Look before you leap into renegotiating an outsource deal

Opinion

Look before you leap into renegotiating an outsource deal

The chancellor's downward revision of the 2008-09 UK growth forecast to 1.75%-2.25% in his 12 March Budget confirmed widespread corporate feeling that the UK economy is slowing, writes Geraldine Fox of Compass Management Computing. Anticipating a downturn in sales and profits, companies are already entering into early renegotiation of contracts with their service providers to cut costs.

The temptation to sign long-term contacts is great, especially when some outsourcers sweeten the deal with deep discounts of up to 25% for 10-year renewals. But all the evidence is that shorter contracts are more successful in terms of both financial and customer service outcomes. Toward the latter stages, longer-term contracts can not only become misaligned with business imperatives, they can also become misaligned with prevailing market price by as much as 40%.

So what can a business do to protect itself against the risks of mortgaging the future for more immediate financial gain?

Benchmarking

The main tool in any outsourcing client's protective armoury is a solid benchmarking clause that allows the business to compare its pricing at regular intervals with the prevailing market price for a comparable bundle of services. These clauses are often restrictive.

For example, the definition of pricing to market is typically restricted to the client's own industry and geographic markets using existing technology. But outsourcing should not limit a business's strategic freedom and clients should ensure they can benefit from emerging technologies and take advantage of the globalisation of outsourcing.

Take offshoring. Five years ago, few outsourcers were managing European clients' infrastructure offshore while today it is common. Outsourcers moving operations offshore to lower their costs usually share only a small part of the savings with the client, keeping the lion's share themselves, often to make unprofitable deals profitable.

Western companies, lured by lower staffing costs, have aggressively pursued offshore application development through outsourcing, but productivity offshore can be lower, so simply buying cheaper bodies will not result in long-term cost savings particularly as the productivity problem is exacerbated by exploding salaries in many offshore locations.

Businesses with an eye on sustainable cost and quality improvements in application development are managing their outsourcers through function points, the only effective way of ensuring value for money.

Future flexibility

Last, but probably most importantly, is to consider how the business and the economy will change during the contract term. This takes into account both changing volume requirements as a result of economic upswings/downturns, mergers, acquisitions and divestitures and the nature of the support that the business requires from IT.

Strategies include:

  • negotiating the lowest minimum volumes and spend reasonably possible (infinite flexibility is rarely possible)
  • retaining the right to go to competitive tender or bring in an independent third-party arbitrator to set pricing if there are large changes in business volumes
  • better still, ensuring you have the contractual right to renegotiate the entire contract if business demand notably grows or shrinks.

In return, commit to enabling the service supplier to take advantage of its own economies of scale by removing any impediments. Jointly invest in consolidation and standardisation initiatives and share the benefits.

To encourage your supplier to be innovative and support new initiatives, structure gain-sharing programmes in which the supplier receives a reward for implementing initiatives that contribute to business success, or improving services that contribute to business growth.

Successful outsourcing deals do not concentrate solely on short-term cost reductions, but also consider the risk factors in an uncertain future, and clients have the information and insight to make the right decisions to meet changing conditions.

Geraldine Fox is global sourcing head at Compass Management Consulting

IT outsourcing: expert view >>

Avoiding contract surprises >>

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This was first published in March 2008

 

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