360° Vendor Management

Outsourcing Negotiations for Beginner Buyers

Let’s begin by saying that beginners really shouldn’t negotiate outsourcing contracts. Outsourcing contracts are among the most complicated deals to negotiate. The negotiating team must account for transition plans, disposition of assets and people, scope control, service levels, indemnification, liabilities, complex pricing schedules filled with escalators and descalators, governance, etc. It’s similar to a divestiture deal - except that you cannot escape the results as easily. Wall Street divestitures are handled by mega-legal firms…so, the odds are that your company doesn’t have the right level of experience.

The most interesting dynamic is that the vendors have negotiated many more deals than customer has - and they’ve managed many relationships, so they know where the risks are and what your pressure points are. Most operations people spend the bulk of their time managing internal functions and politics. Maybe you have experience buying cars or homes. Outsourcing deals are nothing like this type of transaction. If possible, find an outsourcing pro to assist with negotiations. What follows are considerations if you are budget strapped and fool-hardy
Know What You Have and Fear Material Changes - The number one issue buyers should manage is being sufficiently self-aware to know what you know - and to know what you don’t know. There are so many processes, procedures, and exceptions in today’s operations areas, its difficult to know them all. In addition, there are areas where good performance is challenging, season volumes ebb and flow, and your customers’ needs are the exception to the rule. It could take 2-3 months to document everything. Do it and do it well. There are two reasons for this. First, experienced vendors know that their customers always have skeletons in their closets and that they cannot come hat in hand begging for price increases for each one. So, they inflate pricing to give themselves contingency. The less risk vendors have to take, the lower the price you will need to pay.

Second, any major change to an assumption (e.g., systems that won’t work internationally, customers who refuse to allow you to process their transactions overseas) will become a Material Change. Material Changes can carry significant price increase, and always open the door for vendors to renegotiate pricing. Throughout the duration of the contract, vendors will actively defend their profit margins by requiring price increases for any Material Change, such as wage inflation, system changes, new training requirements, etc. Think about it. You’re going to have to have a Material Change anyway, but why open the door for them early in the process when internal acceptance of outsourcing is at its weakest point?

Performance Expectations - Commonly referred to as Service Level Agreements, performance expectations can encapsulate day-to-day performance requirements of the program, as well as planned milestone achievements (e.g., on-time implementations, system conversions). Every performance expectation should be very well documented, quantifiably measured, and carry incentives/penalties for performance. The biggest mistake beginners make is to exclude key expectations. The second biggest mistake beginners make is define a performance expectation that cannot be measured.

A quick word on incentives and penalties: while you clearly cannot expect a vendor to lose 100% of a program’s revenue for every failure, don’t have too much sympathy for your vendors. Profit margins in this business are fat and you shouldn’t allow your vendors to think of your program as an annuity with guaranteed profit margins. That’s not how you view your business, and it shouldn’t be viewed differently by your vendors. Make your expectations clear up front, and don’t back down.

Give Vendors Incentives to Manage Your Risk - Contracts, in a large part, are about managing risks and rewards. If you’re handing over your call center business to a vendor, and they now have access to extremely confidential types of customer information, you are at risk. Vendors will attempt to limit their risk, typically to some portion or multiple of anticipated annual fees. However, what happens if a breach of confidentiality occurs, which results in a class action law suit? Such cases could have legal fees that equal your annual vendor invoice amounts alone, and carry penalties many times more than this. Who pays for this? This is why you need a good lawyer, experienced with outsourcing, to assist and advise you. Whatever you do, don’t take everything your potential vendor has to say at face value. Just like any politically biased journalist, the message contains a twist.

Vendors need to have sufficient skin in the game to put necessary controls in place to prevent a catastrophe. What incentive does a vendor serving a mega-international bank have if their liability is limited to $250,000? The cost of notifying your customers of a breach of confidentiality could exceed this many times over if you consider just postage and printing costs. What about potential lawsuits or regulatory fines?

Give Yourself An Out - Times change, people change, and businesses change. Experienced outsourcing professionals understand that relationships evolve and that deals must be sufficiently flexible to support change. One such consideration is termination for convenience. Again, vendors want predictable revenue and to protect their employees (and their companies’ reputations in the local job marketplaces and regulatory environments). However, don’t fall for guaranteed minimums or huge payments. Termination for convenience should always be priced at a sufficiently high price to avoid impulse decisions and to make the vendor reasonably whole, but keep in mind that the outsourcing business is growing fast, which allows vendor employees to be allocated to other projects, given sufficient notice and planning.

No matter what you negotiate, leave absolutely no ambiguity or placeholder. A specific amount of money and a required minimum notice provision should be included. I terminated one outsourcing relationship that was negotiated by an attorney many years prior, and the language didn’t define the specific amounts to be paid. Instead, it allowed the vendor to calculate the amount of unamortized investment it had made in the account. Pretty soon after our letter was received, the vendor provided a very, very lengthy list of investments (including sales incentives given to salespeople!). Of course we negotiated the outcome, but the situation could have been avoided altogether with some forethought.

This is a snippet of what beginner buyers should consider. As always, work closely with your legal counsel and consult with a professional if at all possible.

This entry was posted on Monday, March 19th, 2007 at 9:09 am and is filed under Outsourcing, Outsourcing Negotiation. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.