Outsourcing power play

Customers must negotiate better to redress balance

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Customers must negotiate better to redress balance

 

Large companies now use their bargaining power to impose onerous terms on suppliers in outsourcing contracts.

 

This trend is reflected in the Office of Government Commerce's model terms and conditions and in a recent Gartner survey, which revealed that suppliers are now being forced into more flexible outsourcing relationships and contract renegotiations during the life of the project.

 

However, this does not mean power is shifting away from suppliers. Research by Deloitte Consulting found that customers do not always receive the anticipated benefits of outsourcing, in terms of cheaper, better or faster services, and that problems often arise in the early stages of the outsourcing relationship.

 

If customers are negotiating better terms, why are they experiencing problems? If a supplier is not performing its contractual obligations, the ultimate sanction is to terminate the contract. But in an outsourcing project, termination is fraught with legal and commercial difficulties, especially if problems occur early in the relationship, and this sanction cannot always be used. This weakens the customer's bargaining position.

 

Right of termination

 

For instance, a right of termination only arises if it can be shown that the breach was sufficiently serious to deprive the innocent party of a substantial benefit of the contract as a whole. However, the scope and length of a typical outsourcing contract makes "substantiality" difficult to measure. For example, in a 10-year contract, what significance should be attached to a six-month delay?

 

It can also be difficult to determine whether some contractual obligations have been breached at all. Outsourcing contracts are usually designed to be "future proof" and so the supplier's obligations are often described as broad objectives, without specifying when or how they will be achieved.

 

A service credit regime is a means by which the customer can regulate important services. If the supplier fails to meet prescribed technical requirements, it will be liable to pay liquidated damages and if the level of services then falls below a certain threshold, the customer will usually acquire the right to terminate. However, the service credit regime will not normally apply in the early stages of the relationship. Also, such a regime has practical limitations: it cannot be used to regulate subjective contractual obligations, such as obligations relating to quality.

 

Pragmatic and flexible

 

Although the parties will usually agree a mechanism to characterise problems as material breaches so issues are identified and addressed before either party acquires a right of termination, it is often difficult to use this in the early stages of the contract. In particular, good practice dictates that the parties to an outsourcing contract should be pragmatic and flexible, but this can mean problems are not confronted early on.

 

On top of all this, most outsourcing relationships are difficult and expensive to unravel. Even if the customer has obtained stringent contract terms, termination is rarely a good commercial option: it is often cheaper to work with the incumbent supplier, even if it means paying them more than originally agreed.

 

The Deloitte survey reported that bargaining power shifted to the supplier after the contract was signed and, in a few cases, the supplier was forcing the customer to renegotiate in order to obtain higher rates.

 

These risks could be mitigated during the contract negotiations, by focusing on the scope and nature of the transitional arrangements and by including specific mechanisms to address problems or delay at the beginning of the contract term. This is often a neglected area in the contract and there may be no real remedy against the supplier until the outsourced services begin in earnest.

 

Also, the customer needs to make use of any management provisions in the contract which are intended to ensure problems are addressed as and when they arise throughout the project. If the customer has not complied with the contractual mechanisms for dealing with such problems, it is very difficult to act on them later.

 

Notwithstanding the strength of the user's initial negotiating position, after they have reorganised and divested their own IT assets and employees, they need to manage the inherent imbalance of power which favours the supplier.

 

Anna Cook is a partner specialising in IT and dispute resolution at law firm Wedlake Bell

 

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