• Technology
  • CFO.com | US

Rethinking Risk in Offshore Outsourcing Deals

Why CFOs should consider the risk of currency fluctuations when sending work offshore.

During the past year, finance chiefs have been wearing bifocals, peering into the crevices of their companies’ various department budgets for cost savings.

Offshore service providers have seen the shift first-hand since the lengths and volumes of new outsourcing contracts began shrinking — or stopping altogether — last fall. While their client companies still want to take advantage of cheaper labor costs offshore, they have pulled back on starting new projects and have been making more demands of their suppliers. In turn, to get business, service providers have been more willing to negotiate.

One topic the service providers are bringing to the table: currency-fluctuation risk. That’s an issue that was largely ignored when the outsourcing industry for technology jobs took off about a decade ago. But as companies have started to scrutinize contract terms and as the dollar strengthened earlier this year, it brought the topic to the forefront. For many buyers and sellers of offshore services, it is now a top-of-mind issue, say professionals who advise both sides on outsourcing contracts.

Currency risk “has become much more of a focus in the outsourcing industry than it has been in the past because of the fluctuation and volatility of the dollar,” Mark Mayo, partner and president of TPI Global Resources Management, told CFO.com.

The shaky global economy brought substantial volatility to the currency markets last year. That was particularly true for offshoring deals — many of which are done in India. The Indian rupee weakened against the U.S. dollar, losing 23.3% of its value in 2008, according to outsourcing advisory firm Pace Harmon. And the rupee has continued to be weak this year: while one dollar would have bought a little over 45 rupees at the end of 2003, today it would buy almost 50 rupees.

Most U.S. companies in the middle of offshore contracts haven’t seen their bills change, since many of them pay for the services in U.S. dollars. But vendors have been earning more off those same dollars since the weaker rupee decreased their cost of services. “While there’s less risk in paying in dollars — in the sense that you know what you pay in dollars today will be the same that you’ll pay tomorrow — you are leaving a lot of money on the table,” David Rutchik, a Pace Harmon partner, told CFO.com.

As a result, currency-fluctuation risk has become a “big discussion point” during offshore deal negotiations, according to Barbara Murphy Melby, a partner in Morgan Lewis’s global outsourcing, technology, and commercial transactions practice. But while the risk of swings in foreign exchange rates has become more of a hot topic, how the parties deal with it varies, depending on the size and experience of the company outsourcing and the whims of their vendor.

Melby told CFO.com that smaller companies tend not to have the in-house staff necessary to properly hedge the risk themselves, and they expect vendors to shoulder the risk instead. However, that demand comes with a consequence. “I don’t think pushing 100% risk onto a vendor is cost-free,” she says. “There is some type of premium or cost attached to that, because the vendor will be taking on the risk. Having said that, some vendors will take on the risk to win the deal.”

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