Renegotiation has become a fact of life in long-term outsourcing contracts, and customers entering five to ten-year arrangements should be prepared for that.That’s the bottom line, according to Syd Hutchinson, senior consultant, COMPASS America, Inc. “It’s unusual for a contract not to be renegotiated,” he said. “There’s no way you can see everything that far out, so you should go into these agreements prepared to renegotiate.”
The renegotiation usually is triggered by service and/or cost issues: the service isn’t what the customer expected, or the customer thinks they are paying more than they should. A third element can be personality conflict, but Hutchinson said that falls far below the other two.
“In some agreements, they go through project managers on both sides pretty quickly until they find two people who can work well together, but by and large, the client is going to be unhappy if they think they’re paying a lot for what they’re getting or not getting what they’re paying for.”
The path to renegotiation usually is predictable. The customer complains about either service or price at lower levels of the vendor organization, and the parties try to work things out at the project or manager level. If that fails, Hutchinson said most people refer to the contract, to determine “what’s in black and white.” If resolution falters there, the dispute moves up the organization chain on both sides until the relationship reaches a critical point.
“If things continue to escalate,” said Hutchinson, “somebody has to decide whether or not this ultimately is a relationship they want to continue.” Despite that harsh reality faced by some customers and vendors, Hutchinson said most relationships can be salvaged.
“There’s a huge motivation for both parties to work things out,” he said. “From the vendor side, it’s just good business to have happy customers. From the client side, it’s a huge drain. All of a sudden, they’ve having to spend a lot of time and energy dealing with a subject that they thought they has put to bed for five, seven, ten years ago. So it’s in neither party’s interest to let these things drag out.”
Preparation: One Key to Success
Renegotiations move more smoothly if the customer expects them to happen and prepares for them, according to Hutchinson.”You need to set up a process to monitor service and the price paid, in order to keep it where you want it to be,” he said. “Then define what happens when you deviate from those norms. If you want your price to be related to the industry, you have to have a way to make sure that’s where you are.”
The nature of outsourcing presents the customer with challenges in one area, according to Hutchinson. “You’re going to lose track of technology, because all of your internal knowledge walked out of the door and went to the vendor. So you’re going to need some external resource of information besides what your vendor is telling you.” That additional source of information assists in the monitoring process. While many people have the process in place to monitor service, Hutchinson believes such a process should be established to monitor price, as well.
“If someone thinks they can predict now a fair price for something they’re going to buy seven years from now, particularly as it relates to technology, I would say they’re insane,” he said. “There is going to be renegotiation. So what’s it going to be based on? How’s it going to be done? Those are the things I think somebody needs to think about.”
Contracts of Tomorrow
Although Hutchinson conceded that companies already in relationships may find it difficult to add the monitoring agreements to the contract, he said COMPASS is seeing many people just entering relationships trying to get the agreements included in their contracts. The monitoring mechanisms alert the parties when situations have reached a point where action should be taken. That action can be automatic renegotiation, for example, or rates being automatically reset when the scope of the work increases by a specified percentage. On the service side, deteriorating service levels can trigger an escalating penalty clause when the vendor doesn’t hit the target.
“If those sorts of things aren’t in place or they aren’t meaningful, you’re going to be headed for trouble,” said Hutchinson.”
He cites networking rates as an example of the way the process works. “People sign multi-year contracts with AT&T or MCI, but they come back and renegotiate every year,” he said. “That’s just the way business is done on the networking side. I think people have to adopt that sort of model when it comes to outsourcing.
Lessons from the Outsourcing Primer:
- Renegotiation should be expected in long-term agreements.
- Renegotiation usually is triggered by service and/or cost issues.
- Most relationships can be salvaged.
- Including monitoring mechanisms in the contract can help the relationship and renegotiation operate more smoothly.