Outsourcing Contracts and Negotiations Getting More Complex

As IT outsourcing matures, you'd think negotiating IT service deals would get easier. Not so, according to the attorneys who deal with service levels, contract structure and pricing models.

Given the maturation of the IT outsourcing market and the introduction of more standardized offerings like cloud computing, you might assume that negotiating IT service deals is getting easier.

Not according to the lawyers hammering out the agreements.

KPMG reports that 41 percent of outsourcing attorneys surveyed for its 2012 Legal Pulse report indicated that complexity in contracting for outsourced services—as evidenced in things like service levels, contract structure, pricing models, use of global sourcing—has actually been increasing. (The survey included outsourcing attorneys at 31 law firms.)

Sure, buyers and suppliers are more experienced and new out-of-the-box services are gaining traction. But that may be increasing complications in contracting. More sophisticated buyers are seeking higher-value benefits from outsourcing, globalization is increasing, and business leaders are sending more complex functional and process work out the door.

"As buyers gain more experience they continue to push the envelope in terms of scope, complexity of work outsourced, number and diversity of service providers utilized, geographical scope and mix of service delivery models. Complexity comes with the territory," says Stan LePeak, KPMG's director of research for advisory services. "So while the outsourcing market is maturing, it is not necessarily getting simpler, easier, or safer."

Address IT Complexity Upfront

A complex contract, in and of itself, is not a bad thing. It can result in greater benefits for the outsourcing customer or may better address issues of pricing, performance and risk "Problems arise when complexity is not adequately addressed, recognized or accounted for upfront and in the ongoing management of the outsourcing efforts," LePeak says.

The key is to make sure that the level of complexity in the legal documents is commensurate with the nature and goals of the outsourcing arrangement and not just the result of a once-burned buyer or overzealous counsel.

Typically, as services markets mature, best practices in contracting tend to cement themselves in the way of standardized pricing, performance assurance and—particularly—defined terms. However, 27 percent of the attorneys polled reported little or no standardization in defined terms, which LePeak says also points to the fact that while outsourcing is maturing, it's also been expanding into uncharted territory in terms of scope, objectives, and geography.

The survey asked about the most contentious issue in outsourcing negotiations. The most challenging contractual terms to reach agreement on were limitation of liability, indemnities, step-in rights, pre-defined direct damages, and supplier financial risk—all of which involve potential financial exposure to supplier or client. The most challenging commercial terms to come to consensus on were termination fees, termination rights, service levels, transformation and transition fees—all of which involve service provider risk.

Arguments over terms related to transformation rated 17 percent higher than last year as more buyers are attempting to include transformation goals in their outsourcing engagements. "Transformation involves building into the contract terms, conditions, or measures for process transformation or for innovation or other nebulous but value-laden keywords," says LePeak. "The challenge is translating a somewhat conceptual idea like transformation into contracted terms and conditions and factoring in all the events and conditions that could impact transformation being achieved or not."

IBM, Accenture and HP Play Hardball

The toughest negotiators by far continue to be the traditional global outsourcers like IBM, Accenture and HP, according to the attorneys surveyed. Contracting with India-based service providers such Infosys, TCS and Wipro tended to be a less complex, contentious and lengthy process, according to the KPMG Research, while the easiest to deal with were regional or niche suppliers.

"Some of the legacy firms just have more and more aggressive lawyers, and there are also situational variances and exceptions across all classes," says LePeak. "But as some respondents noted, legacy firms negotiate harder but remain professional and are less likely to come back later with requested changes and some Indian firms were easier to deal with but would come back later with requested changes or would not negotiate as solid a contract as is possible. So some of it is style and some of it is substance."

And like complexity, a little back and forth during negotiations can actually be a good thing if it leads to a better or more equitable deal. "Were one side to roll over in negotiating, or if contentious points were ignored or not resolved before the deal is signed, it would be worse," LePeak says.

"Ultimately you want the best deal and contract and one that has no holes, meets both sides' needs and reflects the spirit of the effort, and sometime it's harder and more contentious to get to that point," LePeak says. "The key is that when all is said and done both sides are satisfied with the deal, and any contentiousness was not so bad that they can't stand each other and can't possibly work together going forward."

Stephanie Overby is regular contributor to CIO.com's IT Outsourcing section.

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