IT outsourcing agreements: 3 details many negotiations forget

Whether you are establishing an outsourcing relationship for the first time, preparing for a sourcing event, or getting ready for a painful renewal discussion with your incumbent service provider, there is no circumstance where an outsourcing agreement should be executed without each one of these items first being addressed.

It is not hard to come across a blog or article that covers the “must haves” or “gotchas” in an IT outsourcing agreement and, for the most part, there are some good takeaways from them.  When looking to structure an IT outsourcing relationship with a chosen provider and seeing the issues that come up throughout that endeavor, it is important to raise three areas that don’t get as much coverage as they should.

These issues are not only concerning for companies as they look to establish a relationship with an outsourcing provider, but they are also issues that sometimes go unaddressed, resulting in significant challenges and costly headaches for organizations.  Those that fail to address these issues are left trying to correct past mistakes while negotiating their relationship with limited-to-no leverage given everyone at the table knows the likelihood of walking away is minimal.

1. Transition phase – Assigned responsibilities and structure for on-time completion

First, every IT outsourcing agreement must clearly define and assign roles and responsibilities during the transition phase.  Whether this is a transition from the organization directly or from an incumbent service provider, it is critical that all party’s responsibilities are understood and stated in the applicable statement of work (SOW).  In addition, it is vital to have an established timeline with clear milestone and completion dates.  Once addressed, it is important to put in place a contractual structure that will ensure the transition phase is completed on time.  There is not a single organization that would be sheltered from the impact of a transition taking longer than originally expected.  

So, what must be negotiated to avoid this?  The outsourcing agreement should provide an organization the ability to hold back a meaningful percentage of the fees associated with the transition effort. The holdback amount should also be subject to forfeiture should the transition not be completed according to schedule.  The forfeiture of fees helps offset some of the costs associated with the delayed transition while incentivizing the service provider to deliver according to the agreed schedule.  It is important to note that forfeiture of the holdback amount would only apply in instances where the failure is directly tied to the outsourcing provider’s effort.  If the organization caused a delay in the timeline, the structure would be adjusted accordingly.

2. Transition/termination assistance – Established service provider obligations

The second factor that must be negotiated into every outsourcing agreement is a transition and/or termination assistance provision. It may seem problematic to start your relationship with your outsourcing provider with discussions around the contractual obligations should there be a “divorce,” but organizations that fail to address this pay dearly both from a cost and effort perspective. 

Simply put, every outsourcing agreement must have a provision that outlines the service provider’s obligations should the relationship come to an end (whether by termination or non-renewal).  It should cover scenarios where the organization is bringing the work back in-house as well as moving it to a competing service provider.  Additionally, the duration of transition services as well as the associated fees should be clearly identified in the agreement to avoid negotiation of these key terms while the relationship is being terminated. Ideally, this would also include a negotiated and complete rate card as an attachment to the agreement which would apply to the transition service fees.

3. Service level agreement – Meaningful penalty for non-conformance and right to terminate

The third point that must be addressed while negotiating your outsourcing agreement has to do with the ever-important SLA and ensuring that your organization receives the proper services for the fees paid.  Assuming everyone has adequate service levels addressed in their outsourcing arrangement, I will instead focus on how you and your organization can ensure high quality, timely and effective service delivery.  Having service levels is simply not enough. 

Every SLA must include a service level credit structure and right to terminate for service level non-conformance.  If during your negotiations you sense any hesitancy from the service provider on either of these items, you may want to reconsider them as your preferred service provider.  A service level agreement without penalties for non-conformance is only as good as the paper it is written on.  A service provider that stands behind their services should not take issue with being held accountable should they not perform as expected.  

The total service level credit needs to be meaningful (2% is not meaningful) and it should be scaled based upon the extent of non-conformance.  With regard to having the right to terminate, although it is often unlikely that an organization would chose this path given the complications it would create (for example, how is the service going to be delivered while finding a new provider?), it should still be addressed and should provide the ability to re-address it upon repetitive service level non-conformance (i.e., two or more consecutive reporting periods).  You also should not accept the service provider’s requirement that a termination penalty is included.  The only fees that should be required upon termination are reasonable wind-down fees and expenses, which should also be specified in the agreement.

Whether you are establishing an outsourcing relationship for the first time, preparing for a sourcing event, or getting ready for a painful renewal discussion with your incumbent service provider, there is no circumstance where an outsourcing agreement should be executed without each one of these items first being addressed.

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