by Esteban Herrera

What to ask when renegotiating an outsourcing agreement

Oct 06, 2015
Managed Cloud Services Outsourcing

Though outsourcing buyers don't always look forward to the contract renewal process, it can be a productive time to gauge the health of the relationship and evaluate the potential for performance improvements.

The way enterprises address end-of-term outsourcing agreements has changed radically over the last few years. For most of the history of our industry, both buyers and providers took a “head-in-the-sand” approach to the end of the contract, hoping that, if they ignored it long enough, it would go away. But it never did.

Renegotiating or re-competing an outsourcing agreement doesn’t excite the vast majority of people, but it is an inevitability that must be faced every few years. In the past, the buy-side enterprise would often invoke its right to renegotiate far too late to make any meaningful changes, or both parties would simply let the date slip by and the auto-renew provisions would take effect quietly and without much notice. Over time, this do-nothing approach frustrated the parties, both of which knew they had an out-of-date agreement but were afraid of what it might become if it they had to do it over again.

Today, the renewal process is very different. Providers, in particular, are coming to the table with proposals to improve and/or expand the services they provide as early as 24 to 30 months into a contract. They understand they may not be able to protect all of their revenues, but they know enough about the client environment that they feel confident they can optimize their margins. This could mean returning a tower or sub-tower to client control because it never really got off the ground the right way. Or it could mean moving certain services to the cloud. It could also mean adjusting service levels to what both parties finally know to be realistic and required by the business.

Clearly, enlightened self-interest is at play here. Providers understand all too well that the advantage of incumbency has shrunk. The sooner they get to a renewal, the less likely they will be subject to competition. Often, a provider can offer significant improvements on cost or service in exchange for an extension of the contract term. In a quarterly-results-driven environment, these improvements are hard to pass up.

Even with promised improvements, these early renewals may or may not be the best deal for the buyer. Often, renewals have the effect of simply delaying the problem: instead of having an agreement that is out-of-market today, an enterprise will have an agreement that is not market-correct in a couple of years. Buyers are often moved to action by very compelling short-term promises only to find that they missed an opportunity to exercise their leverage a short time later.

How do you know if you should take the early renewal or not? Here are some questions to ask:

1. Could I get these performance improvements another way? Is a renegotiation really necessary?

2. Will the promised improvements deliver meaningful business results, or will they simply be operational enhancements that do not affect the bottom line?

3. What developments are around the corner that I could miss out on by agreeing to these modifications?

4. Am I happy with the relationship? Can I exercise leverage to improve it, or would I just be prolonging a doomed collaboration?

5. Would an external advisor help me understand whether the services offered are market-correct?

6. Am I leaving money on the table by not benchmarking the services?

7. Is the extension a reasonable trade-off for the promised improvements?

8. Besides securing business over a longer term, does my service provider have ulterior motivations?

Because these questions do not have a consistent answer, there is no one-size-fits-all prescription for addressing early renewals. The key is to be deliberate and analytical and to fully understand the state of the market. After the initial contract award, leverage opportunities are difficult to find, so buyers who are presented with one must act strategically—not impulsively—to make the most of it.