Many outsourcing contracts entered into during the 1990s
are coming up for renewal, writes Bobby Gill. This,
coupled with continued pressure to cut costs, explains the current
resurgence in outsourcing. However, for many, past experience of
outsourcing failed to match expectations. As a result, companies
are looking at ways to renegotiate future contracts to give them
the desired results.
The statistics are damning. At least 50% of outsourcing deals fail.
In fact, 80% of all information technology sourcing deals have not
performed to the required level. Yet outsourcing can, and will,
work if the right mechanisms are in place. Those looking to
increase results second time round should look at how they can
translate past mistakes into legal and commercial bargaining
tools.
A significant proportion of users entering into their first
outsourcing contract made two fundamental errors:
- Insufficient pre-contract due diligence to ensure effective
benchmarking
- Lack of meaningful remedies to improve performance.
Due diligence
Users did not perform sufficient internal analysis to arrive at a
full description of the services to be outsourced, and at what
service levels. As a consequence, benchmarking, in terms of quality
and cost of services versus in-house provision, could not be
achieved.
In today's environment, the supplier may provide service level
reporting for users. However, it is unlikely that the contract
contains appropriate provisions that oblige the supplier to
disclose how the services are being provided, which employees are
used to provide these services, and what assets and contracts are
required to enable service provision. Without such key information,
it is difficult for potential new service providers to provide an
accurately-priced alternative bid. This means that the user is
unable to properly assess the risks and costs of changing supplier
or have adequate information to ask for improvement during
renegotiations.
However, contractual and commercial levers can be used to "force"
the supplier to disclose such vital information. For example, one
company in the financial services sector used ongoing 'change
request' procedures as a lever to agree additional and what may
appear as innocuous information provision clauses. This information
enabled the company to make cost savings of over £1m during
retendering and was instrumental in improving service levels.
Performance remedies
It is not uncommon to still find first-generation outsourcing
contracts where the only remedy against a non-performing supplier
is termination. However, the situation has improved over the last
five years and service credits are now the standard remedy.
Yet, from our experience with users, the receipt of service credits
for service level failures does not necessarily work to the user's
advantage, because service credits are set at such low levels (3%
to 5% of the monthly charges). This means that it can be cheaper
for the supplier to fail than to undertake the necessary corrective
action to ensure compliance with service levels. And service credit
clauses often favour the supplier, such as stating that service
credits are "a sole and exclusive remedy for service level
failure".
During negotiations for the renewal of existing outsourcing
contracts, we have advised users on a number of ways to
"incentivise" supplier performance.
An important first step during the tender process is to ensure that
potential suppliers are given adequate "notice" that the user will
be seeking adequate service remedies for service level failures. In
recent negotiations for a FTSE 100 company requiring data services
from one of the leading UK service providers, the supplier told us
that it could not provide service credits as these had not been
stated in the tender proposal and, accordingly, "such risk had not
been priced by the supplier into its pricing proposal".
Nevertheless, we eventually negotiated a meaningful selection of
remedies that did not impact price. Effective remedies
include:
- "Super" service credits that ratchet upwards depending on the
severity of the failure
- The right of the user to call out a third-party expert to
recommend appropriate action for a cure. This contractually
requires the supplier to provide access to confidential
information
- Free services such as consultancy
- The loss of an agreed benefit, eg exclusive service provision,
or cancellation of a support contract.
Learning from the failures of the 1990s
During the first round of outsourcing, the main problems
were:
- Services failed to deliver the anticipated economic
benefit
- The exact scope of the outsourced services was unclear, making
re-negotiation very difficult second time round
- Insufficient contractual remedies to ensure proper supplier
performance.
Bobby Gill is an outsourcing specialist at
law firm Osborne Clarke
(www.osborneclarke.com) This article has been written in conjunction with Richard
Britton, management consultant at French Thornton