ERP deals are complex from a contractual structure and negotiation standpoint. And because many mid-market companies are just beginning to venture into ERP application territory, an area that until recently was reserved for large companies, mistakes are common.
Most ERP blunders that are made from a contractual and legal standpoint fall into two major categories. First, outsourcing customers fail to understand the complexities of dealing with a software licensor, an integrator, and an outsourcer in a manner that will deliver accountability and protection, says attorney Bill Deckelman, shareholder in the Austin law firm of Munsch Hardt Kopf & Harr, P.C. And second, from a contractual point of view, customers fail to separate the licensing and integration work from the ongoing operational outsourcing work.
The Complexity of Software Licenses
Normally in an ERP deal, the customer must negotiate the licensing agreement with a third-party software dealer. The license is usually perpetual, meaning that a long as the customer complies with the license it is allowed to run the software. But software licenses are usually very restrictive, Deckelman says. For example, software licenses usually restrict the accessibility of the software to third parties, so if a company is going to outsource the implementation and ongoing outsourcing of the applications then the customer also has to negotiate the right of the vendor to use the applications.
“Unfortunately, over the years there has been a lot of conflict about letting an outsourcer have access to ERP applications because sometimes the outsourcer is a competitor of the licensor of the software,” Deckelman says. “And if and when they do allow it, they often charge a pretty substantial fee because of the intellectual property involved.”
It’s a good idea to simultaneously negotiate the software license and the outsourcing of the integration, he says. Then if there is an issue with the licensor you can get help from the integrator. If you don’t do it simultaneously the customer could end up with a license that is too restrictive for the integrator to use effectively. Whereas, if a company involves the integrator in the process it can usually get better terms because the vendor can help negotiate with the licensor, especially if the customer needs to make a final decision regarding more than one ERP package. But allowing the integrator to choose the applications by itself is not a very good idea either.
“Sometimes the customer relies on the integrator to acquire the software and then it turns out that the software does not meet the customer’s functionality requirements,” he says. “So it is good to have all sides involved.”
Negotiating With the Vendor
In negotiating with the integrator, there are some critical issues that need to be covered. Having a project plan is very important. So a company must make sure that there is at least a contractually committed preliminary project plan, even if a more detailed plan will be delivered after signing, which is the optimal way of doing it, Deckelman says.
“All the devil in the detail starts to come out after the customer signs the contract and so the contract ought to have a high-level preliminary plan in it that sets out the principal milestones, which are the critical aspects of the deal,” Deckelman says. “This can only happen if there is an understanding that after the contract is signed the two sides will come back and do the detailed planning that goes around it.”
Milestone dates in the contract are a must and should have liquidated damage amounts tied to them to ensure the integrator’s incentive to meet critical deadlines, he says. The parties should agree on a “critical path analysis” procedure that will allow for fair adjustments in the committed time schedule for situations in which the integrator will not be held responsible.
Because integrating an ERP package is not the typical vanilla implementation, there are almost always interfaces or additional modules that have to be customized in order for the customer to increase functionality; that is why the customer outsources the integration in the first place, he says. So milestones usually include a design phase, or a requirements or specifications phase in order to accomplish that. Other milestones usually include a date for completion of the coding that the vendor is doing on the software, and a date to begin and complete testing.
The customer must also identify the deliverables in the contract. They should be identified specifically, with clear acceptance procedures and clarity as to the legal effect of acceptance. And then there are the customer responsibilities that should be detailed and clear, Deckelman says. With these two things in order, determining which party is liable for certain situations will be a little easier to determine.
“Liability must be addressed not only in terms of the impact on the customer for a poor implementation, but the customer should also ensure that it’s clear which party is responsible for the overall package selection, including the functionality assessment, and the impact of the implementation on the customer’s business process when its current systems are replaced by the ERP system,” Deckelman says.
One of the biggest problems companies run into is that they rush into an integration or outsourcing contract before they have completed a careful analysis of the functionality issues, he says. And as these issues become more apparent down the road there is a tendency to point fingers and to begin placing blame for some party’s failure to point out significant functionality issues. Often times it is not clear that the integrator assumed this type of liability, so the customer ultimately assumes this risk
Negotiating the Outsourcing Deal
Unfortunately, many companies agree to “bundle” the ERP implementation and the ongoing outsourcing deal, which means that one vendor is both the integrator and the ongoing outsourcer, Deckelman continues. If there is a long-term contract, say in the area of ten years, this could mean trouble. If there are very sketchy terms devoted to the integration accountability issues, as described above, when the integration project gets in trouble the customer realizes that it has signed a 10-year agreement to allow the outsourcer exclusive rights to implement and run the ERP system.
“Negotiate the integration agreement and then if it is successful go forward with the ongoing outsourcing arrangement,” Deckelman says. This assures the customer that they are not committed to a lengthy contract before the outsourcer satisfies the deliverable on the front end. Customers tend not to spend as much time and focus on it as they would if they were doing strictly an integration agreement.”
Lessons From the Outsourcing Primer:
- Software licenses usually restrict the accessibility of the software to third parties, including vendors.
- Simultaneously negotiate the software license and the outsourcing of the integration, so the vendor can help choose the most optimal ERP package.
- Have a preliminary project plan and fill in the details after the deal is signed.
- Liability should be addressed in the contract to ensure that it is clear which party is responsible for the ERP application selection.
- Negotiate the implementation and if it is successful then negotiate the ongoing outsourcing contract.†