be cheaper to take work in other markets, so certainly it might make it less lucrative, less financially appealing in some respects. I think outsourcing would certainly continue on – perhaps less profitably for some of the providers – but I think there are too many other factors that are driving outsourcing. What a drop could do is further accelerate a trend we’re already seeing which is where buyers and their providers are looking at greater profits automation to take the labor element out of the equation. With rising wages globally, labor arbitrage isn’t as appealing as it was, so firms are already looking at how to automate these activities more to get people out of the loop. From a labor standpoint, economic change would continue to drive that automation.
But the US certainly isn’t alone as a dysfunctional government, there’s a lot going on in India right now, China’s always a little bit of a wildcard and you’ve had some ups and downs in Latin America
NSAM: In terms of existing contracts, if the dollar were to drop would it become more difficult for clients to keep their end of the bargain or would it be the outsourcers that struggle to fulfill their quotas for the price previously agreed?
SL: I think it would be more the latter. The outsourcers would be committed to deliver at a service-level based on a currency rate that you predicted. And if that changes significantly, the question then becomes, “how do you still deliver that profitably?” It would be a situation where, at least in the near term, the provider would have to bite the bullet and be less profitable. But then again, I think when you look at the profitability of an account it would go beyond this (brief, less profitable) period in most cases. It would have to become severely unprofitable for a provider to want to push for renegotiations. You’d have to be making the assumption that the drop was going to be more permanent rather than a shorter term blip.
NSAM: But if it were a long-term drop, is there any way that outsourcers or major clients could get out of their contracts?
SL: I don’t think it’s very common for contracts to have clauses based on exchange rates, they’re typically based more on performance, but I think they could certainly push for that. But then that raises the question of “what’s the alternative?” If you’ve outsourced a significant portion of your business then are you going to be able to rebuild that capability in the near term? If you did the outsourcing because of skill shortages or because you didn’t feel it was worth investing in a particular set of activities then I think it would have to be a pretty dramatic change to make firms backtrack on that. Things would have to be pretty dire before they say “we’re going to really significantly overhaul the model we’ve been pursuing for the past (in some cases) 15 or 20 years now.”
NSAM: Could it become more common to push for get-out clauses as a back-up in future contracts?
SL: I think it goes both ways. If the clients want to put in a clause to protect themselves then the providers will want to put in a clause to protect themselves going the opposite way. So you can get tangled in the process. I think it would be a subject for discussion but it could be very complicated to put it in the contracts.
NSAM: Even if the US does not default, will it now be considered a more unstable place to do business and will this push companies to outsource more of their work?
SL: I think from a strategy and planning standpoint it would be a reminder of some of the political disarray that’s going on in the US market and it would be something that would further encourage people to think about diversifying your workforce and maybe having a little less work in the US and a little more somewhere else, or just recognizing that it’s important to be diversified in general from a risk management standpoint.
But the US certainly isn’t alone as a dysfunctional government, there’s a lot going on in India right now, China’s always a little bit of a wildcard and you’ve had some ups and downs in Latin America. In some of the markets you have issues with the political environment and slowing of economic growth. I think there are a lot of political and economic challenges across the globe, the US and Europe included, so that’s a real reason to diversify, but also to have a very active process or program to do continual monitoring and risk assessment. I think it’s important for organizations to look beyond the cost of outsourcing and what they’re getting from a skills and performance standpoint and recognize there’s a lot of turmoil in the world and it’s probably not going to go away any time soon so you need to be able to factor that in.
NSAM: Is there a chance that the US’ credit rating will be downgraded again, as in 2011?
SL: From what I’ve been reading, yes I think that’s a possibility. The last time around it impacted a lot of things, prestige being one of them, but I don’t think that it directly impacted buyers’ appetites for outsourcing or service providers’ pricing or profitability. I think it would be disappointing if that happens, but I don’t think it would have a big impact on the outsourcing market because even if the US’ rating is downgraded, it still has a pretty good standing relative to its global peers.
NSAM: So, have outsourcers been affected so far in the current government stalemate?
SL: I polled several of my peers ahead of this interview and right now we’re not really seeing any impact in terms of how the buyers are approaching outsourcing either for new deals or ones in play. I think buyers are certainly observing what’s going on, but we haven’t seen any significant pull-back or clients ducking a deal for example. It’s similar to the whole debate around immigration reform – which now looks less likely because everybody’s focused on the default – but that could have a pretty serious impact in the short-term because of restrictions on staffing. But even there a lot of firms are typically taking a latency approach or a “too-early-to-tell” approach and I think there is an expectation that things will tend to work themselves out. You could say people are pragmatic, or even complacent, but from what we’ve seen so far they’re not acting hastily to do anything in the short term. If that’s good or bad, we’ll have to see later, but the expectation is that it will be somewhat “business as usual” a few months from now.