by Stephanie Overby

Outsourcing Contracts: Clause Control

Mar 01, 20073 mins

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.

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.

Mandatory Reference Clause

If you’re going to fight for only one protective clause in an outsourcing contract, says Daniel Masur, who represents outsourcing customers at Mayer, Brown, Rowe & Maw, make it the mandatory reference clause. It’s got nothing to do with pricing protection directly. It mandates that the vendor use you as a reference at least a certain number of times a year. “In terms of aligning interests of parties, there is no more powerful clause,” says Masur, than having to put unhappy customers in touch with new prospects. “Do well and you can use me as your greatest cheerleader. If I’m not happy, you’re putting future work at risk.” Others argue that this clause is too easy for vendors to ignore. “It’s not enough of a lever,” says Mark Robinson, executive director of advisory services for outsourcing consultancy EquaTerra.