Undesirable market conditions in Latin America and diminishing IT budgets are leading many companies to renegotiate their contracts with service providers in an attempt to reduce costs and gain greater flexibility. The trend toward renegotiation was particularly pronounced last year and it is expected to continue throughout 2015 as competition among vendors intensifies. Buyers have the upper hand in such negotiations, but analysts warn they should still exercise caution given that there are certain drawbacks of having to switch service providers.
Globally, more than US$100 billion worth of outsourcing contracts will be renegotiated this year, according to ISG estimates. This trend is already having a significant impact in Latin America, Nearshore Americas learned from Guilherme Campos, Technology Industry Analyst for the Americas region at Frost & Sullivan.
“In Latin America, and especially Brazil, 2014 was a very weak year for many companies, including in IT,” Campos explained. “So the companies that are buying IT services started to try to renegotiate their contracts in order to reduce costs. They all opened RFPs (requests for proposals from other service providers) – even when they were satisfied with their providers – just to see if they could get other providers with the same quality but reduced prices, or to get the existing provider to reduce their prices.”
Renegotiation is most common in “older sectors where the heavy hitters are,” said IDC Research Director Xiao-Fei Zhang, citing banking, healthcare and government as some of the sectors where organizations are seeking to replace outdated service agreements with newer, leaner models. Campos added that “Renegotiations are more common in the large enterprise market, not so much in the small and medium-size enterprise market.”
Buyers Target Cost Reduction
“We’ve surveyed 313 end-users in Brazil and the primary driver by far is price reduction,” Campos said. “We’ve been hearing that the budget in IT is decreasing in most companies.”
Other analysts consulted by Nearshore Americas noted that other significant causes for this trend include a greater need for flexibility and efficiency. “Some of the newer contracts feature outcome-based or transaction-based pricing models whereas a lot of the old contracts are still based on full-time equivalent based pricing,” Zhang said. “The pricing model is important but the core matter is ‘can you really do more with less? Can you do smarter, new delivery models?’ If you are becoming more efficient and you can do more with less, then customers will want some of the savings.”
Jimit Arora, Vice President of IT Services Research at Everest Group, added that: “Renegotiation is driving what I call the anti-incumbency trend. So when the contract comes up for renewal you recognize that you definitely don’t want to be stuck with the same kinds of terms and conditions. You want more flexibility and better pricing and in a lot of these situations we have seen that not only are the clients renegotiating but they’re actually opening it up for an RFP. And if you open it up to an RFP then our research shows that in about four out of ten cases the incumbent tends to lose and the infrastructure contract does not get renewed.”
Falling Contract Lengths
With technology changing so rapidly and the Cloud disrupting established service models, buyers are also increasingly reluctant to commit to the long-term outsourcing deals that were once common. “Usually when buyers are starting with a new provider in Latin America it’s a two-year contract and if everything goes well during this period and the clients are satisfied then they have the option to renew the same contract for two or three more years,” Campos said.
“Several years ago a lot of services contracts lasted five or even ten years but nowadays it’s very difficult to find a ten-year service contract,” he added. “We’re still seeing some contracts for five years but that’s more related to the really big IT players IBM and HP. But overall, the smaller companies like Unisys and Stefanini – companies that are big but not as big as the giant IT players – they are working with two- or three-year contracts.”
Now, before such deals run their course, buyers are increasingly looking to negotiate more favorable terms. “Typically we’ve seen that people start the process approximately 18 months before they reach the end of the contract, maybe even longer – say 24 months – if it’s a longer deal,” Arora said. “We’ve seen a lot of these conversations start at the midpoint of the tenure… one of the things that they’re hoping to accomplish is to not feel that their legacy IT environment cannot change until their contract comes up for renewal, so they’re looking to find ways to partner with the service providers so that they can get to the acceleration sooner rather than later.”
This trend is accelerating, Zhang added, citing IDC research that “shows that on average businesses have started renegotiating a few months earlier in the last couple of years.”
Vendors Have Little Choice
When it comes to the negotiating table, service providers are in an undeniably weak position. “I don’t think service providers have an option,” Arora said. “They either renegotiate and potentially keep a portion of the business or they play hardball and get nothing at all. Service providers don’t have much choice but a lot of them have recognized that this is the new way to operate and we’ve seen them making smart choices.” Zhang agreed that service providers are essentially forced to accept less favorable terms: “they have to do it because the pressure comes from the market and the customers, but overall revenues will decline.”
Campos also concurred: “They are in a weak position. If they do not renegotiate then there are a lot of other providers waiting for the opportunity to win their client. This affects basically every service provider and it cannot be helped because the power is in the client’s hands.” However, he noted that there are certain measures vendors can take to mitigate their losses. “What service providers can do is say, ‘OK, if I need to reduce cost then I can reduce a certain amount but I cannot reduce more than that because my margin will not allow it.’”
Campos added: “Another thing that some providers are doing is try to differentiate their offerings from those of the competition by saying, ‘If you go to another provider then you might spend 5% less or 10% less and I cannot offer you this but I can offer you a better quality of service or an additional service.’ Sometimes service providers cannot reduce their prices anymore but they’re trying to find ways to improve their offers to offer greater value to the client without directly impacting their costs.”
Buyers Must Exercise Caution
Despite being in an enviable position, buyers must be careful not to overplay their hand, Arora warned. “We obviously tell our clients to be careful in terms of what they ask for. Clients don’t want to sign up for minimum volume or minimum dollar commitments. They want more flexibility to ramp up and ramp down. One of the challenges that it’s very important to consider is if you’re not signing up for minimum commitments the provider will have to hedge their risks and in a lot of situations that might mean that you end up potentially paying more than you would have in a traditional environment,” he explained.
“But we’ve definitely seen changes in the marketplace when it comes to termination for convenience and minimum volumes,” Arora added. “Earlier there were significant penalties if a client wanted to terminate the contract just for convenience, but now we are seeing some models out there where without paying a big penalty you can terminate the contract with just three or six months of notice.”
Campos also advised a degree of caution, noting that “The buyer can lose out because if they only consider price then they can end up with a new provider that is not used to the environment of the company and may need six months in order to understand how they work and how to provide them with good service.” The transition between two different vendors can also be complicated, he added: “Sometimes it doesn’t matter if the provider has all the skills necessary to provider good service. The transition time will still affect the company somehow because you are taking off one provider and including another so some problems can happen until they get used to it.”
No End in Sight
“This is happening all over Latin America and it’s especially strong right now in Brazil. The providers are expecting it to continue throughout all of 2015,” Campos said. “From what I’ve been hearing I think the competition will be even fiercer between the service providers in 2015. Now that the service providers understand that this is the reality and they need to compete this way, they are trying to prepare themselves better for negotiations, so we will see even greater competition between them in order to win these contracts.”
Moreover, there are few new clients entering the enterprise segment because most businesses already outsource at least some basic functions, Campos noted. This means vendors will have to concentrate more or retaining their existing clients and poaching their rivals’ customers than searching for virgin partners.