Outsourcing Contracts: Foundations for Success

Your organization shouldn’t enter the process acting like a first-time buyer

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Most business and IT leaders learned to negotiate with outsourcers 15 or 20 years ago, when the virtual corporation was seen as the organization to emulate. Although virtual organizations have faded, they provided valuable lessons regarding how to structure outsourcing contracts. Unfortunately, those lessons are being lost. Over the last few years, I have encountered multiple organizations making “first-time buyer” mistakes when negotiating with outsourcers.

During outsourcing contract negotiations, remember the basic tenets:

  • Begin with asking why. Reasons to outsource include meeting seasonal demands, gaining access to specialized skills and changing from fixed to variable costs. These motivations affect all parts of the contract but are critical for determining service levels, metrics and costs. In the absence of clear, agreed-upon motivations, some executives will inevitably be unhappy with the final arrangement.
  • Be thorough. Analyze the proposal carefully. An outsourcing contract is a complex document that attempts to clearly describe the tasks the outsourcer will perform and those that the customer will retain. Clarity can be difficult, particularly when the original document was written by multiple departments, or by technicians who dislike writing proposals because it isn’t “real work.” Cross-check the different schedules, exhibits and definitions; it is fairly common for an outsourcer to create a proposal by combining sections from previous proposals. Hastily prepared documents rarely receive adequate internal review.
  • Build your own financial model. Outsourcer pricing can cover everything from detailed technical measures to business-based charges such as cost per payroll check. Regardless of the pricing model, compare what your costs would be with outsourcing and without it. The outsourcer’s one-time transition costs and ongoing operating costs are easy. Other costs can be more difficult to determine. These include penalties for prematurely terminated contracts, future technology refresh and staff to manage the outsourcer. While this exercise may not change the decision, it is part of a thorough analysis and is useful if the eventual decision is ever questioned.
  • Anticipate the future. Typically, sales teams dismiss major business changes as unknowable and as something that will be “negotiated in good faith.” While both parties should negotiate in good faith, leave as little as possible to a change order. Consider the business model before finalizing the contract. Holding companies should ensure that the contract clearly addresses acquisition and divestitures. Seasonal businesses need to be able to increase or decrease usage quickly without being penalized. Highly regulated businesses need guarantees regarding continued compliance.
  • Get a prenup. Although everyone hopes an outsourcing relationship will be successful and long-lasting, these partnerships are not marriages. Define the services the outsourcer will provide if you decide to terminate your relationship and move to another outsourcer. Specifically, the outsourcer needs to predefine fees, deliver your data in a prescribed format and assist with the transition in a timely assistance.
  • Get promises in writing. Once the contract is signed, the delivery team will take over from the sales team. The delivery team won’t know what the sales team promised but will worry that too much was given away, so that they will have a hard time making the account profitable and getting a bonus. Similarly, the buyer’s negotiating team is likely to change as executives focus on other issues and team members are reassigned, move to the outsourcer or leave for other organizations. With so many new participants, only the commitments that are in writing will be honored.
  • Acknowledge that the outsourcer is not your BFF. Salespeople are affable and many appear to be your new best friend; however, salespeople are paid by the outsourcer. This does not mean that salespeople are unethical; it means buyers must perform their own analysis and should not be lulled by sales rhetoric.
  • Implement a negotiation strategy. A good negotiation strategy is built on three pillars: information about the outsourcer’s needs, knowledge of the outsourcer’s fiscal year and the level of access its sales team has to decision-makers. Determine which contract terms are important to the seller. Time your negotiations to culminate slightly before the end of a quarter or the end of the fiscal year. Demand a more senior sales team (particularly if you want something beyond the normal contract terms,) if your team does not have access to decision-makers.

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