Originally published in CIO Canada, July 2007.
Perhaps the most significant new and evolving development in outsourcing is competitive procurement. More and more customers are approaching the process of choosing an outsourcing service provider through a competitive bidding process with the use of more effective RFPs and a more disciplined process governing responses.
There are many factors which motivate this approach. Perhaps most importantly, there is a general awareness that better deals can be obtained when suppliers know that there is real competition for your business.
The traditional approach ten to fifteen years ago involved the selection of a single vendor on the basis of high-level RFPs and responses defining high-level prices, subject always to numerous assumptions. This selection process was then followed by a one on one negotiation of a contract carried out in parallel with a due diligence effort by the supplier. The result was a refinement of the original prices, usually upwards, based on discoveries made through the due diligence process.
The bargaining power and leverage of the customer in this process diminished throughout the negotiations; and facing a deadline for starting the outsourcing process, the customer was often forced to accept unfavourable terms, usually involving risk allocation. After a certain point in the process, switching suppliers became an undesirable if not an impossible option. Suppliers on the other hand used their increasing bargaining power effectively to reduce risk and in some cases to maximize financial benefit. This is not an indictment of suppliers, but simply recognition of the realities of the process.
The opposite of the above is a fully competitive bidding process involving a fully negotiated transaction, with all business, financial and legal terms settled with two or more suppliers, followed by a selection of one of those suppliers. On the face of it, such a negotiation process is more costly for the customer. But it also gives the customer increased bargaining power. And the process will likely be shorter because by necessity it is more disciplined and organized.
As the bid costs are significant, in some cases measuring in the millions, suppliers will want a decision made as early in the process as possible. Customers, however, will want to keep this process going as long as possible to be able to exert competitive pressure on all of the bidders until all of the significant legal, financial and risk issues are settled.
The process is not risk free for customers. If your process takes longer than advertised and the bidders face mounting costs without the assurance of getting a contract, you may have suppliers deserting the process in the middle. This may leave you with a single supplier before settling all of your major issues, at which point you will have no leverage. In order to avoid this, it may be worth offering to pay a breakup fee to each bidder should it prove to be the loser. A cash outlay upfront may ultimately pay dividends in the form of better terms from competing bidders.
What should you be doing at the outset to determine whether your company is likely to reap the full benefits of a competitive process?
First, enumerate all of the factors that will make you a valuable prospect for bidders. These may include the size of the offering and the number of committed years. Then look to see if the value of the contract is likely to increase through organic growth or increase in scope.
Also consider whether or not your project represents a special opportunity for any of the suppliers. For example, does it enable a supplier to gain traction in a field dominated by another supplier? Or does it enable an established supplier to keep new entrants at bay?
You should also be aware of the negative impact of an incumbent on the bidding process. Renewal of an existing relationship eliminates the need for a transition and all of the attendant costs. Bidders may also be concerned that the bidding process will be used simply to drive down the price of the renewal. New bidders may conclude that they will not be able to compete against the lower costs associated with incumbency.
If you do choose to embark on a competitive process, it is important to make it as efficient as possible. You will need apples-to-apples comparisons on the financial and risk assessments. The only way to achieve this is to precisely document in your RFP what you want and on what terms you want to get it. This means a full description of the services in scope, and a fully drafted contract that has been customized for the specific offering. In the single-sourcing process, the RFP document usually included either a high-level term sheet only, or a form of contract which was not customized for the specific offering. As a consequence, in that process the legal requirements were not taken seriously by bidders because the RFP itself communicated that they were not important enough to demand a precise response.
The last formal step in a dual-stream process is the request from all bidders to submit a best and final proposal by a certain deadline. This request should also indicate that the bidders must commit to be willing to sign the agreement as submitted. The problem with this is that there will be many factors which will be taken into account in scoring the relative value of the bids submitted, and there may be an obvious overall advantage to proceeding with a particular bid even though that bid may not reflect one hundred percent compliance with all of your requirements, including some of the legal requirements. You can use one or more tools to address this.
After the favourite is identified, you should continue to negotiate the remaining issues with that supplier. You will have added leverage that comes from the knowledge by the favourite that it will, as a matter of certainty, receive the business if the remaining issues can be resolved to your satisfaction. In this last step you may expect the supplier to be singularly focused on assessing its appetite for compromise.
As a final note, throughout this process your organization will need to pay close attention to the law applicable to tenders. You should be able avoid any legal entanglements associated with the bidding process if you make it explicit that the customer will have absolute discretion to make a choice among the various bidders without following any of your published formal rules. This will get you maximum flexibility, but in doing so you will be emphasizing for bidders their exposure to the risk of unrecoverable upfront transaction costs.
Gabe Takach is a partner with the law firm Torys LLP. Based in Toronto, he is the head of Torys’ Technology Contracting.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.