Short term gain versus long term loss, part 2
This post continues my views on the long term damage which might result from sourcing decisions which are based on emotions than rational decisions (‘Behavioural Sourcing’). In the previous post I looked at the subject from the client perspective while I use this one to provide my thoughts on the supplier perspective).
Supplier perspective
As mentioned in this post do I expect that some service providers will not make it through this economic winter as their shrinking revenue and margin are not matched by the amount and speed they can loose redundant employees and get fresh capital.
That service providers are signing contracts in order to get some new revenue in (the gain), which most likely cannot be made profitable during the contract term (the loss) is reflected by the Dutch IT entrepreneur (owner of SME service provider Centric) Gerard Sanderink. In an interview with the Financial Dagblad (Dutch financial newspaper, article here), he states that some large scale layoffs can be expected within the Dutch IT industry. According to him were service providers forced to give large discounts on deals signed in Q1 2009, resulting in contracts with a negative NPV. Especially large clients were able to get discounts up to 20% which makes it almost impossible to make a positive margin in at least the first couple of years of the term. This means that there is a serious over capacity within the IT market which will not be absorbed easily. Even the Indian suppliers feel the slump in demand as they also are cutting their rates. According to the Times of India, large outsourcing firms are trimming their invoices by 35 to 40 per cent. One can now hire an IT specialist in India for about $16 per hour, which is low even for Indian standards.
In this post from last week I already mentioned that I suspect some service providers to go bust somewhere in the next two years are their cash reserves deplete faster than their ability to cut operational cost.
Another source of vulnerability is a higher likelihood of suppliers trying to close a contract by deploying unethical behaviour. Because the enormous pressure on sales executives to sign new contracts, some might resort to bribing the client. It will depend on the culture of the country and companies involved whether this practise is used. But both senior managers within clients and suppliers have to be vigilant of the long term fallout which can result of fraudulent practises getting public (e.g. Wipro and the World Bank).
Another type of fraud is inflating the value of the company by creative bookkeeping with Satyam being a prime example of the effect it can have on the company as a whole. Companies which are cash strapped and want to get additional financing by either selling stock or a loan from a bank might be tempted to stretch or break some accounting rules. Like with recent probing of the English regulator FSA into hedge funds which use very small auditing firms, it might also be wise to be a bit worried of SME suppliers using similar practises.
A risk which may work out positive in the short term, but bite back in the long term are currency fluctuations. In 2008, the Indian rupee fell more than 23 percent against the U.S. dollar, which meant that the supplier could land an additional profit margin of 20% by doing nothing extra (if it would be stock-listed in India and thus reporting its financial figures in Rs.). The situation can however also turn around as the U.S. economy will be struggling to pay of its debt the next couple of decades. A heavily indebted country normally has a weak currency while the continuing growth of the Indian economy would increase the appreciation of the rupee. This is an effect both client and supplier have to be aware of and include related rules of engagement in the contract.
Two more generic pieces on the challenges the suppliers are facing here can be found here and here. I guess the message of this post for suppliers to keep their heads cool and resist making decisions they will regret in two years time.
Supplier perspective
As mentioned in this post do I expect that some service providers will not make it through this economic winter as their shrinking revenue and margin are not matched by the amount and speed they can loose redundant employees and get fresh capital.
That service providers are signing contracts in order to get some new revenue in (the gain), which most likely cannot be made profitable during the contract term (the loss) is reflected by the Dutch IT entrepreneur (owner of SME service provider Centric) Gerard Sanderink. In an interview with the Financial Dagblad (Dutch financial newspaper, article here), he states that some large scale layoffs can be expected within the Dutch IT industry. According to him were service providers forced to give large discounts on deals signed in Q1 2009, resulting in contracts with a negative NPV. Especially large clients were able to get discounts up to 20% which makes it almost impossible to make a positive margin in at least the first couple of years of the term. This means that there is a serious over capacity within the IT market which will not be absorbed easily. Even the Indian suppliers feel the slump in demand as they also are cutting their rates. According to the Times of India, large outsourcing firms are trimming their invoices by 35 to 40 per cent. One can now hire an IT specialist in India for about $16 per hour, which is low even for Indian standards.
In this post from last week I already mentioned that I suspect some service providers to go bust somewhere in the next two years are their cash reserves deplete faster than their ability to cut operational cost.
Another source of vulnerability is a higher likelihood of suppliers trying to close a contract by deploying unethical behaviour. Because the enormous pressure on sales executives to sign new contracts, some might resort to bribing the client. It will depend on the culture of the country and companies involved whether this practise is used. But both senior managers within clients and suppliers have to be vigilant of the long term fallout which can result of fraudulent practises getting public (e.g. Wipro and the World Bank).
Another type of fraud is inflating the value of the company by creative bookkeeping with Satyam being a prime example of the effect it can have on the company as a whole. Companies which are cash strapped and want to get additional financing by either selling stock or a loan from a bank might be tempted to stretch or break some accounting rules. Like with recent probing of the English regulator FSA into hedge funds which use very small auditing firms, it might also be wise to be a bit worried of SME suppliers using similar practises.
A risk which may work out positive in the short term, but bite back in the long term are currency fluctuations. In 2008, the Indian rupee fell more than 23 percent against the U.S. dollar, which meant that the supplier could land an additional profit margin of 20% by doing nothing extra (if it would be stock-listed in India and thus reporting its financial figures in Rs.). The situation can however also turn around as the U.S. economy will be struggling to pay of its debt the next couple of decades. A heavily indebted country normally has a weak currency while the continuing growth of the Indian economy would increase the appreciation of the rupee. This is an effect both client and supplier have to be aware of and include related rules of engagement in the contract.
Two more generic pieces on the challenges the suppliers are facing here can be found here and here. I guess the message of this post for suppliers to keep their heads cool and resist making decisions they will regret in two years time.
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