The discounts offered by IT outsourcing service providers in the early years of contracts are disappearing because suppliers can no longer afford it.

According to research of 125 outsourcing contracts carried out by Compass Management Consulting, the current shortage of credit in the economy is forcing suppliers to reduce discounts.

“Discounts in the initial years [of contract] are no longer available as outsourcing suppliers are now unwilling or unable to fund losses in the early years of their contracts,” said the report.

The company noticed this trend in the contracts signed towards the end of 2008.

Discounts in the early stages of contracts are used to encourage customers to sign long-term contracts. This initial discount is recovered in the later years.

Andy Gallagher, consultant at Compass, said outsourcing is no longer a source of working capital for businesses. “Fewer outsourcing providers are entering into contracts that have negative cash-flow in year one in order to fund a short-term discount for their clients.”

“Just as the credit boom transformed the outsourcing sector’s ability to fund discounts based on an annuity stream from contracts, the shrinkage of credit will have a transformational effect on the sector. The economics of outsourcing and the way deals are managed is going to change radically in the months to come,” he said.