India, the biggest location for global outsourcing, has seen its currency take a tumble. The devaluation has fattened the profits of Indian outsourcing providers, but customers in the U.S. are unhappy that they’re not getting any benefit from the currency’s move.
The rupee has fallen hard against the dollar amid concerns about the Indian economy, getting as high as 68 per dollar in late August. By mid-September, it was trading at 63 per dollar, up from 54.77 at the start of 2013 and 45.12 at the start of 2011.
Since U.S. companies generally pay in dollars for work they send to India, “these Indian firms are gaining margin, because our U.S. dollars are buying that many more rupees,” said Richard Chang, a principal at Alsbridge, a sourcing advisory and benchmarking company. “That’s a fairly big windfall for them.”
Outsourcing contracts typically have five-year terms. Companies in the U.S. that negotiated deals a few years ago, when the rupee was stronger, are paying much more for that work than the current rate. If outsourcing customers with existing deals went back to the marketplace now, “they could get 20% to 30% cheaper pricing than when they signed their deal,” Chang said.
Given the benefits the outsourcing companies have realized from the rupee’s depreciation, some companies are starting to ask their providers for a break, said Peter Bendor-Samuel, CEO of Everest Group, a global services advisory and research firm.
“Right now, a lot of them are going back and saying, ‘We negotiated our contracts at 45 rupees a dollar and it’s now 68. Wait a minute, we want a discount,’” he said. “There are quite a few conversations going on now.”
“Although we haven’t seen a lot of pricing concessions made yet, I think it’s going to happen soon,” Bendor-Samuel said. “I don’t think the Indian firms are going to be able to resist the demands to cough up some of the benefits.”
Outsourcing contracts generally have a provision for a cost-of-living adjustment (COLA). Bendor-Samuel noted that at the same time outsourcing providers in India are enjoying the benefits of the weaker rupee, some of their overseas customers have been getting notices about cost-of-living increases. “People who are getting COLA increases while the rupee is collapsing are saying, ‘This isn’t right,’” he said.
David Rutchik, a partner at consulting company Pace Harmon, said that in recent deals he’s worked on where companies wanted to pay in dollars and not include foreign exchange provisions in the contract, “we’re often successful in arguing there shouldn’t be any COLA.”
The termination for convenience clauses frequently seen in outsourcing contracts give customers some leverage in renegotiating, said Rutchik, pictured at left. “And from a relationship standpoint, [outsourcing firms] are usually pretty amenable to it. Most of the deals we do, there’s no minimum spend, so even if there’s not a termination clause per se, you can say I’m going to move” some of the work elsewhere,” he said.
Chang agreed that outsourcing customers have room to negotiate. “Obviously if you’re a provider, you want to keep your customers. Part of keeping your customers is realizing that if foreign exchange is set up to be borne by the provider, you’ve had the better part of the deal. You ought to come to the table and re-price the deal according to current rates,” he said.
Going forward, there are a number of ways a U.S. company could take foreign exchange considerations into account when they’re arranging outsourcing deals.
U.S. companies could switch to paying in rupees, but Rutchik said many aren’t comfortable doing that. “They’d rather just keep it in dollars,” he said. “It goes into the budget, they know what they’re spending, it’s not going to move.”
Paying in rupees also means the buyer is taking on the foreign exchange risk. Given the extent of the rupee’s move to date, that may not be a wise move. “The devaluation has been so substantial that going forward, it may go in the other direction,” Rutchik said. “Just jumping in and saying I’ll pay in local currency now would be pretty problematic.”
Companies that pay in rupees, which generally happens when they negotiate in India, rather than from the U.S., get a better price, according to Bendor-Samuel. “If you’re doing the procurement out of India, you’ll get a substantial discount over what you’ll get if you buy it out of the U.S.,” he said.
If a company is negotiating an outsourcing contract denominated in dollars, there are a number of ways to include foreign exchange considerations.
Alsbridge’s Chang said contracts can be indexed to exchange rates, or COLA increases can be tied not only to a wage index, but to moves in the foreign exchange rate as well.
For example, if the COLA increase was capped at 4%, a move in the rupee outside of a certain band could push that COLA cap down to 2%, or to zero, Chang said. “That way, the U.S. dollars that go the provider, when they translate into Indian rupees, there’s a leveling effect, rather than such a large windfall to the provider,” he said.
Given the slide in the rupee, some market participants are considering contract terms shorter than the five years now standard, said Everest Group's Bendor-Samuel, “because there are only so many hedging and contractual mechanisms you can put in place. At some point, if you have big swings in forex, you’re out of alignment.”
“Typically the vendor community has always wanted long contracts. We’re starting to see them say, ‘I’m going to give you this concession, but I want a two-year contract or a one-year contract.’ They’re afraid that if they give concessions, and the rupee reverses, they’ll lose money,” said Bendor-Samuel, pictured at right.
While outsourcing agreements can involve sizable sums, finance and treasury departments typically aren’t involved in negotiating the contracts, Rutchik said. He argued that that ought to change. “It’s just viewed as a functional procurement of services and there’s very little understanding and sensitivity to all these foreign exchange aspects that can create windfalls in either direction. It’s a lot of money and the fact that it’s not getting appropriate attention is unfortunate.”
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