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.
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.
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