If you have an outsourcing contract, the chances are that at some stage you will need to consider some form of renegotiation. Up to three-quarters of all outsourcing deals are renegotiated at some point, and this figure is rising.
This year, with a record number of contracts due to expire, the profile and importance of renegotiation is set to rise. So what is renegotiation, what is driving its importance, and how can you take advantage?
Renegotiation is a dialogue aimed at agreeing major change with your existing outsourcing supplier. It represents the first step in trying to redefine an outsourcing contract.
Critically, renegotiation stops short of the “nuclear option” of going back to the market to retender your requirements. Given the massive cost and disruption that retendering and contract exit can entail (not only finding a new supplier, but simultaneously managing the exit of the old), renegotiation is usually the smarter way to fundamentally redefine a contract.
Four basic triggers underlie almost all renegotiation. First, and most obviously, is the timing factor. If contract expiry is imminent, the outsourcing client needs to either agree an extension with the current supplier, find a new supplier, or bring the work back in-house.
Second, there is the issue of under-performance. This is not always about pricing, although a recent Gartner survey showed that 40% of companies thought they were paying too much for outsourced capabilities.
Underperformance also covers persistent shortcomings in service, failure to meet key performance indicators over an extended period, and underperformance against the market.
Underperformance may or may not entitle the client to legal or financial recompense, but it undoubtedly provides a reason to renegotiate.
A third and related type of trigger is contract flaws, which often can only be resolved through renegotiation to address omissions in the original contract or unintended behaviours from poor drafting.
An example of this kind of trigger is the contract between EDS and the US Navy Marine Corps, which went through extensive renegotiations in 2004 to restructure and simplify the service level regime.
Finally, major business change is an important driver of renegotiation. Any good outsourcing relationship should be able to deal with day-to-day change, in terms of minor scope extensions or adjustments to service levels or pricing.
But when a proposed change could fundamentally alter the nature of the relationship, contract renegotiation can be essential. For example, when the client acquires a new business, moves into a new market or hires a new CEO, the basic assumptions of the existing deal may no longer apply.
This last trigger has resulted in a number of high-profile renegotiations, such as the JPMorgan Chase deal with IBM ITO where work was brought back in-house, and the Powergen deal with Vertex, which resulted in litigation.
This trigger can also encompass the need to apply technology or legislation not foreseen in the original deal, such as new compliance requirements (who pays for Sarbanes-Oxley or Mifid work?) or technology solutions.
Given these drivers, renegotiation is a complex challenge. Ideally, client and supplier will have a frank and constructive relationship, far removed from the brinkmanship and posturing that characterises so much of outsourcing deal-making.
Successful outsourcing relies on building sustainable relationships, not screwing out every last concession, and smart negotiators will seek to ensure the relationship is underpinned by clear mutual benefit on both sides.
Ultimately, however, the outcome of renegotiation will depend on the negotiating position of both parties, which will be largely determined by the options available to the client.
If, for example, the client could easily retender the work to a range of other suppliers, a failure to agree would still leave viable alternatives, which is a good basis for influencing the renegotiation outcome.
In cases where one or both of the parties have attractive alternatives, renegotiation is unlikely to get off the ground. In all other cases, the parties will need to spend time negotiating the point at which their interests and position intersect.
Improving your renegotiating power by developing alternative sourcing options is a long-term task that should start before the original contract is signed and continue throughout the deal. The following broad concepts are the most important considerations:
l Build competition and transparency into the contract: minimise your reliance on proprietary systems and software, and make use of industry-standard processes, tools and benchmarking. Wherever possible, try to promote a multi-sourcing approach by not relying entirely on a single IT provider to supply all your needs for a given function.
l Minimise the contractual barriers to exit: ensure that the master contract provides a clear and equitable basis for termination, both for “cause” and “convenience”. This should include providing a fair mechanism for compensating the supplier for the client’s premature exit. Clarify the responsibilities in terms of transfer or retention of intellectual property and personnel.
l Retain expertise: do not lose the ability to understand the functional and technical detail of the deal. Run a contract management office that retains a complete grasp of the outsourced activities.
In addition to building up your sourcing options over the long term, the actual process of renegotiation needs to be well managed. The first consideration is getting the timing right.
Considering that a renegotiation process can last from two to six months depending on the complexity of the situation, and that 12 to 18 months’ contingency is needed to run a retendering process, starting a renegotiation fewer than 18 to 24 months before the contract expiry date seriously reduces a client’s negotiating leverage.
The starting point for the renegotiation process is establishing a clear set of goals, and identifying those of the supplier – in some situations, it will be possible to agree a joint statement of shared objectives.
The objectives will provide an agenda for the renegotiation, and should focus only on the killer issues, underpinned by a clear picture of the longer-term requirements of the business, such as the IT, finance and HR services it will need in the next two, five and 10 years, and what its overall sourcing strategy is.
Finally, before starting to renegotiate, the client needs to plan the terms of engagement with the supplier, clearly setting out fair rules, such as the number of people who will be involved, and the timeline for concluding (or calling off) the renegotiation.
A clear and disciplined approach for the renegotiation sessions themselves is essential. Central is the use of a single, jointly edited version of the contract, capturing revisions to the agreement in real time.
Progress will rely heavily on the quality of the underlying relationship between client and supplier, as mistrust or tactical games will delay or derail agreement.
Senior client and supplier involvement is also vital, symbolically emphasising mutual commitment to the process, while minimising decision-making delays.
Renegotiation is not a panacea. Redrafting a contract is no substitute for maintaining a constructive relationship with your supplier. Where problems persist, termination and retendering may well be the right answer.
But although retendering continues to get all the headlines, dozens of forward-looking firms are turning to renegotiation to refine and extend their sourcing strategies.
As deals get shorter, and as firms get better informed and more sophisticated in their outsourcing thinking, a silent revolution will take place in attitudes.
Renegotiation will no longer be a niche activity; it will emerge as a central skill for all businesses engaged in outsourcing.
l Paul Morrison is a senior manager at outsourcing advisory firm Alsbridge
Don’t let the wheels come off your deal
The right outsourcing strategy
This was first published in March 2007