Canada: Negotiating Outsourcing Contract Renewals

You have an important outsourcing agreement that is coming to an end. It's a significant contract for your organization. Under it, a supplier is taking care of all your hardware needs (mainframes, servers and desktops), otherwise known in the trade as information technology (IT) infrastructure, as well as operating your software on a hosted basis and doing software development for you. Even if it were performing just one of these three functions, it would still be a very important supplier relationship for you.

You're not alone. Estimates differ, but probably around 200 of these critical, large-scale outsourcing deals are coming up for renewal in Canada over the next few years. And while the mix of services covered by these deals may vary, the common denominator to all of them is that they are very important, and if the renegotiations are managed properly, the result can be better renewals.

Making Your Contract "Market"

The importance of the outsourcing contract renewal opportunity is driven largely by the fact that your present deal is likely not reflective of current market conditions. This shouldn't come as a surprise to you. Your current deal may be seven to 10 years old — some that we're working on go back 15 years, well into the 1990s, once you consider they have gone through one, two or even three previous renewals (and these prior renewals typically have not gone through the rigour I suggest below).

Well, the world has changed fairly dramatically in the last decade. Your requirements have changed. The technology has changed. The demands of the increasingly global marketplace have changed. But very likely, your outsourcing agreement has not changed — or not nearly enough.

The agreement's description of the services you actually use, or actually need, may be extremely out-of-date. The service levels you have may be measuring the wrong things, or not enough of the new things that really should be measured. Your service-level credit mechanism (if indeed you have one — some older agreements don't have this importance device) may be incentivizing the wrong behaviour — and not doing enough to promote the right behaviour on the part of the supplier.

You also have the queasy feeling that you're paying too much for what you're getting. Many hardware and software costs have dropped over the past 10 years. As for people costs, while human resource expenditures have increased in North America, the movement of a range of IT and business process functions to lower wage jurisdictions like India and the Philippines has had a dramatic impact on overall labour costs as well. And you're concerned you're not seeing the benefits of these cost savings.

As for the outsourcing contract's terms and conditions, again, much has happened in the marketplace since the late 1990s. To mention but one example, many agreements from that era that are still being used today don't even contain the word "privacy." Given the changes in privacy law over the past decade, the current sensitivity to privacy breaches, and the importance of security and confidentiality policies in today's Internet-based and networked world, you can be sure that privacy issues are front and centre in today's terms and conditions for outsourcing and offshoring deals (so your current agreement, if it dates from the 1990s, or even the early 2000s, may be woefully out-of-date).

Start Homework Early

In order to be able to meaningfully address the relevant service, price and contract terms issues in an outsourcing contract renewal, the key is to start your homework early. Sadly, if you're already in the final year of your current agreement you are probably too late.

To be effective, you have to start your homework about 24 months before the end of the current term. Your homework phase will take four to six months. Then you must allot about two to three months for Term Sheet negotiations with your current supplier. And if you can't come to a new deal with the incumbent supplier, you'll need 12 to 15 months to go to market for another supplier (or two or three of them), including transition time. Hence the importance of starting early.

If you are in the last year of your current agreement, however, consider negotiating a one- or two-year extension to your present deal, on essentially the same terms. This is merely to bridge you over so you can do the full, proper renewal process in that year or two. In some agreements, the customer has this right of extension built into the current agreement — it can be a very useful provision indeed.

Realigning Services

An important — and time consuming — part of your homework is to realign the outsourcing agreement's services description with your business. Inevitably, your business has changed in a number of fundamental ways over the past decade. Your markets and customers may have changed — sometimes dramatically. Your own products may be quite different — or if they are relatively unchanged, the way they are produced, marketed and sold likely has undergone a minor revolution.

So, the first step is to reach out to your business units, and their leaders, and have full and frank discussions about the services being outsourced, and how they can be modified — or sometimes redesigned altogether. This can be a good opportunity for a wholesale rethinking in some cases of which IT services you need — and which ones you no longer require.

Updating Service Levels

You will often find, in the course of such a review, that even where a specific sub-service is still required in more or less the same fashion as it was provided 10 years ago, what has changed is the required service level. A decade ago, a 98.5% uptime standard for a particular IT support function may have been adequate — or that level of service may have been all that was available in the market place.

Today, by contrast, the best practice standard for the same service may be "five nines," that is, 99.999% uptime. To use a low tech analogy, you still need more or less the same automobile, but 15 years ago the windows had hand cranks, while today power windows are standard. In essence, you don't want to go through another contract renewal without getting the equivalent of power windows.

Recalibrating Price

Not only do you want the equivalent of power windows, you can remember from the last time you upgraded your car that a lot of the new features — like front and side air bags — were included in the price, and that that price was fairly competitive (particularly in light of all the new features that were "standard"). Meanwhile, you have a sense that the prices under your legacy outsourcing agreement may no longer be competitive.

The surest way to test what is current market pricing is to go out to the market with a thorough RFP process, and to invite leading suppliers to submit competitive proposals. Then, when their bids are submitted, you would typically negotiate price (and other terms) with at least two of them to truly determine what their best price and terms would be.

If you decide against a fully competitive RFP, there are still ways of reviewing what market prices should look like for your suite of outsourced services. One method is benchmarking, where you tap into the database of relevant prices kept by a firm that collects precisely such data for just such a purpose. While benchmarking is not an exact exercise — some say it's far more art than science — it can give you a meaningful sense of generally where you are on a continuum of price points for similar services.

Updating Contract Terms

Another area that requires attention is your contract's terms and conditions. In essence, there are many provisions that would be included in an outsourcing agreement today that were only rarely — if at all — addressed 10 years ago. Therefore, it is strongly recommended that your agreement be brought up-to-date as part of your contract renewal with your vendor.

The kinds of clauses that we see being inserted in effectively negotiated renewals include those dealing with: benchmarking (essentially, the process mentioned above is enshrined in the agreement for subsequent use), privacy, security, confidentiality, service-level remedies, and new approaches to intellectual property indemnities and limits on liability (to name just a few).

Term-Sheet-Based Negotiations

Once you have done your homework on services, service levels, pricing and contract terms, you should reflect your wish list in a meaty Term Sheet. Then, assuming you decide not to undertake a competitive RFP process, you would present your current vendor with the Term Sheet accompanied by a succinct message: "If you and we cannot come to an agreement on the provisions contained in this Term Sheet, we will go out to market with a full RFP." And you might add that your current vendor will not be invited to respond to that RFP.

What then follows is typically a very meaningful negotiation period, capped off by a sensible win-win renewal/amendment of the current contract, but containing a range of changes that address your reasonable requirements. Renewing outsourcing agreements on any other basis amounts to wasting a golden opportunity.

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.

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