The leaves on the trees are falling over here.
For a lot of outsourcing contracts this means COLA clauses will be dusted off shortly. COLA as in: Cost Of Living Adjustment. COLA is a bit of a misnomer as we will mention below.
For example, Aon Hewitt's Global Salary Increase Survey was recently published, as always in September.
What are best practices for indexation?
1. Insist on having a COLA clause in your contract.
Duh… but clients may want to avoid it, seeking their vendors to absorb the risk. In the end, those clients may pay for it anyhow. Better to be transparent about it upfront to avoid difficult conversations later.
2. Start conversations on indexation early.
Quite a few organizations prepare their annual budgets toward the end of the year. If you are too late with sharing the COLA impact, you run the risk that the budgets are set. In that case the commercial discussion becomes difficult because your client counterpart has limited room to maneuver.
3. For service providers Salary Increase Indexes are more relevant.
More relevant than consumer price indexes such as EU’s harmonized index of consumer prices (HICP). Labor costs can account for as much as 70% of total business costs. Therefore, for maintaining profit margins it is much more relevant to compensate for salary increases than for other cost, such as equipment or office space.
4. Be clear in the contract what exact index will be applicable.
Indexes typically have tens of definitions. If the contract clause is ambiguous this will result in difficult commercial discussions and a race to the bottom.
5. Use a global standard.
Using a global standard such as Aon Hewitt's Global Salary Increase Survey gives objectivity and legitimacy to the indexation discussion.
6. Be creative in indexation discussions.
Applying the contract straightforward is just one option in a multitude of options. For example, if any of the previous points were missed then ultimately you enter into a negotiation situation with limited guard rails. In that case define a target outcome, minimum outcome and BATNA (best alternative to a negotiated agreement). A target outcome for a service provider could be to cover as much as possible of the salary increase that their workforce has received. For a client it might be interesting to understand if that reported average salary increase is relevant to the team that is working for them. And does a client have to accept profit margins staying the same while their overall cost has increased as well?
7. Other options
With the current overheated labor market there may be other ways for both parties to deal with increased labor cost. Look at your staffing mix in terms of seniority, promotions, location, sourcing.
8. Remain unconditionally constructive in finding a solution.
If you’ll search hard enough there will always be a Zone Of Possible Agreement (ZOPA).
Good luck with your upcoming indexation discussions!
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