Canada: Value Drivers For It Outsourcing Deals In An Economic Downturn — Part II

Last month's column considered the core price-related rationales for renewing IT outsourcing deals early: the customer gets the benefit of immediate lowered prices; the supplier gets the certainty of a new five-to-seven year agreement. If you are contemplating such an "early renewal" deal with your outsourced services supplier, there are a few other value drivers you have to negotiate.

Flexibility is the Ideal End State

Various value drivers may be summed up in one overarching objective: giving you greater flexibility over the new five-to-seven-year term of the renewed agreement. In turn, flexibility comes in various guises.

Especially given the current difficult economic environment, one important flexibility objective is to have the contract address what happens if you simply need fewer services over time because your own business is shrinking. Ideally, the outsourcing agreement's price algorithm should reflect overall price reductions if you use fewer resource units (even if the cost per unit stays the same or even rises slightly at the lower unit utilization run rate).

In traditional outsourcing deals, the price schedule might contemplate what happens if service volumes drop by up to 25 per cent. In today's uncertain business environment, however, smart users are expanding this range to 50 per cent or more, to give the customer greater flexibility.

Or, what happens if your company has several material subsidiaries or different business units, and you sell one of them? If the purchaser is a strategic buyer who can easily provide IT services to the newly acquired entity, then that is an ideal scenario. If, however, the buyer is a financial buyer without its own IT infrastructure, then it would be very valuable to the purchaser — and indirectly to you as the seller — if your outsourcing deal would permit the newly divested entity to continue to obtain IT services under your existing arrangement, at least for a reasonable transition period.

This sort of transition deal can often be negotiated with the supplier at the time it is needed. Invariably, however, the price would be much lower if the transition deal is negotiated as part of the overall initial outsourcing arrangement, when the supplier is still not sure it will be awarded the outsourcing business, and therefore offers some very attractive prices and contractual concessions.

Repatriating Work

Traditionally, the suppliers of outsourced services took the position that once they were awarded a certain scope of work — such as operating all of your company's computer servers — that work became "exclusive" to them, such that no other service provider could do that work, nor could you do it yourself (until the current outsourcing agreement expired).

This sort of rigid stance on exclusivity is now being softened in many outsourcing agreements, again with a view to providing the customer with greater flexibility. Today, it is not uncommon to provide that up to 20 per cent of the scope of work (such as 20 per cent of your servers, to use the previous example) can be "repatriated", either by bringing the work back in-house with the customer, or by the customer handing it over to another service supplier.

This type of flexibility can be very useful to you. For example, you might be acquiring a new material software system that will operate on a new set of servers. A new supplier has agreed to operate this software for you, but as part of that service, wants to operate the related hardware servers as well (on which the new software will operate), so that they have control of the entire computing environment (related to the new software) and therefore can guarantee 99.999 per cent uptime availability for it. If you have no repatriation rights in your main outsourcing agreement, this sort of scenario becomes impossible — much to your chagrin.

Early Termination

In a similar vein — but often even more important — is the termination for convenience clause, that allows you to bring the outsourcing arrangement to an end (at some point during the term of the agreement) even though the supplier is not in default in terms of the performance of the outsourced services. This can be a critical provision of the outsourcing agreement, as it offers maximum flexibility to you.

You need such a provision because all sorts of things might happen over the term of the agreement that no longer make it sensible for you to carry on in the relationship. For example, your company may be acquired, and the purchaser may have an IT capability that is going to provide you the services previously sourced from the outsourcing company. In that case, it is imperative you have the ability to bring the outsourcing agreement to an end. There are numerous other scenarios that make having such a clause a "must have" in your outsourcing agreement.

Partial Termination

Where you are obtaining multiple services from the outsourcer, it is important that you have the ability to terminate each service for convenience (in addition to the overall arrangement). For example, in a typical outsourcing deal for IT infrastructure services, you will have outsourced the following so-called "towers" of different services: servers, desktop computers, help desk, the main frame computer, and likely several other activities. In a couple of years into the deal, you might find that the supplier has "lost interest" in its help desk service offering (it is still offering it, but it is no longer making material investments in the contact software needed to keep it state-of-the-art, etc.). And another supplier has since developed the leading help desk outsourced service offering.

In such a scenario, you may want to terminate your current help desk service, and move over to the new player. You will not be able to do so unless your agreement permits you to terminate an individual service tower. Again, the importance of such flexibility-enhancing provisions cannot be overstated.

Early Termination Fees

Often the most contested negotiation you will have with the supplier is not whether you can have the right of early termination for convenience by service tower, but rather whether you will have to pay a fee for this privilege when you exercise this right. Supplier positions on this issue vary widely.

Equally, some suppliers insist that such an early termination clause (while provided for in the agreement generally), cannot be exercised by the customer for some period of time (typically for one or two years after the start date of the contract). Again, this is a highly negotiable point.

To maximize your negotiating leverage on these two very important issues, I strongly encourage you to have these discussions while you are still in negotiations with at least two bidders for your work. Particularly in this economic environment, where suppliers are extremely keen to get your business (or continue it, if it would be a renewal), some very favourable terms can be achieved on these points, if you negotiate them while there is still a healthy competitive tension between two or more prospective service suppliers.

Along these same pro-competition lines, savvy customers today are in fact not ending up with only one supplier of outsourced IT services. Rather, they are concluding arrangements whereby two or even three suppliers are "pre-approved" as being able to provide services in a certain category (such as software development and maintenance), and then as specific projects arise, these are submitted to the two or three authorized bidders for their best and final offers (which are often for firm, fixed price quotes). Assuming each supplier has already been cleared from a quality perspective (i.e. — each of them is clearly able to do the job from a staffing and expertise perspective), then this multi-supplier sourcing structure can save you many dollars by ensuring that each supplier submits a very competitive "best and final offer" for your specific project.

In conclusion, while difficult economic times generally constrain companies from pursuing creative strategies, in the outsourcing area there is never a better time than an economic downturn in which to conclude a sensible deal with the supplier.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.