Consider the Source

Forget Inflation. It’s Deflation Time.

Guest blog by Chris KalnikPartner & Managing Director, Financial Analysis, TPI

In only a few months the global economy deteriorated with incredible speed and with it came deflation worries. Economic forecasts are clear and so too is the news: consumer and producer prices exhibited a jaw-drop last month in the U.S. with deflation risk rising. But will the outsourcing industry deflate as well? Probably not.

The goods, labor, commodity, and financial markets are all sending the same signals, and no matter what side you take on the issue, deflation is a risk. On a macro level, businesses will look left and right to shorten purchasing cycles, improve productivity levels, and substitute services to maintain profits.  Many will try to replace long-term contracts with short-term, deflation-sensitive agreements. That’s because the bottom line is highly sensitive to price adjustments.

And this will have a direct affect on the outsourcing industry. For one, it’ll attract new business as many are facing a decrease in producer prices that will squeeze profits. When they realize it’s cost-effective to buy services instead of laboring in-house, they’ll turn to service providers to weather the storm.

Don’t Forget Inflation

Today's blog comes from Dinesh Goel, Director, TPI.

Price adjustments can have a significant impact on the bottom line. So when outsourcing, forgetting about inflation is not an option, especially during contract negotiations. Unless, of course, you’re comfortable with the assumption of this risk.

 

Inflation affects service providers (especially those in high growth emerging markets), the contract structure, and therefore the firms that are outsourcing. That’s why contract negotiators must be aware of the role of inflation in service delivery and the adjustment principles that can be used to account for price fluctuations.

 

A service provider generally experiences inflation due to an upward cost-wage spiral, where wages respond to high business growth rates and costs of inflation sensitive items, creating positive feedback. To manage the inflationary impact on their cost structure, service providers try to replace more experienced employees with recent graduates, utilize cost structures in low-cost sourcing destinations, and distribute the average wage hike.