Negotiating a Fair Rate

Let’s assume that you have selected a few companies for your shortlist and are getting close to the final stage of negotiations. At that point you already have the “asking” rate, which should be within reasons. Negotiating space in offshore deals is rarely above 30% and if asking rate is 100% above your expectation the vendor should not probably be on your list.

Now, how to make sure that you get the best rate and at the same time not push your vendor beyond the line where your negotiating “success” will backfire? The key is to drive for “win-win” arrangement with every prospect vendor and pick the best one. Here are a few tips on doing that:

  • First, most important, you need to set the focus of your negotiations. Your goal is not to minimize the rate but minimize the Total Cost of Outsourcing (TOC) over the terms of the engagement. TCO is an abstract concept unless looked at in retrospect, yet it could be reasonably assessed with some basic assumptions. After the assumptions are locked you can easily negotiate towards minimizing TOC.
  • Next step is arranging your arsenal of negotiation options. You do not want it “all come down to rate”, that’s just one aspect of TOC plus it’s likely to stall the negotiations. List all aspects of the contract you could to negotiate and form your position on each of them. Offshore contracts typically offer large number of areas to negotiate, e.g. financial and payment terms, work hours, overtime rates, length of engagement, access to resources, multiple operation benchmarks and guarantees, etc. Each of these items could have a massive impact on the TCO.
  • Research what is reasonable in terms of rates for your vendors. There are plenty of tools to do that. For example follow up with references the vendor should have given you (it’s amazing how much info you get if you just ask), check regional job boards to determine salary ranges, etc. Take you research data with grain of salt though, e.g. be aware of the timing of your data. For example I was involved in contract negotiation with the same vendor in 99, ’02 and just recently; the terms of the contract were somewhat similar, the rates for mid level java developer were respectfully $42, $21 and $27 an hour.
  • Negotiation is a complex skill if not art. If negotiations are not particular your cup of tea you may consider involving professionals, in particular those who have experience negotiating offshore contracts. At least go through some serious reading on the topic prior to diving into the deal making. Here are a few great books to consider: Secrets of Power Negotiating by Roger Dawson, You Can Negotiate Anything by Herb Cohen, and Getting Past No by William Ury.
  • One aspect of the rate is often gets overlooked – the rate changes overtime. The easiest approach here could be locking rate for the term of the engagement, yet it might be not feasible due to many reasons. You want to make sure that you do not get hit with huge changes and at the same time you do not want to find your vendor loosing money on your project due to for example natural changes in the cost of living. Linking rate changes to some objective index might be a path to consider, see an example below.

X.  Cost of Living Adjustment. With respect to the rates stated in each Work Order with a term longer than one year, commencing on the first anniversary of the effective date and on each anniversary thereafter during the term of each such Work Order (each, an “Anniversary”), if the Employment Cost Index, Total Compensation, Not Seasonally Adjusted, Private Industry for Professional Specialty and Technical Occupations published by the Bureau of Labor Statistics of the United States Department of Labor (the “ECI”), as published on the most recent date the ECI was published prior to the Anniversary of the current year (the “Current ECI”). is higher than the ECI published on the most recent date the ECI was published prior to (i) the effective date of the Task Order with respect to the first Anniversary; or (ii) the Anniversary of the previous year with respect to all subsequent Anniversaries (the “Prior ECI”), then, effective as of such Anniversary, the then-current rates for such charges shall be increased by an amount calculated by multiplying then-current rates by a fraction, the numerator of which is the Current ECI and the denominator of which is the Prior ECI, minus 1. For example, on the first Anniversary of a Task Order, if the Current ECI is higher than the Prior ECI, the increase to the then-current rates under this Section 5 would be calculated as follows:

Increase to then-current rates = the then-current rate on the first Anniversary X ((Current ECI / Prior ECI) – 1).

If the ECI ceases to be published, then Consultant and Client will agree on and substitute another comparable measure published by the same or another reputable source.

Offshore Developer Rates

What is a fair rate for a mid-level Java developer working offshore? Seems like a simple question, yet the answer you are likely to receive from anyone familiar with the subject is “It depends…” A fair rate you need to negotiate towards to with your supplier depends on many attributes and circumstances. Here are the most important:

  • Location. Almost like in the real estate business location plays utmost important role in the cost of the product (rates in this case). Location granularity is roughly at a city level, meaning that in a single city you will have roughly the same rates for specific position. Large cities such as Bangalore, Beijing, and Moscow may have some pockets / districts with higher / lower rates, those differences are not as dramatic. Raising level of granularity to a country level skews the results significantly unless you limit your horizon to only “first tier” cities.
  • Other geopolitical factors. In countries experiencing explosive growth or political turmoil standards of leaving fluctuate greatly and that inevitably leads to dramatic changes in rates. Rates of vendors from Eastern Europe and China have been growing at the highest rate recently. It’s no surprise considering major improvements in standards of leaving of these countries and weakening dollar as well.
  • Competency. That’s an interesting phenomena I have observed over the years. It appears that engineering community competency has very notable local preferences. For example there is a great deal of skills in mobile development in Russia, Vietnam developers seem to prefer to speak .NET, you find many developers working with OS cores in Israel.
  • Company size. Unlike in the food industry where large chains offer lower prices s/w outsourcing has opposite trend – typically you will be able to negotiate better rates with smaller shops.
  • Vendor business model. In high-level view there are several business models which offshore organizations operate on:
  • “Body shop” – under this model the vendor is focused on billable hours / resource utilization and is typically in the business of selling mediocre resources in bulk. This not the business model you will find presented in RFP or website of the vendor, however you will see it between the lines of the proposal, in general practices, etc. This model scales well and you can see body shops ranging from Krishna’s Shack to multi-nationals of colossal proportions.
  • “Consulting Organization” – same as above but with vigorous attention to the quality of resources. These organizations are typically smaller and have much higher quality of the resources.
  • “Boutique shop” – I use this term for small sized high-end consulting firms which offer top quality resources often in a very narrow field / niche.

Rates naturally would be the lowest for first model and the highest for third. The questions of course is appropriate analysis as most of body shops present themselves as consulting organizations and some smaller one pretend to run “boutique” operations.

  • Engagement model. There are plenty of models you can elect to work with offshore, for example resource augmentation on T&M basis, fixed bid engagements, Built-Operate-Transfer, Managed ODC, etc. Each model will offer slight adjustment to the actual rates.
  • Contract details. Rate can vary greatly depending on the details of your contract, with each element being a double edged sward though. For example you can reduce the rate by committing to large number of the resources or longer term of the engagement, by agreeing with termination fees, etc.

Here are a couple links for more detailed view on this subject:

Offshore outsourcing statistics for services in 2007
Global Services Location Index (GSLI) for 2007
Choosing the Right Country for IT Offshoring

And finally, the rate table, take it with a huge grain of salt though

Group of Countries Outsourcing sweet spot Rate Guideline, USD an hour
Canada, Israel, Ireland some Eastern European countries such as Hungary, Romania R&D activities, Java/.NET, mainframe, product development 35 +
Most of Eastern European countries such as Russia, Ukraine, Czech Republic, Poland, some South American countries such as Brazil, Argentina Mobile development, some R&D, C/C++, Java/.NET, product development 25 – 45
India ERP, maintenance, mainstream development, Java / .NET, QA 20 – 35
China, Philippines Java / .NET, QA 15 – 25
Pakistan, Malaysia, Vietnam, Chile, Bolivia and many new outsourcing players TBD 10 – 20

It’s Not Over, Till It’s Over

I was fairly certain that an offshore development company with majority of their staff in St. Petersburg, Russia was the best choice for a large scale initiative for my company. The decision came after complex vendor selection process which included on-site visits, marathon interviews, long and pricy MSA negotiations, etc.

I hang up the phone after final discussion with the CEO and smiled. I liked the team in Russia, some of the guys I met there were at par with my best developers in-house, I was happy with the location as it was offering a cure for my nostalgia, and I was proud to be able to deal with the biggest obstacle I faced on the day one of the negotiations – substantially higher rates of developers in Russia comparing to those in India.

“Why work with India if you can find more expensive developers somewhere else?” is not exactly the question you want to be discussing with BoD or your executives. My convoluted negotiation scheme has paid off. I was quite happy with what I was able to squeeze out of the vendor. There were only a few formalities to take care off and I would move forward with the project.

I have t ell you – having had set my eyes on the Russian vendor I had to stick my neck out a great deal. There were plenty of concerns with outsourcing in my organization to begin with, moving it to Russia was a challenge of a much high caliber. “If the creator had a purpose in equipping us with a neck, he surely meant us to stick it out.” [Arthur Koestler] Those are the words to live by. I was selling idea of using the Russian team as there was no tomorrow. My efforts were paying off on that side as well – I had full support of my executive team and was ready to move forward with the contract and a very hefty budget.

Next day I was on my way to LA, long weekend offered a perfect break from the grueling selection process and contract negotiations. I was in a wonderful mood and almost all the way through the 10 hour trip when I got a call from my vendor’s CEO. For some reason he decided to speak in English: “Nick, my board of directors has reviewed all the details of the contract and after much discussions had made the decision to withdraw our proposal and exit the negotiations.” I said something borderline polite, hang up the phone, and issued a very loud, long and very politically incorrect tirade…

Funny enough things worked out to the best, the vendor that was awarded the contract instead of the Russian team in many respects offered a better match, stronger skills and less time difference… Plus, I added a few more notes to my bag of tricks, tips and traps:

  • Never come to the finish line of selection process with a single vendor in mind. Make sure that your short list has at least two, better three capable companies.
  • Do not rely on your intuition (bias, preferences, etc.) when selecting the vendor; let the facts, spreadsheets and team consensus drive the decision.
  • Do not oversell your team, company, and execs on the benefits of outsourcing and especially on any specific vendor. Remember no matter how low you set the expectations your offshore vendor will easily fail them.
  • Do not get lost in complex gambits and convoluted negotiation schemas.
  • And the most important, do not try to pay the vendor less than they can generally get in the open market.

The last bullet deserves special attention as a fair rate is a moving target and depends on many aspects and circumstances. I guess that will be my next post.

ODC Hidden Fees

The conference call I had with my ex-partner in Noida, India was quite unusual and it’s worth mentioning. Two PMs, AM and I were going in circles for 30 mins in attempt to solve a $10,000 conundrum. About a year ago we purchased 3 servers for our team in India, at roughly $3K a piece. The relationship came to an abrupt end due to major reshuffle of the road map on our side a few months ago.  Naturally we wanted to get our servers back in a form of iron or cash.  That turned out to be unreasonably costly.

As it turned the servers were in some special industrial zone and to get them out of the zone we would have to pay a de-bonding fee to India customs.  The fee at this point would be about 75% of the price of the new server, supposedly if I would wait for about 5-6 years the fee would be reduced to almost zero.   But today to get the servers to San Francisco between shipping and customs I would have to pay the price of new server for one year old box I already “own”.  I could not even donate the boxes to any of my friends in Noida – they would have to pay de-bonding fee to take the servers off the vendor’s premises.  Talk about hidden fees and small print!

That would be my latest lesson learned on ODC hidden fees.  There are a plenty of others you need to be on look out for when negotiating a contract with an offshore vendor.   Here are just a few I came across over the years:

  • Telecommunication, a variety of expenses associated with connectivity and other telecom needs
  • Setup costs, including workstations and other expenses
  • Administration fees, a bizarre combination of fees including janitorial, rent, etc.
  • Recruiting fees in a wide variety of contracting clauses
  • SW Licenses, sometimes for just “non-standard” components often for all
  • Termination fees, a variety of clauses preventing from or penalizing you for canceling agreement
  • Variety of financial fees, such as late payment fees with percentage higher that you would see from credit card vendors

What is important here is of course not the fairness of the fees.   You need to inspect every inch of the contract, every caveat and clause to avoid surprises and control your total cost of outsourcing.  Hopefully that will save you from serious blunders and oversights like mine.

And just FYI, thanks to Chris Balmain, here is a link for de-bonding procedures http://india.ewasteguide.info/files/Debonding_Summary-Report_2007.pdf

Offshore Risks: Team and Personal Impacts

Transferring even a small portion of your development offshore has inevitable impacts on your team and yourself. The impact could be dramatic to a degree that it defeats the purpose of outsourcing. Each of the dimensions of the impact should be considered a risk that needs mitigation plan and is dealt with efficiently through out the lifecycle of outsourcing. I’ll touch upon most significant areas:

  • Loss of team support / respect / relationships with the team. Even the most open minded employees on your team will be concerned with offshore introduction. And they should, the practice of outsourcers replacing the sheer fabric of the company, it’s all too familiar. As an instigator of the process you are likely to become a target of negativity. It comes in all shapes and forms with essence being “you are a traitor of ”. I remember well one of my key architects giving me an ultimatum “it’s me or them”. I do not know of any bullet proof shield here, the chances are some percentage of loss will happen no matter what you do. For me the best risk mitigation strategy in this case has always been transparency and honesty – when you can afford it. I do my best to personally deliver the message to every member of the team or alternatively setup a process which ensures consistent and accurate delivery of the message.
  • Loss of team spirit / internal unease. Mutual trust even in small teams has some level below 100%. Even a perfectly delivered message will be taken with a grain of salt and generate negativity. So only medicine here is reinforcement of the message – positive reassurance is like food – you can not get enough for life time in one seating.
  • Decrease in team’s productivity / commitment. Loss of key personnel / technology and business knowledge loss. Loss of team spirit / internal unease even if managed well is likely to result in tangible losses. You need to plan for them in advance of introducing the idea into your organization. Do you have sufficient redundancy in your organization to deal with inevitable loss of key personnel? Are your schedules have sufficient padding to cover for loss of productivity? Are your knowledge transfer / retention devices in place? If answer to any of these and similar questions is ‘No” you need to deal with closing the gap first and searching for vendor after that.

On a personal front the risks are substantial as well. What would championing an offshore initiative would do to your career? What’s your organization’s risk tolerance? What is its failure tolerance? How would the failures of the vendor affect your position in the organization? And so on – there are countless questions to ask here.

But even more important set of questions is around lifestyle impact. Are you prepared to shift work hours? Are you ready to deal with the never ending stress? What is your own failure tolerance?

I remember welcoming Paul Lake (an outstanding account manager for a prominent IT outsourcing company)  to a role of AM on an offshore engagement.  While no stranger to IT outsourcing he had never dealt with offshore side of the house.  “That’s the end of the life as you know it…” – I told Paul – “You will now need to learn how to start every call with “I am sorry, I have to apologize…” I wish I was at least somewhat wrong…

Offshore Vendor Selection: Site Visits

The idea of this post partially came from Offshore Visits. Tom’s post is about visits to an existing vendor, the visits during vendor selection process are quite different though.

I am fairly convinced that the unwritten rule – “must visit perspective vendor site to make a selection” was originated by offshore sales force. This is a well known closing technique similar to test driving the car (“must drive before you buy”) a.k.a. “puppy close”. The goal of the salesperson is to build your commitment to purchase and getting you involved, getting you to invest the time paves the road to closure.
From vendor’s standpoint on-site visits help tremendously in many other dimensions, for example having you on their territory (care salesperson would take you to his office “just to discuss some details”), playing one of the strongest powers of persuasion – reciprocity, etc.
Does it mean that to avoid high pressure of sale you should avoid on-site visits? Not at all. You just need to keep your eyes on the ball and counter the pressure. Shear understanding of the role the site visits play in the selection process will help a great deal. Also here a few simple techniques that should help you counter the pressure:

  • Visit several vendors on the same trip.
  • Separation of duties may help a great deal – if it’s at all possible use people not involved in the final decision making to go on the trip.
  • Be the driver of the agenda for all meetings on the trip.
  • Concentrate on your needs and things you should accomplish on the trip.
  • Take a few days off after the trip to do some personal travel and enjoy the scenery which you may never have a chance to see again.

The main goal is to make progress in your vendor selection in a way beneficial to you and not helping vendor to close the deal. In that light I find site visits extremely helpful and educational. My typical agenda would include:

  • Interview with perspective team (I usually go for marathon interviews – 20-30 people per company, 20-30 min per person)
  • Informal interview of managers, executives, etc. – I do not interview them per se, instead get a chance to see them in action
  • Review infrastructure, take a pick in server rooms, see desktop environment
  • Check out employee lifestyle – workstations, libraries, transportation, food, break rooms, wallpapers, etc.
  • Assess physical and other aspects of security

I do my best to avoid:

  • Meetings with large participation and no purpose
  • Sales presentations in any shape or form
  • Any optional activities that do not pass sniff test

Offshore Vendor Selection: Criteria

There is no one-fit-all list of vendor selection criteria, as the list depends on the organization, its needs, scope of outsourcing initiative, etc. I would like to suggest some items that you may want to consider for including in your list.  To offer some structure to the list I put items in five major groups:

  • Macro Factors. This group includes criteria important for selection of outsourcing region and type of outsourcing organizations to pursue in your search.
  • Critical Factors. The group of selection criteria covers items that are critical for the success of the outsourcing initiative.
  • Relevant Factors. While these search criteria are important I always take them with a grain of salt as assessment of these factors is complex / subjective.
  • Things to Consider. Tie breakers, items of relatively low importance which could still affect your decision with consideration of special circumstances, etc.
  • And Personal Factors. That is a very important group of criteria if you are the person who has to carry on the engagement. If you only charged with selection these items should reflect needs of future stakeholders, assuming they could be reasonably assessed.

My recommendation is that you take a critical look at the list below and pick only items of the high importance; selecting vendors based on an excessive list of criteria would be a daunting task.

Macro Factors

  • Geography – Region / Country / City. Impact of locale on outsourcing initiative is multifold; in large degree the geography determines time differences, language, culture, history, average rates, typical turn over ratio, etc. There are however some notable fluctuations based on specific city and company. For example some companies in Eastern Europe change their work hours to minimize time difference.
  • Political Stability. Political stability will affect multiple aspects of an outsourcing relationship, an impact range from minor fluctuations in productivity to mandate to cease the operations.
  • Legal System Maturity. Generally you are not planning on going to curt with the vendor yet you should never dismiss a possibility of that happening. What’s good about your NDA or MSA if its clauses are not enforceable?
  • Company Size and Organizational Structure. The attention you receive from the vendor is directly proportional to percentage of revenue your business represents; see offshore outsourcing Rule # 1.
  • Business Model Match. Search for vendors that support and have track record of executing under the outsourcing model that is right for your organization. See Vendor Selection Rule # 3.
  • Financial Stability. Multiple aspects of financial stability are important factors in the selection process, with most important being profitability and cash reserves.
  • Time in Business. The time in business should be defined as the time in doing business in specific model / under specific circumstances matching your needs. See Vendor Selection Rule # 3.
  • Business Focus. Many outsourcing vendors chase any and every business opportunity inevitably creating organizations with unstable structure, staff and culture.

Critical Factors

  • Capability Maturity. Certification level. See Vendor Selection Rule # 2. Make sure that certification is applicable to the specific ODC / location you are considering.
  • Methodology Match. Is methodology you are planning to use is in DNA of the vendor? Does vendor has a track record / history of using specific methodology in the target ODC? See Vendor Selection Rule # 3. Keep in mind that methodology is bigger than just SDLC, it should cover project / program management and other essential process.
  • Delivery Track Record. I would give that criterion a very high weight and would do my best to assess the track record of success on engagements similar to your initiative. Keep in mind specific aspects of your engagement such as change rate ratio, urgency of deadlines, etc.
  • Staff Competency & Domain Expertise.  It’s clear that staff competency is critical to the success of the initiative. To rate that criterion you would need to decipher what the competency of staff assigned to your project would be. That would require understanding vendor current state of competency, sourcing and competency building methodologies.
  • Training. Tightly related to previous item this one is all about assessing what vendor does to sustain and increase competency of its employees.
  • Knowledge Transfer and Retention. With turn around being unavoidable knowledge transfer and retention are critical to “average competency” of the organization. To rate that criterion you will need to understand what tools, processes, and methodologies are used by the vendor to assure continuity of knowledge.
  • HR Practices, Staff Sourcing & Development. Vendor activities in order to find (“source”) and retain its employees are critical to countering turnover and increasing “average” resource competency and quality.
  • Data Security & Privacy.  This criterion is particular important if your organization is dealing with sensitive data such as financial or HIPAA covered data. You need to look into multiple aspects of security (policy, physical, network, data, etc.). Assessing state Data Security & Privacy could be very time and resource consuming. Asking for results of a third party audit is probably the easiest short cut.

Relevant Factors

  • IP Protection. IP Protection is a critical factor yet assessing it is extremely challenging, see some of my thoughts in Protecting Data and IP when Outsourcing Offshore.
  • Organizational Mission.  Alignment of organizational missions may have a good positive impact on success of your project. The chances of finding the alignment are not high though.
  • Client Management. Client management or account management is especially important when access to the top is limited.
  • Quality Management. Some organizations, in particular those high on CMMI scale, offer somewhat independent quality management which could be a value ad to the engagement in a long run.

Things to Consider

  • Organizational Statistics. Organizational statistics, such as %% of sales vs. development, %% of people with advance degree, etc. could offer interesting insights on the organization and suggest trends.
  • Outsourcing Tools. Engagement tools such as communication dashboards, time tracking tools and others could offer substantial value in tracking the progress.
  • Specific Expertise. Narrow niche domain expertise or specific technical competence offered by vendor could be important if not critical factor. I find counting on that fairly risky.
  • Network Infrastructure. Many outsourcing companies today offer network infrastructure at par or even better than you may have in house. Its sufficiency needs to be verified though.
  • Telecom Infrastructure.  Similar to the item above, strongly related to geopolitical criteria.

Personal Factors

There is a great variety of personal factors that should be considered. They range from personal preferences to geography to your own risk tolerance, from your career aspirations to knowledge of foreign languages. And depending on your relative weight within organization they might be even more important than critical factors.