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.

 

For those already outsourcing, the story is a bit different. If cost of living adjustments are already a part of the sourcing contract, there’s no need to worry–if they were carefully constructed. For clients lucky enough to have retained good assistance in negotiating their agreements, they are fairly well protected in a deflationary environment. That’s why TPI advises clients to include adjustments based on a government price index, where index choice is critical.

But what about those that opted for no cost of living adjustments in their contracts? Are they protected in a deflationary environment? Unfortunately, no.

As deflationary pressure increases, some will find themselves locked into higher priced services as their contracts do not allow for adjustments over the term of the agreement. They’ll be paying a nominal instead of the real rate while struggling to keep up with top-line pressure. That’s why we can’t stress enough the importance of reaching an agreement, where risks are known and balanced, at the outset.

It’s all about the contract setup.