Time flies when you're outsourcing. Deals that were struck five or six years ago as the industry really started to take off are showing their age. With technology pressing ever onward and market conditions and customer needs shifting, the outsourcing industry is seeing a wave of contract renegotiation, restructuring, renewal -- and termination. Technology Partners International reports that of the 64 deals with total contract value greater than $250 million signed in 2000, only 45% remain active with no significant restructuring. For some insight into how companies can best manage the renegotiation process, Corporate Dealmaker's Kenneth Klee spoke with Robert M. Finkel, a partner in the global corporate group of Milbank, Tweed, Hadley & McCloy LLP and a veteran of multiple outsourcing contract renegotiations. Excerpts:
Corporate Dealmaker: What are the main reasons for companies to renegotiate?
Robert M. Finkel: One is just the passage of time. As the outsourcing marketplace matures, agreements need some tinkering just to be kept up-to-date. The second is change in technology, which can motivate either side to renegotiate. If technology changes lead to lower prices, there may well be benchmarking provisions in the contract that call for renegotiation. Next, there's the situation where the vendor is not performing and not meeting its contractual obligations; in that case, the customer is going to want to renegotiate or perhaps terminate. And finally, there's M&A activity. If a customer is involved in a corporate transaction, there may be a change in philosophy regarding outsourcing or a consolidation of operations.
If the contract still has some years to run, is it hard to begin a renegotiation?
Well, renegotiations do require lots of advanced planning. And customers definitely need to know their contractual rights and who has the leverage in the renegotiation. But most vendors want to keep their customers happy, so even if a customer has no contractual right to renegotiate, most vendors will listen to them and try to accommodate them because they don't want unhappy customers out there.
What's the typical sequence when the contract is running down?
Most people, a year to a year-and-a-half before the contract expires, begin to look up and say, OK, what are we going to do now? If the customer is happy with the vendor, then they will usually open up discussions at that point on renegotiation of the terms. They will oftentimes do a market check to see whether the terms and service levels are market-competitive, but they will not necessarily competitively bid the deal. Then the renegotiations usually begin, six months or so before the contract terminates.
If the customer is not confident in the vendor, or if there have been some problems on the transaction, or if they're not confident that they're able to get a good assessment as to whether the terms are market-competitive, clients are more likely to put out the contract for competitive bid. And then, what typically happens is six months to a year before the end of the contract, they'll actually send out an RFP [request for proposal] to vendors, including the incumbent. In my experience, though, most contracts stay with existing vendors -- even if there's an RFP for the renewal.
Tell us more about the market check. Can it be a source of negotiating leverage?
Absolutely. A market check can be as simple as having consultants come in and provide their assessment regarding pricing for transactions, or it can be a month's worth of analysis. The more information the customer has about where the vendor stacks up against the competition, the more leverage the customer will have. The expense of running a market check in most cases will be well worth it.
What kinds of provisions do you put in contracts to give customers leverage in later renegotiations?
They take a few different forms. One is a benchmark provision, which is pretty common in long-term outsourcing agreements. It's basically an opportunity for the customer to get a market check and see whether the contract is competitive, in terms of pricing, in terms of service level and increasingly in terms of the technology that the vendor brings to the table. The second thing is that some contracts provide for continuous improvements and bringing new technology to the table over the course of the deal. There may also be an early termination right enabling the customer to end the deal for a negotiated fee.
Is the rise of business process outsourcing, involving complex functions like finance and accounting and human resources, changing things? Are the contracts tougher? Are they resulting in more renegotiations?
I think there's a greater challenge in BPO deals. I'm afraid to say that the art of writing the contract hasn't always kept up with market developments. Many still just take the basic IT outsourcing contract and apply it to a BPO deal, which doesn't always work, because in a BPO deal there are different risks and different considerations. If you're doing a finance-and-accounting transaction, the risks associated with Securities and Exchange Commission compliance are much greater than in an IT deal, and the contract ought to reflect that. In an HR outsourcing transaction, compliance with law is much more important than in a typical IT deal.
Is it harder to get comparative market information in the BPO realm?
Yes, I believe it generally is harder. The deals are much newer. There's no common platform. A lot of times, the technology supporting the services is new. And it's harder to compare yourself versus other customers out there because so many of the BPO deals tend to be custom transactions.
A lot of these BPO deals are so-called transformational deals, entailing major changes and improvements in the business processes. Do those pose special problems?
Usually, there's a significant transformational period, a year or two where the vendor is going to come in and re-engineer things, and you find out in that period whether it's going to work. So customers are building into the contracts provisions allowing them to assess the vendor performance earlier on.
We're seeing more terminations in the early years of BPO deals, and I think that will continue until the market matures more. That is not to say the demand for BPO deals is not strong or that the risks outweigh the benefits; in fact, I would expect the BPO marketplace to continue to expand rapidly.
What are the typical BPO problems?
One is that sometimes the vendor may not fully understand the customer's environment or, alternatively, from the customer's perspective, they are disappointed that the vendor can't provide the full level of services that they thought they would receive.
"Transformation" is kind of a grand-sounding word. Does it leave room for miscommunication?
Yes, it can. Oftentimes, in these transformational deals, a lot is left unsaid about what the actual transformation will look like. It might be described at an extremely high level without a lot of the details, and then once you get around to actually figuring out what that transformation is, disagreements can arise. From a customer's perspective, that's one thing to be very careful of in deals: They should have in the contract as much precision as possible regarding the transformation. I've seen some deals where the transformational commitments from the vendors are not as developed as they should be, looking more like marketing pieces than they do actual contractual commitments.
Is it hard for the customer to anticipate the details, given that, by definition, the process is going to work in a manner they're unfamiliar with?
Yes, of course, for the customer this will be all new. And for the vendor, particularly with some of the custom BPO offerings, they may be going through this for the first time as well. Or at the very least, they're going through it for the first time with that client. And in the HR and F&A areas in particular, clients can run their operations differently. So the vendors can't always apply the same transformational formula that they've used in the past for other clients.
Sounds like we'll continue to see lots of renegotiation in outsourcing.
Yes, it's really the nature of the business. Every customer who enters into a deal can expect that there's going to be a renegotiation at some point, if for no other reason than the fact that there is a stated term for the contract. Like everything else in life, any particular outsourcing deal simply is not perpetual in nature. CD
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