In 2019 the global market for IT services will exceed one trillion dollars. \u00a0Roughly 1\/3 of that business will be contracts that come up for renewal and one third of that business will be retendered. \u00a0One thing that is certain is that contract renewal is big business. \u00a0It is also clear that the incumbent vendor will have significant negotiating leverage. \u00a0If the proper counter measures are not applied, customer negotiating teams will be transferring a significant portion of shareholder value over to their providers.\nAre your outsourcing contract terms on the horizon? If so, you generally have four options:\n\nRenegotiate the contract with the existing vendor\nRenegotiate a portion of the contract with the existing vendor and retender a portion\nRetender the entire contract\nInsource portions of the contract\n\nThere are a number of factors to consider in making the determination of which path to choose. These factors include:\n\nStrategic considerations such as a change in technology landscape or vendor rationalization\nIncumbent performance or nature of the current vendor relationship\nImproving the customer\u2019s economic performance by exploring lower cost options\n\nAn additional factor that contributes to any contract renewal is the consideration of switching costs. Switching costs can be classified into two broad categories; those costs which are reasonably quantifiable, and those that are more subjective in nature.\nQuantifiable switching costs\u00a0include contractual penalties or lost credits, transaction costs to select and negotiate with a new vendor, transition costs to plan and execute the switch, and the accounting for the redundant service relationships managed during the time of transition.\nSubjective switching costs\u00a0include the consideration of potential business disruption, accounting for lower than anticipated future vendor performance, and the loss of both business and personal relationships that have been nurtured as a result of the incumbent\u2019s engagement.\nThe risks of switching vendors should not be underestimated. Switching risks are often times greater than the initial transition to outsource. New risks related to the ability to transfer assets between vendors, dealing with the incumbents fixed contract time horizon, and the ability to transfer knowledge from one vendor to another are typically not easily mitigated.\nHere are a few things we can learn:\n\nIf the incumbent is perceived as delivering high value, then there is likely to be a corresponding perception that switching costs are high\nIf the perception of switching costs is high, the likelihood that the sourcing organization will choose to retender vs renegotiate is diminished\nThere is some qualitative evidence that suggests that if the incumbent and the client have customized the service offering to fit the client\u2019s needs, clients may feel guilty evaluating alternative suppliers\n\nWell managed vendors recognize the importance of switching costs. These vendors understand that switching costs create a barrier of entry for competition. These costs therefore become a factor in driving price during contract renegotiations.\u00a0The vendor playbook\u00a0to build the client\u2019s perceived switching costs typically includes: offering rewards based upon volume or duration with the brand, building a client\u2019s dependence on vendor\u2019s proprietary assets to deliver the service, and bonding with the client in some intangible ways that fulfills personal needs and desires. Once the psychological platform of high switching costs has been laid down, incumbents can drive pricing higher during renegotiations knowing the client is less likely to consider switching.\nCustomers can regain some of this psychological leverage by running their own playbook to lower the incumbent\u2019s perception of switching costs.\u00a0This playbook should include three sections:\n1. Initial contract negotiations\nInclude actions to lower switching costs such as clearly defining exit terms and responsibilities, licenses to utilize assets in perpetuity and methods of dealing with end of contract credits.\n2. Vendor management\nIdentified countermeasures that can be implemented which reduce the vendor\u2019s ability to increase perceived switching costs without diminishing the vendor\u2019s value proposition. Tactics include documentation audits, client tracking of vendor performance, and C-level briefings on incumbent performance.\n3. Renegotiation strategy\nA well-defined plan for negotiating contract renewal that works to reduce the vendor\u2019s perception of switching costs. Steps in this strategy include an early start supporting the concept that switching is actually an option, providing honest feedback regarding vendor performance, and demonstrating knowledge of current price and service levels available in the marketplace.\nWith the average size of renegotiated contracts ranging from 20 to 40 million dollars and renegotiation frequency increasing, customer negotiating teams can no longer hand the perceived switching cost advantage over to the vendors.