In the heady days of the early nineties, a term of five years for comprehensive outsourcing agreements was common and ten-year deals were not unheard of. Given the novelty of the arrangements, the length of these commitments seems curious in hindsight. As these contracts come up for renewal, it is useful to reflect on what worked and what didn’t.
As we negotiated these long-term contracts, we worried about the impact of unforeseen changes in technology and requirements. Experience proved that we were right. The single most often cited reason for customer, and sometimes service-provider, dissatisfaction is the perception that pricing for changes during the term was not fairly dealt with under the overall contractual regime. The problem is that customers find it difficult to stop comparing their contractual price commitments to the market as time progresses; they become self-satisfied with the fixed price when the market goes up but feel cheated when the market goes down.
Exclusivity provisions
Their misgivings with respect to the fees paid apply not just to the services within the defined contractual-service categories but also to new services. Exclusivity provisions in some of these long-term contracts made matters worse. Through these provisions the service provider either had an absolute right to supply even new and undefined technology requirements or had a right to a preferential position in any bidding process.
Some contracts adopted various forms of benchmarking to deal with periodic price reviews throughout the life of the contract. These efforts often failed, however, because the procedures to be followed were left to later agreement and, as one might expect, agreement was hard to reach in a process that necessarily leads to winners and losers. Other contractual provisions prescribing benchmarking were based on misplaced expectations of rapid emergence of industry-accepted benchmarking metrics as new service categories emerged. Even now, most benchmarking discussions start with an acknowledgement: it is easy to do only in the mainframe environment. Benchmarking continues to be a hot requirement for customers but it is being approached much more carefully by service providers.
Winning Strategies
So what are the win/win strategies for the future?
First, avoid exclusive arrangements and, more importantly, try not to give all of your business to a single supplier. Any up-front pricing benefits in return for long-term exclusivity are likely to be illusory, even with a very tight and precise contract. In a way, even a traditional comprehensive outsourcing contract has a multi-vendor aspect. No service provider is able to deliver all of the contractual deliverables through internal resources; they backfill through subcontracting with other suppliers. Generally, this approach moves the customer further away from controlling the service activities.
Contract for a term shorter than the hitherto customary five to ten years. A shorter term will let you deal with pricing issues as part of the renewal decision. Shorter terms will also minimize the impact of prices for new services arrived at without a competitive process. While suppliers will not be happy with a shorter contract, they will find it easier to make commitments knowing that they will be able to revisit them at the time of renewal.
Divide your needs for different categories of services among several suppliers. If you are worried about how the suppliers will interact, you can provide for this in specific provisions requiring co-operation. As an added benefit, by placing service providers side by side in parallel contracts you will have direct access to service level commitments from each of the service providers.
Don’t be deterred by supplier sensitivities for working with competitors. In fact, this is where the benefit lies if you couple a multi-vendor approach with shorter term. If suppliers can potentially replace other suppliers, you will have quiet competition for all of your business through-out the contract term. The result will be more responsive service quality and more disciplined price discussions for incremental services. Moreover, and perhaps most importantly, you will have the peace of mind knowing that more than one supplier has a broad understanding of your technology requirements if the need arises to replace a single supplier on short notice.
Gabe Takach is a partner at the Toronto law firm of Tory Tory, where he heads up the firm’s technology contracting practice. He can be reached at gtakach@torys.com.