Contract renegotiation is an ongoing process during which both parties should be open and honest with each other, writes Rod Newing.
An organisation and its business climate can change significantly during the term of any outsourcing contract. In the last two years in particular, many businesses have become unrecognisable. The terms of their outsourcing contracts may no longer be relevant and, with additional pressure to cut costs, organisations are scrutinising them closely.
“Renegotiation is rife at the moment,” says Bob Fawthrop, a sourcing consultant. “Three quarters of all existing contracts are currently being renegotiated or are under review, compared with only 30-35 percent historically.” Some contracts are renegotiated when their term expires, typically five years. However, many clients use existing clauses or governance relationships to vary the contract, often quite significantly, during its term.
Historically, planning a renegotiation started about 18 months before the end of the contract. Time is needed to consider the major options. Organisation must decide whether to negotiate a new contract with the current partner, invite other service providers to tender, or bring the service back in-house.
Professor Leslie Willcocks, director of the outsourcing unit at the London School of Economics and Political Science, says that two thirds of contracts are let to existing suppliers. This is because the switching costs can be huge. The incumbent knows a lot about the organisation, so does not experience the learning curve of a new provider, and the parties have built useful relationships.
It would be wrong to think that outsourcing contracts are set in stone. Well written and managed contracts are constantly reviewed as part of good governance procedures. “The contract is out of date the day it is signed,” says Willcocks. “The initial transition phase shows that things were not right or there wasn’t enough detail, so contracts are often heavily renegotiated 18 months in.
Clients constantly look at what they want delivered, what is actually being delivered, the terms under which it is being delivered and whether there are better ways of doing it. There is a continuous learning and improvement process between contracts.”
In tandem
Renegotiation should always be a collaborative process between trading partners, who are keen to find ways to advance each others’ businesses through a common goal. Clients should never be tempted to ask the service provider to do more for the same or less money.
Equally, the service provider should never use the contract to hold the client to damaging terms, however lucrative. Renegotiation should always be driven by the current and future needs of the client’s business.
“You have to maintain a sustainable relationship between the client and the service provider,” says Fawthrop, “otherwise it encourages bad behaviour and creates problems in the longer term. Writer Mark Kobayashi-Hillary, whose latest book is ‘Talking Outsourcing’, is a director of the National Outsourcing Association.
He says that it isn’t sensible for service providers to ‘bleed their customers dry’. “If the customer has a failing business they may not want to honour the contract at all,” he warns. “It is better in the long term for the provider to get around the table and work out how a new and more flexible contract can be struck. You can reduce the cost of the contract in the short term, yet build in flexibility to grow again when the client’s business recovers.”
Sooner, not later
Rob Thompson, director of marketing development at SunGard Availability Services, a service provider, actually encourage clients not to wait until the full term approaches before renegotiating.
Keeping to the existing contract risks losing the business. “The sooner you have sensible discussions about how the customer’s business is changing and how you are going to supply them the better you are placed as an outsourcer,” he says. “If we are servicing the customer properly, we are in continuous dialogue with them, so there should be no surprises.
The biggest problem at the moment is client’s uncertain strategy predictions about how their business is going to change, so they struggle to predict their own needs.”
Fawthrop advises continuous review of contracts, at least annually, irrespective of the current economic climate. After it has updated its overall business plan, the client should review the service actually provided against what the business wants, levels of innovation, appropriateness of service levels, etc. They should also review bringing some of those services back in house, as a ‘litmus test’.
“You should plan renegotiation every year from the first year onwards,” he says. “The service provider needs to refresh its delivery to support the client’s updated business plan. Towards the end of the contract term, it will be delivering a ‘fresh’ service, so it is easier for them to continue.”
Roy Barden, group director at The Hackett Group, a strategic advisory firm, says that a good outsourcing relationship is much more than the contract. It is about the day-to-day relationship between the players and a good outsourcer will be looking at ways to share gain with their client in a way that both win.
“Renegotiation on a rolling basis ensures that each side is kept honest, brings flexibility and often results in the current contract being extended for another year,” he says, “Renegotiation is about what you are doing now, not at the end of the contract term.”
Change your ways
One of the problems is that as business needs change the service level agreements built into the contract may no longer be valid or relevant. At worst, they can encourage a level of service that is higher than the business needs and is expensive to provide.
Service levels should always be adjusted to meet the current business needs. What isn’t on the table for negotiation at the moment is significant investment in technology and transformation. Clients don’t want the capital investment involved and terms are too short for service providers to help fund and recover that investment. “Historically, clients have been prepared to spend to reduce the operating cost of the contract,” says Fawthrop. “Now they don’t want to spend any money.”
Service providers should be experts in innovation, yet there seems little appetite from clients and the industry has a poor reputation for introducing new technology and practices.
However, Professor Willcocks expects that to change over the next year. “In recessions you discover that you can’t go on just doing things the way you used to,” he says. “You can work harder and you can spend less money, but there is a limit to working in that way, so innovation comes on the agenda.” For Fawthrop, low innovation has resulted from contracts that are ‘sweated’ out, with nothing new brought to the table. Renegotiation causes both parties to rethink what service is being delivered and how.
The biggest area of innovation is cloud computing, which provides information technology as a service over the internet, sharing infrastructure and applications between multiple clients. Paying only for usage, this model lowers costs and converts capital budgets into operating costs.
“Too often innovation is a technical issue, when the market requires service innovation,” says Thompson. “It may well involve stitching together some emerged technologies, but an endless procession of better mousetraps is not necessarily the best way to drive a business forward. Service innovation is being less concerned about the technical platform and more concerned about the overall service proposition to the client.”
Barden says that clients expected more innovation, change and ideas and haven’t seen them. Innovation is key in the current changed environment and clients want structured continuous improvement to be built into the contract, with improvement targets.
Innovation is a mutual thing and the service provider cannot generate it on its own. “You should look beyond the technical process to create a model that allows agility and change,” he says. “People need to move off their own technology onto a service provider’s platform, where it is much easier for it to innovate using standard technology on behalf of multiple clients, rather than each client’s own platform.”
Good terms
According to Andrew Brierley, head of business development for strategic outsourcing at IBM UK and Ireland, the secret to renegotiation is for the parties to be absolutely open, honest and clear with each other about the business outcomes they want to achieve. They must also accept that it is possible to achieve those outcomes. “There is then an opportunity jointly to show flexibility and collaborate to achieve what the business genuinely wants at a price that is acceptable to the provider,” he says. “Partnership behaviour results in a much smoother process and a much better outcome for both organisations.”
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