Give suppliers a fighting chance to deliver

If you drive too hard a bargain with your suppliers they could end up with margins so tight they can compromise the quality of...

If you drive too hard a bargain with your suppliers they could end up with margins so tight they can compromise the quality of service they are able to deliver you.

IT managers are now under greater pressure than ever to negotiate more favourable contracts with suppliers to reduce costs and ensure that projects stay on track and on budget.

But given the complexity of modern IT projects, maintaining a mutually beneficial relationship seems harder than ever. An ongoing legal battle between the Co-op and Fujitsu Siemens is among a number of court cases that demonstrate how badly wrong things can go.

User-supplier relationships can go awry very easily, right from the start. Mistakes are made when not enough effort is put into understanding end-user requirements, says Rakesh Kumar, international vice-president of enterprise datacentre strategies at analyst firm Meta Group. They are then compounded when the supplier is not clearly informed about what is expected.

The classic confusion, particularly in outsourcing, is not making clear whether the goal is to cut costs or improve service. Generally it is hard to achieve both.

There are two aspects to buying technology or technology services, says Kumar: due diligence in terms of finance and technology. "You need an asset management team that looks at the financing of the contract. It is very much an accounting issue. Then you have a technical team, quite independent of the financial aspects, which does technical due diligence: will the technology deliver; can it be integrated; what technical issues are involved to make it work successfully, and so on?

Once you have established that the technology or service is what you want, then comes the nitty-gritty of the contract itself. Bearing in mind that contract negotiation is a skill that the supplier is likely to be better at than the corporate IT user, it makes sense to draw on the negotiating expertise of the corporate procurement department.

Get someone in from procurement for face-to-face negotiation with the supplier but with support from IT staff who are skilled in asset management.

Given that suppliers are increasingly eager to undercut one another to get new business, however, users are in a strong position to get a good deal. "Once you know that you are in the ball park [for good prices] then move on to value," says Kumar. "Expand the contract to what you want. Push for services [to be included] such as 50 days of consulting. You will be surprised what you can get." One extra benefit of bundling in services like consulting is that they disappear into a software contract budget and are not itemised as consultancy spend.

Other industry experts, however, warn users not to squeeze suppliers too hard. "The US automotive industry had a very acrimonious relationship with its suppliers, but a financial analysis showed that they were paying far more for their parts than Japanese manufacturers which had long-term partnerships with open-book accounting," says Gary Barnett, research director at Ovum.

But even if the supplier relationship remains open and trusting the contract will need to be flexible enough to track changes in the business. Many cannot.

Businesses are not static, and neither are their IT requirements. IT contracts must be flexible without being woolly. Suppliers make money on change, so users must limit the amount of change they impose.

"The term of the contract is key. Today, a five- to 10-year contract may seem sensible for outsourcing some functions, but think back over the past five or 10 years," says Fahri Zihni, IT manager at Wolverhampton council.

"If you had contracted then how much of it would have remained relevant today? IT change and innovation cycles have shrunk to about three years. Try to think of it as a dynamic relationship, rather than one where you write a contract that locks you in."

It is impossible to achieve flexibility without vagueness in a contract, says Zihni. There is no escape from having an in-house capability to determine continuously make-or-buy decisions and multisourcing. Those controls must go into the contract up-front. Future technology and service prices will inevitably be different, and IT costs for delivering a service usually fall as technology improves.

As a rule of thumb, says John Hetherington, managing consultant of benchmarking specialist Compass, "IT costs will reduce by 5% on each previous year. Over a 10-year contract the price could be 30% less [by the end], so that needs to be allowed for in the contract." The supplier should pass on any cost reductions to the customer as technology becomes cheaper.

Companies need to ensure that the contract does not bind them to prices for a service even though the cost of delivering storage, for example, may fall over time. This steady decrease must be allowed for contractually. Like it or not (and most suppliers do not, warns Kumar) it would pay for users to benchmark their IT costs and the performance of their supplier annually against industry averages presented by a third-party specialist.

It is essential that the initial contract allows the benchmarking to take place, and the results to be acted upon, says Hetherington. The whole issue of benchmarking ties back into service level agreements. "There is a shift away from technical SLAs to end-user availability SLAs," says Hetherington.

It is best to contract with one primary supplier which is responsible for delivering the whole service, rather than numerous contracts with your supplier's sub-contractors, that could pass the buck among themselves for a failure of one or other part of the service.

Contract management is the area where users must invest time, effort and money, but all too often do n0t. Be prepared to set aside about 10% of the contract value to contract managementtonurture the relationship with the supplier for your mutual benefit.

An understanding of what kind of relationship is required must run through supplier relationship management. If you arebuyingacommodity - a generic system that does not give you a competitiveadvantage - then price is the key consideration.

"Commodity IT is where the user says, 'We know exactly what we want and it's pretty unchanging'," says Barnett. "Banks, for example, do not compete on their mortgage application systems, which all do more or less the same thing." Conversely, "along-term desktop contract could grow or shrink by 20%. It could be a variable cost."

The areas that need most care and attention by way of relationship management, he says, are those in which the service provided has the potential to give the user an edge over competitors, such as e-commerce. Here, the specialist knowledge of the supplier is invaluable and a close working relationship is essential.

Shouldsuch partnership require risk-and-rewardstylecontracts,in whichthe supplier has a stakeinthe customer's success, taking a financialresponsibilityfor thesuccessor failure of the IT systemor service?This new breed of contractis mostcommonlyused for outsourcing service.

It sounds great in theory. However, risk-and-reward contracts tend to be even more tightly written than usual and this can feel like straitjacket rather than a contract. "If you ask someone to do work and incur costs it is not unreasonable for them to recover their cost at a reasonable margin," says Barnett. And what is a fair margin depends on the risk.

"I like the risk-and-reward model," says Kumar, "but I have seldom seen it implemented. I do not entirely blame suppliers - there are too many instances where [performance] is outside their control."

Hetherington likes risk-and-reward, up to a point. "IT directors think it's a great idea," he says. "Another way to set up a risk-and-reward contract is to allow the supplier more freedom than usual to drive through far-reaching technical and business changes.

"It can work extremely well," says Hetherington. "I know of one user which was able to drive out costs of £1m a year on a £12m annual spend. It was a significant benefit, but if you want [that kind of relationship with suppliers] you have to reward your suppliers."

Mistakes to avoid in supplier management

As the recent legal battle between the Co-operative Group and ICL illustrates, large IT projects can easily turn sour. Each failed project will have its own unique features but there are common mistakes made by the IT user organisation. 

  • They do not know what they want from the IT service or may be seeking something too complex  lFailure to specify requirements in sufficient detail, and manage them during the project, leads to "scope creep" 
  • A lack of technical know-how and therefore the ability to challenge the supplier as to whether they have done what they say they have, or reached particular milestones 
  • Unrealistic budgets or expectations, or lacks empowered sponsorship for the project, which can lead to inadequate resources being deployed 
  • Failure to understand dependencies - the things the supplier is required to do under the contract, such as work on legacy systems which, if not done, may give rise to a claim against them 
  • Not doing due diligence to check out the supplier used on the project  lFailure to document contract variations, keep performance records and retain documents generally, especially e-mails.

Key points to remember in negotiations

  • Establish clear end-user requirements  lMake your requirements clear to your suppliers 
  • Make objectives clear to suppliers. There is usually a trade-off between cutting costs and improving services 
  • Ensure that service level agreements are defined in end-user terms (for example the availability of the application in normal working hours) instead of obsessing over transaction rates 
  • Use the corporate procurement department's expertise when negotiating contracts 
  • Talk to business managers in other areas of the organisation about how they manage their suppliers. Harvest internal expertise 
  • Don't sign a supplier's contract. Get it to sign yours  
  • Watch out for stiffing clauses. Software licensing is a world of its own, and not all corporate procurement and legal departments understand the issues and implications 
  • Watch out for back-loaded contracts, where the supplier effectively buys the business for the first couple of years, then starts to rake in its profit. IT directors whose shelf-life is shorter than the contract may be happy with back-loaded contracts as they will be gone before the pain hits 
  • Consider that, where cost of purchase is high, for example for public sector IT that is required to follow cumbersome "level playing field" procurement procedures, framework agreements can save the cost and hassle of endless single-contract negotiation. But take care that prices are not frozen at the time of signing the framework agreement 
  • Don't freeze forward prices on a long-term contract. Always make sure that your contract allows you to benchmark prices and services as the contract runs, so that your organisation can take advantage of reduced industry costs 
  • Be clear in your mind about what you want and why. "Suppliers love a confused organisation," warns Meta's Rakesh Kumar 
  • Accept that you will have to spend up to 10% of the contract value on making sure you manage it effectively 
  • Build in benchmarking points on all service level agreements, that contractually allow you to re-price products and services at industry averages as they change over the duration of the contract.

Caradon reviews suppliers and cuts £300,000 from its IT budget >>

Wake-up call: the lawyer's view >>

This was last published in April 2003

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