Experts are warning CIOs not to put too much of a budget squeeze on outsource service providers due to the slowing economy.

According to research from Compass Management Consulting, companies are demanding discounts of nearly 23 percent from outsource service providers during contract re-negotiations, especially when hammering out long-term deals. The UK based management consultants carried out a global survey of listed companies over 12 months and closely analysed 120 deals worth over £30 million each. Their research discovered a substantial increase in the price pressures being placed on outsource service providers during the first two months of this year. Compass said British companies were opening negotiations with demands of 15 to 23 percent.

Geraldine Fox, leader of the global sourcing service line at Compass said, “Although the broader economic signals are mixed and senior managers are 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.”

Compass believes that these discounts will end up in contract failure. “It depends on whether exiting price is competitive, and that can only be clear after due dilligence,” she said, adding that the due dilligence process is being “skipped” by some organisation rush into deals. Of most concern is that organisations are signing long term deals now with a hefty discount to meet short term budget concerns.

At the heart of the problem, according to Fox, is the relationship between CIOs and outsource providers. In too many cases outsource providers are not partners or even service providers, instead Fox describes them as being “out task providers”. “They are being micro-managed too much and the relationship and service does not develop.” This attitude towards tasking is affecting the way outsource budgets are treated. “In some cases, managers are beginning to to treat outsourced service providers in the same way as a discretionary spend that can be cut at will. In fact outsource providers are delivering core service to the business.”

This short-term budget fixation is going to cause longer term problems for the industry according to Fox, who fears a general decline in the quality of outsource providers. “If the outsource providers is delivering a good service already, these negotiations can have a negative impact. If the discount puts the deal into loss mode for the outsource service provider they will cut corners to deliver the service for the price agreed.”

Fox also warns against signing long term deals, and advises short term five year deals, so that as the client you are upmost in the outsource providers mind and therefore receive a good service.

Outsource service providers are under increasing pressure not only to offer discounts, but also from wage inflation of three percent of more, especially in India. Some services are returning to the UK, such as help desk support, but the UK and EU do not have the developers available to bring application development nearer to home.