If an outsourcing contract remains flexible and keeps its integrity, the likelihood that a vendor will keep its customers coming back for increased services and contract extensions is more likely.
Kodak was one of the first major corporations to be involved in a blockbuster outsourcing deal in 1989 when it sold its mainframes to IBM and hired the IT company to do its data processing for what is now ten years, and has been extended to the year 2005. After seeing the success of the much-storied deal, many companies followed Kodak’s outsourcing lead in the early 1990s. And many chose IBM as well.
Now, IBM is at an interesting point as many of its customers’ contracts are nearing expiration and are being renewed, says Doug Elix, general manager of IBM Global Services Americas. The interesting thing is how much of IBM’s revenues stem from renewed contracts and not new business. Last year IBM signed up $33 billion worth of business and in the United States, of all the contracts that IBM signed, 38 percent were either renewals or amendments to existing contracts, Elix says.
“That level of activity gives you a sense that once the customer gets used to the contract and makes it work, how comfortable they are in either renewing the contract or expanding it to do more work,” Elix says. “It also gives the sense that, if properly done, the customers are very comfortable with renewing their contracts and, in fact, expanding the relationship.”
For many of IBM’s new clients, outsourcing is a big step for them, and often one in which the clients have little experience in doing. Elix explains that it is very important, even today, to explain outsourcing to clients — how contracts are put together, how the service levels, the relationship and the employees are managed, and how the transition will be done. But even though there are many companies that are still not too savvy when it comes to how outsourcing works, at least the reasons for outsourcing are moving in a much more positive direction.
“If you look back six years ago, the motivation for outsourcing was that companies were in financial stress and they were looking to reduce the cost of operating technology, and in some cases to help restructure their balance sheet. So outsourcing was very much motivated by performing the operations on the same level or better, but more importantly, at a cheaper price,” Elix says. “Now most companies are in good economic shape, the economy is booming and the motivational criteria is a lot different. Now it’s ‘how can I transform my company? How can I be in e-business? And how can I get access to skills that I can’t possibly get in my own organization?’ So with that motivation comes a different set of success criteria and therefore a different emphasis on the contract.”
The contracts that IBM writes today are quite different than the contracts written five or six years ago when outsourcing was relatively immature. Back then, contracts were written with terms and conditions that covered all of the outsourcing systems’ measurements and service levels. And while those reasons are still important, what people really want to focus on today is flexibility. Clients want to know how well the supplier will respond to changing business circumstances, respond to changes in the exploitation of technology, how well the supplier integrates with the customer’s people and how much thought leadership the vendor brings into the partnership.
“All of the things that were in the contract five years ago are still in them today because all those system functions have to be performed. But we are finding a lot more emphasis today in our contracts concerning flexibility, responsiveness, adaptation to change, and the introduction of thought leadership in transforming capability,” he says. “So flexibility is key in this new era of outsourcing.”
An Important Consideration
Along with price and skills, contract flexibility and integrity are two of the main considerations for a customer seeking outsourcing services, Elix says. When companies turns over something as important as their information technology infrastructure or their application development to a vendor then they want to know that they are going to stay connected with the supplier. They also want to know that the vendor is going to be as responsive to their business as the employees would have been had they never outsourced. These objectives are attained with a combination of how the contract is written and how the relationship is managed.
“The ability to adapt and change is something that our clients want,” Elix says. “The contracts have to be flexible enough to allow technology upgrades and adjustments, and handle different business models as their business changes. The contracts also contain benchmarking capabilities so that our clients can constantly check the outside for capability, service and price competitiveness.† This gives the client the option of being able to move to different services and prices as the market place changes.”
Contracts also contain termination clauses, so that if the customer’s circumstances change and it needs to go in a different direction, then it is not excessively punitive for it to do so. “This is so the customer doesn’t feel like they are locked in with nowhere to go,” he says.
Amendments are a necessary part of outsourcing contracts, but totally redoing a contract is not. IBM tries to build in enough contract flexibility so that the contract can be adjusted, but Elix said that it would be a shame if the customer and supplier had to go in and totally redo it. Take Kodak for example. Since the contract’s inception in 1989, Kodak and IBM have done 23 amendments to the initial contract and Elix says that the contract and the relationship itself is dynamic and will never stop changing.
Washington Mutual (WAMU) is another example of a company in constant change. Over the three year outsourcing relationship it has with IBM, the financial institution has been involved in three acquisitions. And WAMU went from $25 billion in assets to $100 billion in assets along the way. Each acquisition also required an amendment to the contract.
“Very few of our contracts expire, or in other words, go their full term and then get renewed. It is almost always the case that there is some sort of change before then,” he says. “That means that you go in and amend the contract and adjust it to changing circumstances. Without flexibility that wouldn’t be possible and a lot more time and resources would be used to redo contracts”
Lessons From the Outsourcing Primer:
- Suppliers can retain client loyalty by having a flexible contract.
- Many companies are still new to outsourcing and need contract coaching from a consultant, lawyer or the vendor.
- Along with price and skills, contract flexibility and integrity are two of the main considerations for a customer seeking outsourcing services.
- The ability to amend contracts is an essential part of flexibilty.