Managers under financial pressure seem as ready as ever to succumb to the attractions of short term discounts on offer from outsourcers, despite all the evidence that such “distress sourcing” is likely to store up huge operational and financial problems in the future.

Yet, according to our latest global study of outsourcing contracts, UK quoted companies are using the fear of downturn to press outsourcers for discounts of up to 23 percent, as they re-negotiate the extension of long term deals.

A 12 month analysis of 120 deals worth over £30m each by Compass Management Consulting has shown a marked increase in the price pressure on outsourcing vendors in the first two months of the year. Compass reports UK quoted companies opening negotiations with demands for 15-23 percent cuts across the board, regardless of whether the service provider is delivering a fair market price.

So, although the broader economic signals are mixed and senior managers largely optimistic, we are seeing aggressive, high-level targets plucked from the air in contract negotiations which bear little relation to what the business needs.

Moreover, many clients are renewing deals in order to get short term discounts from vendors without due diligence, and with no understanding of the competitiveness of their current contract. This lack of visibility on true costs and value means that asking for a 20 percent cut across the board could be too much – and drive a contract to failure. It depends on the whether the existing price is competitive and that can only be clear after due diligence which is being skipped as clients rush into making long term business commitments for a short term boost to cashflow.

In some cases, managers are beginning to treat outsourced service providers in the same way as discretionary spend that can be cut at will, whereas they are in fact delivering core services to the business over the long term. Moreover, companies will loose capacity in the medium term that will leave them without the resources to meet the increased demand of a growing economy.

Increased use of outsourcing by UK companies in recent years means that clients are putting short term pressure on providers to achieve operational cost savings. However, in many cases, companies are making unilateral decisions with no data on whether the price they are paying is competitive, and they lack clarity on the areas where they and the provider could collaborate to achieve sustainable cost reduction.

Extending contracts in order to get discounts with no detailed understanding of where the fat lies in a deal is bad practice – and is likely to lead to unsustainable pricing. That in turn will generate a de-motivated suppler, a poor working relationship and poor service quality. There are simply no bargains to be had over a five-year outsourcing contract.

Studies of contracts by Compass show that while outsourced service providers can offer discounts of up to 18 percent below the in-house operation they replace on day one of a deal, they will claw back this differential over the term of the contract. Compass has observed pricing in the final years of a deal running at 36 percent above comparable top quartile internal operations by year three of a five year contract.

Instead of pressing for blanket discounts, Compass sees the best performing companies are entering into dialogue with their suppliers to identify how they work together to achieve top performance and a fair market price. This often includes collaborations such as rationalising applications, standardising business processes and consolidating sites.

Personnel costs account for up to 80 percent of a call centre or business process outsourcing contract. The outsourcers’ freedom to cut costs in this area is limited a many of these staff have been transferred from the client company to the outsourcer under the terms of the 2006 Transfer of Undertakings (Protection of Employment) legislation which protects the working conditions of outsourced workers.

Compass points out that with predicted wage inflation of three percent or more it is hard to see how outsourcers will achieve savings without a detailed understanding of how they and their client’s operations are performing in relation to the market price for comparable services.

Geraldine Fox is global serviced lead for outsourcing at Compass Management Consulting