Scoping Out Scope | Article

Taking a closer look at a ContractFrom the legal standpoint, creating a proper statement of work can be the trickiest part of negotiating an outsourcing contract.

Too often at least one party is not putting enough effort into clearly defining the boundaries of the contract. This cavalier attitude can cause thorny problems down the line when buyer demands slips into the gray zone, according to Richard Raysman, a partner at Brown Raysman Millstein Felder & Steiner LLP, a law firm in New York City specializing in outsourcing. He says as many as 30 percent of the outsourcing contracts he has seen over the years haven’t done a razor sharp job of defining scope.

Raysman says some vendors prefer to pen a high-level generic work statement because this kind of arrangement removes the many details they would have to comply with. However, this tack can be a two edged sword, according to the attorney.

For example, a general agreement can require an outsourcing provider to perform all necessary accounting functions. But what exactly is “necessary?” A customer can ply the vendor with an exhaustive list of necessary accounting chores as the contract progresses. This type of agreement “can open the door to a very large commitment,” warns Raysman. He’s seen clients “lose a bundle” the first few years of the contract because the scope of the agreement was unclear.

On the other hand, if the buyers are the lazy ones, they may have to pay more because the vendor can insist the requested service was not included in the contract.

Injecting Reality Into The Contract

The attorney says the process of defining the scope of the agreement is an important process for both sides. He calls it “a meeting of the minds to determine exactly what needs to be done.” In addition, it fleshes out the technology requirements for the contract.

Most important, these discussions inject reality into the expectations on both sides. The vendor knows what it will cost to provide the services the customer needs, while the customer knows exactly what to expect.

One of the best ways to scope out scope is to commit qualified professionals to the process. Sometimes vendors don’t want to do this because it is “enormously expensive,” notes Raysman. Customers who are new at the game don’t realize they may need to bring in their technical people.

In his experience, Raysman says buyers are well served if they hire an outside consultant to help them navigate through the shoals of contract negotiation. Some balk at this because of the price tag. For others, it’s a political problem. Whatever the reason, it’s usually a mistake not to. “Too often they find out six months later the few dollars they saved cost a lot more later on because of errors in the contract,” he observes.

Raysman tells of one company that didn’t want to spend the capital to hire an outside firm when it began the outsourcing process. Handling the negotiations itself, it signed an agreement that had a very restrictive confidentiality clause.

When it was clear the relationship wasn’t working, the buyer wanted to bring in an independent third party to them sort out the problems. The vendor refused to allow the company to work with a third party and could do so legally because of the confidentiality clause.

The Prod of Performance Credits

The buyer had signed a long term contract and was stuck. The mutual unhappiness eventually forced the two to work things out. Raysman reports the renegotiations were very unpleasant. The customer lost months of valuable work time, too.

“They were blindsided,” says the attorney. “Vendors are very sophisticated. They have done this before.”

Companies tend to negotiate about metrics the same way. Raysman says vendors are “really reluctant” to commit to firm service levels and the performance credits that go with them. He says the chief reason is vendors are afraid of the impact they may have on their organization. “They are afraid their people will get demoralized,” he explains.

Of course, there’s the financial piece, too. Poor performance could cause the performance credits to kick in and that could affect the vendor’s margins.

Performance credits are tricky. The credits themselves are a good way to get the vendor’s full attention, which is what the customer wants, points out Raysman. He recommends that they remain a relatively low percentage of the overall monthly fee. Anything higher creates financial risk for the vendor.

What To Do About Vendor Pricing Mistakes

Most clients negotiate limits of liability “pretty strenuously” since it’s a fairly contentious point. Raysman tells the story of a vendor who negotiated a good limitation of liability but had not done its homework on price of other aspects. Consequently, this mistake caused it to lose a great deal of money. Under this clause the vendor cut the buyer a check to staunch its losses. This caught the buyer’s attention. Its management agreed to renegotiate the contract so the vendor could continue providing services profitably.

Vendors make mistakes for many reasons. A common reason is they assign pricing tasks to relatively new employees, says Raysman. The tight employment market is forcing vendors to hire new people who may not know the intricacies of the vendor’s pricing structure. The problem becomes compounded when a manager doesn’t review the pricing in the contract thoroughly. Limits of liability are a good way to get out of a contract if a vendor makes a mistake.

On the other side, customers often don’t understand their own internal pricing. When an outsourcing provider gives them a bid, they don’t have an accurate number to compare it with. They don’t know if outsourcing is saving them money or not. “At the end of the day, the customer wants to save money,” says Raysman.

Lessons from the Outsourcing Primer:

  • Spend time clearly defining the boundaries of the outsourcing contract. Each side must take the time to do this.
  • Assign your best people to the process. Include the appropriate technical people.
  • Buyers should consider hiring a third party to help them. This will prevent them from getting blind sided by onerous clauses that may cause trouble later.
  • Vendors can use the limit of liability clause to help them buy out a contract if they have made a mistake.
  • Buyers need to know their internal cost structures so they can compare it to the outsourcer’s bid.

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