Outsourcing IT services: goals and negotiations

Tactical and strategic negotiations are important to businesses of all sizes, from SMEs to the largest enterprises

The supplier selection phase of the sourcing lifecycle is dominated by negotiations and characterised by tactical measures. Contract negotiation starts with the request for proposal (RFP), which prepares the main prerequisites and is finalised with the contract signature.

Negotiate and agree to as much as possible before the contract is signed, because renegotiating during an existing outsourcing relationship requires time and effort, decreases agility, and is always based on less competition, which influences the provider’s motivation and the price.

It is impossible to negotiate and define everything before the contract signature, but many things should be clarified and agreed to up front, such as pricing for services and known projects (transition, transformation), pricing schemas for new services and out-of-scope projects, as well as all service levels. IT procurement staff need to ensure that all necessary prerequisites are in place before the contract negotiation starts, and should avoid, where possible, leaving any contract elements open after the contract has been signed.

Negotiation process

The RFP is the first step of the negotiation process with possible suppliers. The to get comparable and binding price information, a description of thefuture client outsourcing solution, and accepted or rejected (and commented on) statements of the future contract. Achieving these goals requires sufficient details about the client’s existing and future services in the RFPRFP statement of work (technical description) and the insertion of a draft version of the client’s outsourcing contract, or at least its most important terms and conditions.

The more details that are in the RFP, responses, and descriptions about the future client solution in providers’ proposals, the better the outcome.

A strong RFP is critical, since it will become the basis for the negotiation process and decrease time and effort. Additionally, what you learn about the shortlisted main goals of an RFP are suppliers helps to define the right negotiation tactics. Based on Forrester’s contract review activities, it appears a lot of services outsourcing contracts are defined from the provider’s perspective. It is not easy for IT procurement staff and the client’s legal departments to identify issues that could be disadvantages from the client’s perspective.

A strong RFP is critical since it will become the basis for the negotiation process

A best practice would be to draft your own contract with your most important standard terms and conditions, ownership clarifications, pricing models and governance model structure. This draft should address all standard and critical contract statements and be attached to the RFP document for confirmation or rejection (with explanation) in the corresponding proposal. This reduces time and effort spent during the negotiation process dramatically, and IT procurement staff can focus on the essential elements. It also gives the provider a clear sense of what provisions may be deal breakers early enough in the process so that you don’t get into a final negotiation only to walk away because you cannot agree on terms.

Negotiation goals

The negotiation process is characterised by a lot of tactics. Every participating party follows its own goals and objectives and tries to enforce them. Often the client has objectives that are contrary to those of the provider, and whether the client achieves its goals depends on the priorities and the strength of its negotiation team.

Other objectives could be in the interest of both parties. IT procurement staff have to ensure that requirements for “go” and “no-go” decisions are clearly defined, the right objectives are identified, and all goals are aligned within the negotiation team. There are two points you should consider. First, balance your desire to share risk with the supplier’s desire to mitigate it. Clients’ growing insistence on transferring higher responsibilities in services delivery and more accountability for services quality to the suppliers and in enforcing less interaction and clear separation between the client and providers in daily services management increases suppliers’ services delivery risks. For example, sourcing models such as managed services embody these properties.

Suppliers are not reluctant to use these models, because they can use their own processes and can fully manage the services delivery. But during negotiation, suppliers try to mitigate these delivery risks, especially if the client requires challenging services levels, plans to use services credit (penalty) models, and wants to have price benchmarking in the contract. During the negotiation, the provider will try to get the client to agree to minimum service levels and soft services/credit models mostly combined with earn-back incentives and weak benchmark clauses.

Clients need to understand the supplier’s underlying objectives to find agreeable compromises. Second, understand the provider’s profit targets to help you get cost reduction and flexibility. A lot of clients decide to outsource with the goal of reducing their costs. Cost pressure has been the biggest driver for outsourcing in recent years, and clients tend to choose suppliers with the highest cost reduction opportunities. But suppliers have clearly defined profit targets they must achieve with an outsourcing deal.

If the provider feels the original contract deal will not achieve that profit target, the supplier will try to achieve its goals with contract extensions, out-of-scope activities, or with delivery cost reductions. This influences the supplier’s responsiveness, willingness to be proactive, and its decision to handle additional activities only for additional fees. Inflexibility and non-agility in outsourcing relationships is mostly the result. IT procurement staff should remember that price negotiation is important, but squeezing price concessions mostly results in a contract with no flexibility and hinders the client’s ability to build a strategic partnership with its outsourcer.

This is an extract from the Forrester report, Negotiate a successful IT services outsourcing contract by Wolfgang Benkel, a principal analyst serving sourcing and supplier management professionals.

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