Renewal of Outsourcing Contracts - A Necessary Opportunity, Outsourcing Leadership Newsletter

This article originally published in  Outsourcing Leadership, an eNewsletter of Alsbridge Consulting.

The outsourcing market is maturing, many outsourcing contracts are nearing the end of their life and there is a trend toward shorter contract terms. According to industry sources, an unprecedented number of contracts were renewed or restructured in 2005 and this trend should continue in 2006. The renewal of an outsourcing contract represents a significant opportunity for customers to revisit the terms governing the relationship, including pricing, scope, service levels and legal requirements. Too often, customers let this opportunity pass and simply renew the contract for an additional term without considering changes in the customer's business, the outsourcing industry, or the regulatory and legal environment.

Aging Contracts

A successful outsourcing relationship is dependent upon factors that are constantly changing, including people, business requirements, technology and business processes. Add to this changing laws and regulations and a dynamic outsourcing market, and it is easy to see why outsourcing contracts are not aging gracefully.

Significant time, energy and money are often invested in negotiating the original outsourcing contract. The customer's team often consists of interested business constituents, outsourcing consultants and legal advisers. This knowledgeable and experienced team helps craft a strong contractual foundation on which to build the outsourcing relationship. However, by their nature, outsourcing contracts are static. They are printed on paper and do not magically change with the business relationship. Furthermore, companies generally do a poor job of amending these contracts when the parties alter their course of dealing. Indeed, it seems that, during the life of the contract, the only time the contract documents are referenced is when there is a dispute. Not surprisingly, these disputes often arise due to poorly managing the relationship to the requirements of the contract.

A contract's renewal may be the best opportunity for both parties to reset the contract and align the document with the parties' operations, requirements and business expectations. In particular, this renewal period represents a significant chance for the customer to adjust the terms and scope of an outsourcing transaction to help ensure that the deal remains competitive in the outsourcing market and complies with legal and regulatory requirements.

Terms to Reconsider During Renewal

  1. Price and Scope

    On the top of a customer's list of terms to consider renegotiating should be the price and scope of the deal. The outsourcing industry is expanding and diversifying, creating a competitive buyer's market. There are more providers offering more services from more locations. Offshore service providers are increasingly capable of competing with the leading U.S. and multi-national service providers. This increase in suppliers has resulted in companies strategically outsourcing various aspects of their businesses to different suppliers in order to capitalize on the suppliers' relative specialties and strengths. This diversification has resulted in a greater acceptance by suppliers that customers now require suppliers to work with competitors in multi-vendor environments. All of these factors are forming a dynamic and competitive outsourcing market that is driving increased value to customers. To the extent that a customer has not revisited a contract's scope and price in a number of years, the renewal period should be used as a tool to reevaluate and potentially re-bid or benchmark the current deal against this new outsourcing landscape.
  2. Service Levels

    Often customers discover that the initial service levels in the contract are not as effective as they could be because they measure the wrong thing. In addition, rapidly changing technology and improved business process should drive customers to reevaluate expected service levels so that such customers can remain competitive in their respective industries. Service providers are continually achieving higher productivity through streamlining and refining processes. A customer should take advantage of these improvements and demand higher service levels, and service levels that more closely measure business impact and outcomes, when the contract is up for renewal.
  3. Legal and Regulatory Requirements

    The last few years have seen significant changes in the legal and regulatory environment in which public and private companies operate. Sarbanes-Oxley, privacy laws and national security regulations may require different actions and contractual language then was required just a few years ago. Accounting for and incorporating these requirements should be a top priority for customers during the renewal process.
  4. Governance and Disengagement Plans

    Governing an outsourcing contract is both a science and an art. The science is in dutifully tracking and enforcing the performance of the outsourcing provider against the contractual commitments and service levels in the agreement. The art is in managing the relationships between key customer and supplier constituents. One problem in managing these relationships is the fact that the individuals who negotiated the initial outsourcing contract are often different from those that manage the relationship on an ongoing basis. In addition, over the years there will be inevitable changes to personnel governing the relationship on both the supplier and customer side. Because of this, a governance model that is overly dependent upon the rapport and trust built between individuals will necessarily deteriorate over time. A change in personnel or a weak governance framework may require the parties to revamp the entire governance structure.

    In addition to governance, a customer should use a contract's renewal to update or create a thorough disengagement plan. This is the document that outlines each party's obligations in the event that the contract is terminated and the responsibilities of the supplier are transitioned back to the customer or to a third party. Disengagement plans are often not fully developed in the original contract due to a lack of information regarding the scope of services and uncertainty regarding the interactions between the customer and supplier. However, because the parties will now have the advantage of experience, it should be easier to develop a robust disengagement plan.

The Renegotiation Process

Thomas A. Edison said, "Opportunity is missed by most people because it is dressed in overalls and looks like work." There is no doubt that renegotiating contract terms during the renewal of a significant outsourcing relationship will be hard work and may require similar resources and planning as was necessary to create the initial contract. However, this opportunity should not be missed. Outsourcing customers should take advantage of the leverage gained during the renewal and put in place terms and conditions that reflect the customer's requirements and preferences as well as current market conditions.

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