by Elana Varon

Vendor Management Strategies

Nov 01, 200315 mins

When Jeff Chasney signed on a few years ago as CIO of Vicorp, which owns the Village Inn family restaurant chain, he inherited a contract for maintenance of point-of-sale terminals that had “great, low rates.” But service was a disaster. When equipment that was used to input orders to the kitchen malfunctioned, it wasn’t repaired promptly, and the downtime resulted in lost revenue.

He fired the vendor and put the contract up for bid again. To his surprise, every proposal he received quoted a higher labor rate than he had been paying. “While everyone was doing high fives over getting such a great price, we had put [the vendor] in such a bind it was impossible for them to be successful,” Chasney says. He agreed to pay the next contractor more; system uptime improved and so did the bottom line.

Chasney, now the executive vice president and CIO with CKE Restaurants, the $1.3 billion franchisor of Hardee’s, Carl’s Jr. and La Salsa restaurants, says he always looks for “fair deals,” in which the vendor makes money and he gets value. After 15 years as a CIO, he’s familiar enough with vendors’ costs to know how far he can push them without hurting himself.

Yet according to an exclusive CIO survey, he’s an exception rather than the rule. Although 94 percent of the 118 IT executives surveyed make the effort to negotiate lower fees, that kind of lowballing generates precious little business benefit. Indeed, the same survey found that for nearly two-thirds of respondents, squeezing dollars from vendors’ fees wasn’t very effective at adding business value. It didn’t, for instance, make employees more productive or generate new business. And in many cases, it boomeranged into poor service and support. When it comes to relationships with vendors, the old adage still applies: You get what you pay for.

“If you get the lowest cost and that hurts the vendor, you will suffer,” Chasney says.

To make sure he gets what he pays for, Chasney negotiates detailed service-level agreements (SLAs) that spell out what he’ll get for his money. And in fact, what does add value, according to the survey respondents, is crafting airtight contracts that balance toughness with fairness. Fifty-four percent of those surveyed give high marks to the effectiveness of comprehensive SLAs. The more specific the SLA, the better, CIOs say in interviews, so that both you and your contractors agree about what they have to deliver and when, and how much it’s going to cost.

“You should avoid the tendency to take the last nickel off the table,” says Wayne Bennett, an attorney with law firm Bingham McCutchen who negotiates IT contracts. “When push comes to shove, there are things that will go wrong with a project, and you’re going to have to have a discussion about how to right this ship. That discussion will be colored by whether there is anything left in this deal for the vendor.”

The Hasta La Vista Bluff

These days, any customer—but especially a big customer—can throw its weight around. It’s easy when the economy is still in the doldrums and so many vendors are chasing so few corporate IT dollars. Besides, says Chasney, most products and services are priced for haggling. Buying a million-dollar database? “I know there are [vendors] that put a system in for free to get rid of competitors,” he says. “The cost to them to create five more CDs and another set of books is less than $1,000. The bang for them [is] in the maintenance fees.”

In addition, plenty of CIOs are under orders to keep down costs in the short term. Meeting budget numbers for the quarter, or the year, may take precedence over maximizing value. And there is some value to negotiating lower prices. During the tech boom, some CIOs bought too much and are now stuck with equipment and software that they no longer need. There’s little point in paying full freight for something you’re not using, such as software licenses. Reopening a long-term contract may be an option, but it isn’t easy, says Phil Bertolini, director of information technology with Oakland County, Mich. You have to be willing to walk away from the contract altogether if the vendor won’t renegotiate. And breaking a software or hardware contract may involve paying penalties, and you’ll probably have to shoulder the cost of maintaining systems yourself.

The CIO for a large manufacturer of high-tech equip- ment bought several thousand licenses for an ERP system from SAP in the late ’90s and never used them all. Now he has one-third fewer users, only a couple of hundred of which are active at any one time. The CIO wanted to quit paying the maintenance fee for the idle seats and got SAP to slash $1 million from his annual bill. During the negotiations, the CIO decided he would kill the entire contract if necessary and take on system maintenance himself. Walking away from the deal would also mean forgoing upgrades. “We were prepared to say we’d live at this level, knowing we would be shooting ourselves in the foot,” he says.

In bargaining down his maintenance fees, the CIO did make a trade-off in favor of the vendor: He agreed not to lock in the rate he’ll pay on licenses he reactivates. Locking in rates or rate increases for maintenance fees per license is one way CIOs are able to keep their costs low and predictable. By giving up a long-term negotiated rate per license, the CIO essentially gave his vendor permission to charge him higher maintenance fees in the future. “We’ve started hiring again, and we may have increased costs in the future,” says the CIO. But the renegotiations enabled him to save money now and continue to have SAP support his ERP system.

Even when a deal is for a commodity such as a PC or telecom services, you have to think about factors such as maintenance and replacement costs. Is the vendor that sold you those servers at a rock-bottom price going to replace them if they turn out to be lemons? And if not, how much is that going to cost you later?

Several years ago, Sandra Hofmann, CIO with ERP vendor Mapics, chose a low-price vendor to supply videoconferencing services, only to have that company bought soon after by the larger, higher priced competitor she had rejected. Although the new vendor honored the original contract terms, it decided not to continue supporting the original vendor’s product, so Hofmann had to switch when her agreement expired. Then she had to retrain users on the new software.

“Having to relaunch any service, even with minor changes, means that I’m not as efficient,” she says. While Hofmann still tries to pay as little as she can, she learned that hiring the lowest-cost vendor is risky because it may not be as financially stable. “It may be a reasonable trade-off, but it should be done consciously.”

Frank Enfanto, vice president of operations delivery and information security with Blue Cross Blue Shield of Massachusetts, cautions that if a vendor wants your business badly enough, it’ll promise anything. He recalls a recent negotiation to consolidate his company’s telecommunications services with one vendor out of the three companies it had been using. Enfanto says he settled on the vendor that he was confident could match the price he wanted and still maintain the service levels he required. When he notified the two other competitors of his decision, one of them—a large, national provider—asked for another shot at the contract. “They told me they were holding back” and could beat the prices they had originally offered, says Enfanto. But he wondered if that vendor would really deliver the same service levels and terms at the lower price. Because of his suspicions, he didn’t reconsider his decision.

Getting Value with Volume

What you want, of course, is value for your money. The best way to achieve that is to keep contract negotiations focused on the business benefits of the deal and whether you’re paying enough to achieve them. One of the most popular contracting practices in the CIO survey—and the top-ranked practice for generating business value—was consolidating vendors for volume discounts. This practice, used by 72 percent of survey respondents, offers vendors the opportunity for additional sales at the same time as it allows CIOs to lower their per-user costs. Meanwhile, according to the survey, many of the other contracting practices CIOs say are most effective at generating business value link vendor payments to performance through service-level agreements or other, similar provisions. Such practices require customers and vendors alike to constantly evaluate whether what the customer is paying is realistic to support the work that is expected.

CIOs say consolidation decisions should be driven as much—if not more—by business needs as price if you expect dividends beyond cost-cutting. When Oakland County, Mich., wanted to install a geographical information system from ESRI, a major vendor of GIS mapping software, the county got the vendor to agree to a bulk purchasing deal that included 62 of its municipalities. The county and its cities were able to deploy a single system for about one-third of what it would have cost to have each jurisdiction make separate investments.

The deal provided a predictable benefit for ESRI: The company sold more licenses than it would have if each cash-strapped municipality had to make its own investment to develop and deploy the technology. Bertolini figures many of the smaller villages in the county wouldn’t have made the investment at all, and those that did make the purchase might not have picked compatible systems. With each community using the same system, county and city officials are able to coordinate their delivery of services in ways they never could before.

This summer, the county used the system to provide the municipalities with information about the occurrence of West Nile virus that local officials relied on to make their mosquito spraying decisions. Armed with data about the extent of the problem, the county was also able to provide money for spraying to cities that needed it. As of mid-September, Oakland County had reported no human cases, but the presence of the virus was confirmed in two birds and three mosquito pools, according to the Oakland County Health Division.

Linking Pay to Results

No matter how good a volume pricing deal you’re able to negotiate, however, it may be hard, if not impossible, to realize the full benefits of an IT investment without defining the performance you expect for your money. Christopher Feola is vice president of technology with Belo Interactive, a division of the $1.4 billion media conglomerate Belo Corp. Feola once contracted with a well-known software vendor to build a 40-seat pilot project for a messaging system that would support group collaboration. If the pilot were successful, Feola says, his parent company intended to purchase seats for 9,000 users. But, instead, it turned out to be a failure, and Feola and Belo ended up scrapping the project altogether.

The vendor, he says, put its efforts into designing a system that would work on an enterprisewide scale instead of just in the test environment. As a result, the vendor was never able to focus on Belo Interactive’s requirements for the smaller-scale pilot that the parent company was relying on to demonstrate ROI. The system never worked. The lesson, says Feola, is that it often takes more than a guarantee of future sales to get a vendor to fulfill its promises. In retrospect, he says, he would have made sure the vendor was committed to the same vision of the project that he had. A comprehensive SLA is a good way to do that.

A major reason why SLAs are so effective, says Mohanbir Sawhney, McCormick Tribune professor of technology with Northwestern University’s Kellogg School of Management, is that they align the business goals of both the customer (who wants the ROI) and the vendor (who wants to get paid). Most CIOs use SLAs to define performance for services such as maintenance, operations and software development. Sawhney thinks the concept ought to be extended to whether a customer gets any value from deploying packaged software. Say you deploy a new call center application to improve customer service. Most CIOs, Sawhney says, would pay the vendor based on traditional metrics such as system uptime or how long it takes the vendor to fix a problem. But the business value of the application is to improve customer service, and Sawhney thinks the vendor should be paid based on whether that goal is achieved. Does the software help you respond more quickly to customers? Have your customer satisfaction rates improved?

“The way traditional software license pricing works is completely screwed up,” he says. “The vendor gets paid up front before any benefits are realized.” No wonder CIOs complain.

Bingham McCutchen’s Bennett says he’s seen an increase in such SLAs. But holding vendors accountable for achieving a business result like higher customer satisfaction rates isn’t easy, admits Sawhney. There’s more to the success of a software deployment than whether the product works as advertised, including whether employees use it. For this reason, “vendors will not voluntarily do this,” Sawhney says. That’s one likely reason why although 54 percent of survey respondents say using SLAs that are based on business metrics rather than technical measures is an effective way to obtain value, only 34 percent actually engage in this practice.

Nevertheless, savvy CIOs agree SLAs ought to derive from your definition of business value for the deal. “You need to explain to [vendors] what you’re trying to achieve,” says Hofmann, and show them how the work they’re doing contributes. “If a vendor is not meeting commitments established in the service-level agreement, that impacts how much value I’m going to be able to deliver.”

Sometimes focusing on value may even lead to higher costs, but that’s not necessarily a bad thing. Almost two-thirds of survey respondents who negotiate SLAs with vendors say they’ll continue using this practice, even though it doesn’t often save money. If, as part of an SLA, you ask a vendor to customize a service to address a business need, you shouldn’t be surprised if the vendor wants to charge you more, observes Blue Cross Blue Shield’s Enfanto. If you don’t want to shoulder the extra expense, you have to be less demanding.

Before he negotiates an SLA, Enfanto sits down with business managers and pushes them to define their expectations for the contract, such as how quickly they need a system repaired if it crashes. Their needs drive the negotiations, and part of Enfanto’s role is to educate them about the trade-offs between cost and value. “More and more, our IT budgets, especially project budgets, are controlled by the business,” he says. While they may be willing to pay more for a critical benefit, Enfanto doesn’t always tell the vendor that. He may, for instance, tell the vendor it could lose business to a cheaper competitor, even though the competitor may not be providing all the functionality business users want. But he doesn’t push too far. “I make a value judgment about how much this [contract] is going to cost them,” he says.

For vendors, meeting the commitments they agree to in an SLA has an impact on their business beyond getting paid for their services. For one thing, there’s always potential for repeat business if the deal goes well and for angry customers if it doesn’t. If a vendor isn’t performing according to the SLA, “I have to manage them a whole lot more, and the more time I spend managing, the less business value I get out of them,” Bertolini says.

No matter how conscientious the vendor is, however, crafting a good SLA and making it stick is hard work. There’s no such thing as too much detail, says Chasney of CKE Restaurants. “Everything should be spelled out on paper, so there’s no room for either side to misinterpret the agreement,” he says. But no matter how airtight the contract, no relationship with a vendor is trouble free. Whether you’re able to navigate those disputes depends on how well you understand the value to both you and your vendor.

The bottom line? You want a good deal. And you’ll get one by letting your vendor keep his wallet. If a vendor isn’t willing to be held accountable for performance, concludes Bertolini, “you have to wonder if [you] can do business with them. Obviously, if a vendor sits down at the table with me and I reach across to choke them, they’re not going to do business with me.”