Recession changes outsourcing model

For some years, credit has been growing faster than economic activity. In 1980, debt levels for US banks were running at 21 per cent of gross domestic product (GDP). By 2007, the figure had grown to 116 per cent of GDP. In Europe, by 2008, bank capital had shrunk to 10 per cent of assets as requirements for capital adequacy were loosened. For most of the 20th century, the figure had been 25 per cent.

Some of that credit found its way onto the balance sheets of outsourcing companies, who used it to finance contracts and offer discounts to CIOs in the early years of a deal.

In some cases, the outsourcing provider not only delivered IT services, they became a source of credit too. Compass Management Consulting analysis of contracts suggests that the discount in the first year of sourcing deals was 15-20 per cent below the market rate. This was offset by a premium of up to 30 per cent above market rate towards the end of the contract term.

With the shrinkage of credit over 2008/2009, these variable price deals are no longer sustainable. At Compass, we are calling this a new sourcing paradigm because its effects are so profound.

One example: today's economic conditions are the toughest for several generations. Corporations are looking to cut costs like never before and some think they "deserve" discounts because of the slowdown.

Five or 10 years ago, service providers could secure access to funds, provide the discount, ramp up prices in the final years of the deal (by which time the economy was growing again) and both parties were happy.