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Why your outsourcers’ cost of living adjustments don’t work

Stephanie Overby | May 4, 2016
Cost of living increases are intended to keep IT outsourcing staff happy and working hard on your account. However, only a fraction of the money makes it into the pockets of those workers. Here are three ways to fix that.

For years, most large outsourcing contracts have included standard provisions for annual pricing adjustments based on consumer price indices and other economic indicators. These cost of living adjustments are intended to normalize services fees with economic conditions over the life of long-term deals. The impact on pricing can be significant—in the millions of dollars for a large deal. A $50 million annual services contract with a 2.75 percent cost of living adjustment could mean a $1.375 million increase in annual fees.  

In theory, cost of living adjustments help service providers reduce attrition by ensuring that employee salaries keep up with market trends. Staff retention benefits providers and allows clients to avoid the disruption of employee turnover.

That’s particularly important today as IT organizations look to outsourcing providers for high-demand emerging technology implementations such as data analytics or robotics. “The technology is changing so fast that workforce strategies and finding people with the right skill sets and experience in these areas is becoming an increasingly high priority,” says Michael Markos, managing director with outsourcing consultancy Alsbridge. “And in many cases, you have specific provider resources who acquire the operational intelligence needed to understand a customer’s unique environment.  That value is very difficult to replace.”

But while cost of living adjustments seem like a straightforward tactic to tackle the problem of talent retention for buyer and supplier, they often don’t work as intended. In many cases, only a fraction of the resulting price increase actually makes it into the pockets of provider employees. Instead, the provider account teams build the adjustments into their business plans and apply them to boost margins throughout the duration of the contract. “For example, what often happens is a key team member gets a raise and then leaves the firm for another position. That employee is then replaced by a lower cost resource, with the difference simply going to the provider’s bottom line,” says Markos.

Another issue is determining the true effect of the cost of living increase and factoring in offshore and onshore resources moving on and off an account. The economic indicators on which these provisions are built can be esoteric. Recently, consumer price indices have been volatile; offshore indices have revealed a higher rate of inflation than their onshore counterparts, decreasing the benefits of labor arbitrage over time.  “That has an impact on deal value,” Markos says.

These three steps will help CIOs ensure take these cost of living adjustments have their intended effect of reducing attrition rates among service provider staff:

1. Build specific metrics into the contract to accurately assess turnover.

If staff retention is the goal, IT leaders can create a contractual model and specific metrics aimed at ensuring that these increases are actually used to keep key members on the team. It’s easy to just tack on a 2.75 percent increase annually and be done with it, but it’s not always effective.


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