What Does China’s Yuan Have to Do with Your Sourcing Contract?

You may not think that the recent devaluation of the Chinese yuan, or renmenbi (RMB), has an impact on your sourcing contract. Especially if you’ve done a deal in US dollars. But if any of your outsourced services are being delivered from China, the decrease in value of the RMB by 3.5 percent this week means you may now be paying too much.

Of course, the financial implications of news like this depend on the structure of the contract. If your agreement is based on local-to-local invoicing, you may be automatically taking advantage of the RMB devaluation. If not, you may be losing an opportunity.

Here’s what I mean. On July 30, 2015, $100,000 US bought you ¥608,471 RMB. Today, that same $100,000 buys you ¥639,230. In the span of a fortnight, the US dollar buys 5.06 percent more RMB. Assuming all or a portion of your outsourcing services coming from China are fixed on a monthly basis, you are paying ¥30,000 more per month.

However, if the contract is local-to-local service delivery, your entity in China is paying ¥608,471 a month to your China-based service provider. Therefore, regardless of the devaluation, your invoice in August will be the same as your invoice in July. When you reconcile and consolidate your actual spend back to the currency of your U.S. headquarters, it goes down from $100,000 in July to $95,188 in August.

Of course, when a company pays invoices in lots of different currencies, it is constantly exposed to fluctuations in the foreign exchange rate—fluctuations that can be felt in both the short and long term. Other adjustments in contracts also impact the price. Most contracts of five years or more include a provision for a cost of living adjustment (COLA) or an economic cost adjustment (ECA), which become effective after the first full contract year of steady-state operations. Because these provisions are usually tied to an internationally recognized consumer price index associated with the offshore country where the delivery center is located, they are important to consider when selecting a service provider with centers in Tier 1 and Tier 2 cities in China and India.

Other contract provisions also relate to the foreign exchange market (forex) and ECA. Many companies bake in year-on-year productivity improvements into their contracts, which means they pay less for the same services over time as providers get better at delivering them. The combination of these three factors (forex, ECA and productivity improvements) creates some tricky math. Forex changes can raise or lower costs; ECA usually increases the cost within limitations; and productivity improvements lower the cost. Other cost variables depend on whether your contract is cost-plus, fixed-fee, blended FTE-based or time and materials.

To say the least, there are a lot of moving parts, and when you add currency to the mix, the impact of how these variables interrelate can radically change the economics of your deal, whether services are delivered in China or somewhere else. If you are in a contract that doesn’t take these changing factors into consideration, a quick return to the negotiating table may be a wise move.

ISG helps enterprises negotiate and renegotiate contracts that best fit their needs. Contact me to discuss further. 

About the author

Mr. Chang is a Director, within the Energy, Life Sciences, and Healthcare (ELH) vertical. Richard brings nearly 30 years of experience within the advisory services and strategic sourcing industry. He has broad and extensive expertise across the entire Information Technology and Business Process outsourcing life-cycle, from assessment and strategy to contract negotiations and operational governance. He is responsible for client relationship development and advisory services delivery for ISG’s Healthcare clients.