Trends In Rising Prices Affecting Companies Using Third-Party Services

Prices are rising for goods throughout the US economy because of inflation. Prices are also rising in third-party services, but the increase is more complicated than just an effect of inflation. Let’s look at those complicating factors and the trends in how the price increase affects companies using third-party services.

Trend 1: Wages rising because of acute talent shortage

As we come out of the COVID-19 pandemic, we enter into an economy that is growing robustly (as we at The Everest Group predicted). As a result, companies are almost uniformly looking to take advantage of this economy by expanding their business and moving further into digital transformation. One lesson companies learned during the COVID-19 shutdown was that companies that were further along in their digital transformation prior to the shutdown were better positioned to compete, more resilient, and had a lower cost base during the shutdown.

However, as I blogged previously, we are in an acute talent shortage that forces companies to pay higher wages for in-house talent and talent from third-party service providers. There is far more demand than supply, especially for engineering skills, digital and cloud skills, and business process skills. The demand/supply imbalance naturally results in rising wages, but the acute talent shortage translates into even higher wages.

Consequently, companies now need to revisit their assumptions around wages. People can easily get substantially more compensation in a talent-starved market than they could even just six months ago.

Trend 2: Wages in services contracts

For the services contracts that a company put in place prior to or during the COVID-19 pandemic, service providers will not be able to staff good talent at those contracted rates. It may seem satisfying to say the provider is obligated to maintain that contractual agreement. But it is likely the provider will not be able to staff all the roles for a customer company, or if the roles are staffed, it will be with inexperienced people who are not qualified, which will result in much lower performance.

This is happening at a time when the customer company is in a state where it needs things done quickly and needs talented, skilled workers with experience to do that work. Existing contracts will likely inhibit that. Consequently, companies may need to revisit their contracts for third-party services and may need to apply pricing analytics. The question today is not, “Can we get the talent at the contracted rate?” Rather, it is “What is a fair price, and what is the kind of relationship we need that assures us that we will get the talent we need?” The fact is companies are likely to pay substantially more for that talent.

Companies typically base their assumptions on past experiences. But they now need to recognize the market changed dramatically from six months ago. If the assumption set is built unintentionally on HR and procurement practices that are more than three months old or based upon data that came through at that time, the company likely will be in trouble regarding wages.

Trend 3: Offshore vs. onshore factors

One factor that makes pricing in services more complicated is that it is driven by wages in domestic countries (US, UK, and EU, for example) as well as in offshore locations (India, Philippines, Eastern Europe, etc.). Wage pressures are growing in both regions.

Over the past ten years, service providers made more money from their offshore talent than from their onshore talent. This also resulted in onshore rates being kept lower because a service provider would provide a mix of services, with 80 percent of the work done offshore and 20 percent onshore. Service providers discounted their onshore rates to get the more lucrative offshore work. But this cross-subsidization is unsustainable for several reasons.

One reason is that secular pressures drive more work to be done onshore or at least near shore. As we look at digital transformation and the productivity that can be achieved in the new agile pod models, some of that work is better suited to be done in the same country or the same time zone where the customer’s business is located.

Pod-like structures (such as DevOps) demand a close working relationship and close communication between IT and the business. The tyranny of distance and time zones reduces productivity. Hence, there is a secular pressure to move some work into compatible time zones. This, in turn, stresses the cross-subsidization relationship between onshore and offshore, making the subsidization less tenable.

There is now pressure for the pricing to be separated and for the onshore prices to be subsidized and offshore prices to be reduced or eliminated to allow companies to get the benefit of the new operating models and fully grow their offshore or near-shore capabilities.

The talent shortage both onshore and offshore causes a resetting of the pricing structure as well as a likely rise in both onshore and offshore rates, particularly for digital skillsets.

There is less inflationary pressure offshore than onshore – not because wages are not rising fast but because the relative strength of the currency between the US and Europe and in India or the Philippines. The currency value shifting adds another level of complexity.

Considering this situation in total, wages are rising both onshore and offshore, and there is now a trend for decoupling the onshore and offshore rate structure going forward. This is not good news for companies hoping to control their services costs.

The good news

Despite all the trends and situations I just described, there is good news. As the new operating models take share, specifically the agile pod system, the total cost of service goes down, despite rising unit costs (more for the labor). This is because the new operating models are more efficient, and they rely more on automation (for example, automated tests in the application development and maintenance area or in workloads moving to the cloud arena).

This will put further stress on companies to accelerate into the new operating models where unit prices can rise, but at the same time, the model continues to drive down the cost to serve.