by Stephanie Overby

The Best Time to Negotiate an Outsourcing Contract

Sep 08, 2009

The last days of an outsourcing contract are the perfect time for customers to bargain with their IT service providers for better service and prices. Yet few customers take advantage of that end-of-life leverage, and those who do often wield the power as a cudgel and do more harm than good. Here are six best practices for making the most of the last days of any outsourcing deal.

The final months of an IT services contract are an ideal time for outsourcing customers to negotiate with their vendors for improvements in price and service quality. As the deal end-date approaches, the customer wields more power than at any other point in the relationship since the client can seriously consider alternatives without the threat of termination fees or other penalties.

The only catch is that outsourcing vendors know just how difficult it is for customers to actually cut the cord. “Client threats to repatriate or go to RFP [can] ring hollow as vendors recognize that replacing an incumbent is complicated, expensive and risky,” says Bob Mathers, senior consultant for Compass Management Consulting.

[ How to Renegotiate an Outsourcing Contract ]

As a result, many outsourcing customers watch the contract termination date come and go without taking full advantage of the opportunity that accompanies an outsourcing deal’s natural end. “Renewing with the existing vendor and taking the nominal discount they offer is quick and relatively risk-free. That’s tempting in today’s environment and might very well be a reasonable choice,” Mathers explains. “But you’ve got to do your homework on what other options are available and what you might be leaving on the table.”

At the other end of the spectrum, some outsourcing customers get drunk with power as the end of term approaches, and they demand arbitrary, across-the-board rate cuts without considering existing services or business requirements. That can lead to one heck of a hangover.

“If you’re demanding aggressive cuts based on intuition or from what you’ve been told on the seventeenth tee, that can be very dangerous,” says Mathers. “If the client drives price cuts to the point that the deal is unprofitable for the vendor, the vendor will not be motivated to deliver quality service, put talented people in place, or be responsive or innovative to client issues.”

[ 9 Ways to Save Money On Your Current Outsourcing Contract ]

Any increased influence an outsourcing customer has near the end of a relationship comes not so much from the impending end date, but from an increased understanding of organizational needs and market rates. Knowledge is indeed power. “The true leverage comes from demonstrating that you understand your existing situation, have explored alternatives, and are willing to pursue them if necessary,” Mathers says.

While the wholesale shift of IT support to another vendor or back in-house is rare, splitting up large agreements among multiple providers is not. The vendors know this and should be open to discussions about taking on discrete pieces of the larger outsourcing pie. “Demonstrating that you are seriously looking at these options is the first step to gaining some leverage in discussions,” says Mathers.

On the flip side, smart IT executives will also examine where expanding the scope of the deal might make sense. “It’s about the carrots as well as the sticks,” adds Mathers.

Best Practices for Negotiating Outsourcing Contracts About to Expire

1. Baseline existing operations. “This gives you a stake in the ground to show you where you are with respect to the market, leading practices and business priorities,” says Mathers. Ideally this work should begin 18 to 24 months before the end of a deal.

2. Create a sourcing strategy. Use the baseline data to define current and future needs and evaluate the various options available (renewing the contract, splitting it into pieces, repatriating the work) in terms of benefits, risk, price, and change management issues. Do this at least a year before the contract’s end date to give yourself enough time for renewal negotiations and an RFP process, if necessary. “Waiting until it is too late means rushing through the process, which always benefits the vendor,” Mathers says.

3. Be specific. Everybody wants lower costs and better service. When it comes time to talk turkey with the vendor, create specific targets for improvements, such as reducing storage costs by 15 percent to align with market standards.

4. Define alternatives. Have a response ready if the vendor is unwilling to address requested improvements in specific towers of services.

5. Secure senior-level support. Make sure top executives and board members buy in to your plans. Mather’s firm has seen cases where the IT executive managing the relationship works hard to drive improvement and address quality issues during upcoming contract negotiations, only to find out that top executives have already done the deal with a handshake on the golf course.

6. Get serious. Renegotiations at the end of an outsourcing relationship “can help address the issues the client has learned to live with over the life of the agreement,” says Mathers. “But it takes work and commitment.” Be prepared to follow through on alternatives if the vendor is not responsive.

“The ability to affect change comes from a thoughtful process of defining what you want, evaluating the available options and putting in place a strategy and plan to execute,” says Mathers. “The worst behavior is just not being prepared and assuming that the end of a contract brings with it significant power to negotiate change. It doesn’t.”