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Outsourcing Contracts: Clause Control

Outsourcing contracts can set you and your provider up for a beautiful friendship or a bad marriage. The performance clauses you put in the contract will determine your degree of happiness.

March 01, 2007 — CIO — There are a host of terms in your outsourcing contract that can ensure the competitiveness of the price you pay over time. Here are some of the most important clauses to fight for, along with tips on how to negotiate them:

Benchmarking Clause
This clause stipulates that you will be allowed to compare your outsourcer’s costs with the averages on the open market and negotiate for price reductions if your provider’s costs are higher. For a full explanation of this controversial clause and how to negotiate it, see our special report, “The War on Benchmarking.”

Most Favored Customer
Often requested, but rarely granted, this clause states that charges must be at least as low as the provider’s lowest charges to other similar companies for substantially similar services. Outsourcers loathe it and some outsourcing advisers say it’s impossible to police. “It’s an administrative nightmare,” says George Kimball, a partner with Baker & McKenzie, who represents customers in outsourcing contract negotiations. “Suppliers can’t easily know or compare their rates around the globe, and each contract involves complex, individually negotiated combinations of services and terms.” The state of Texas sought to include “most favored customer” language in its seven-year, $863 million data center services contract with IBM Global Services. The words themselves were dropped in negotiations, says interim CTO Brian Rawson, but the state got the gist of the protection in there.

Cost-Plus Pricing
Some customers are willing to concede any benchmarking rights in exchange for this method of outsourcer pricing. Once a year, the supplier opens its books, reveals its costs and adds a percentage in for profit. Sounds straightforward, but it “removes the motivation for the outsourcer to increase their efficiency because their margins are [always] built in,” says Geraldine Fox, practice lead of global sourcing services for the benchmarking company Compass.

Insourcing/Resourcing Right
Lawyers who represent outsourcing customers are increasingly pushing for provisions that allow the customer to take pieces of work away from the outsourcer without triggering the normal termination fee. It’s a great tool for leverage over pricing in the long term. Vendors will agree—very reluctantly—to grant such rights on larger deals if the customer pushes for it.

Continuous Improvement
Less related to price than service, this states that the vendor will continuously improve its service levels year over year. You’ll need to specify which service levels are subject to annual improvements (some may already be at an acceptable level or may be difficult to raise). A strong clause will specify targeted percentage improvements, though service providers want to limit them.