When renegotiating an outsourcing contract, clients are often unfamiliar with industry changes that could work to their advantage. Having already picked the low hanging fruit, with labor arbitrage no longer a main driver, customers are now hearing from providers that can deliver more operational functions. But this is new territory for many organizations. Navigating the shifts in the market and the changing messages from providers can be a complex journey.
“When renegotiating, customers are now looking to drive business value out of the relationship, as opposed to simply pursuing cost take-out,” says Charles Arnold, partner in the shared services and outsourcing advisory service network at KPMG. “Customers are not interested in redoing an existing deal. It is more a matter of fine tuning the service delivery model, which might involve insourcing some of the under-performing work.”
Assessing where under-performing areas might be insourced is easier than considering where a provider can take on more operational responsibilities. This is uncharted water, and can be more easily understood – and sold – in those areas where advances have delivered measurable value, such as in virtualization.
“Virtualization has changed the core delivery model so that customers are being charged per server instance as opposed to an actual server,” Arnold says. “But there are less obvious areas where, despite a provider’s best efforts, pricing can be inordinately high for a resource unit, or where they are bleeding because they’ve been undercharging.”
Increased transparency would seem to be the solution, as it would put everyone on the same page during a renegotiation – but the truth is that customers rarely get the whole story.
“We work for everyone to be transparent,” says Arnold. “Generally speaking, things aren’t opaque, but there are a lot of situations where there is ambiguity, and people are upset.”
The Time is Now
Issues surrounding renegotiation are at the fore for three main reasons: first, a large percentage of deals are up for grabs; second, providers are upping their operational, technological, and industry-specific capabilities; and third, customers are benefiting from a competitive marketplace.
“When renegotiating, customers are now looking at two or three providers instead of one,” says Arnold from KPMG. “In many deals now the entire operational model is specifically constructed with multiple providers in mind. Keeping providers on the rope is always part of the strategy.”
Patrick Hill, a director at research firm ISG, has written that the “big-ticket, long-term ‘mega deal’ is becoming a distant memory”. What we are seeing instead are customers that are more comfortable picking and choosing their delivery mix. Developing specialist capabilities is one area where providers are differentiating themselves, and also where those providers who are trying to be all things to all people risk losing business.
The challenge is real: according to ISG, the fourth quarter of 2013 saw the number of awarded contracts climb by 13%, with the overall annual contract value dropping 12% to $4.6 billion. The market is becoming more fragmented and ‘noisier’. This can put buyers in a strong position as they renegotiate – assuming they can find their way.
A Third Wheel
If a buyer hasn’t used a third-party adviser in the past, and they are coming to the end of a long-term engagement that has seen few issues, it might seem pointless to seek advice. That can change when a buyer is asked to assess a provider’s new services, many of them touching on operations.
“When customers are looking at a renegotiation they often see a combination of new business services,” says Arnold. “The thing that many people forget – and this is a major mistake – is that the new deal does not correlate to the former one. They need to revisit their entire outsourcing strategy.”
That is often more work than a buyer has bargained for, and therefore an area where a third-party adviser can come in handy. Some advisers are big consultancies like KPMG, others are specific to the industry, like Alsbridge, which will lead or support negotiations in a range of outsourcing relationships. Either way, the advantage that a third party provides is its knowledge of previous engagements, thus giving it insight into what terms a provider is likely to accept. With a third party present an incumbent may still have an edge, but they know that the buyer is negotiating with a stronger hand.
“In any large-scale deal, for the basic services the obvious first choice will be to stick with what you have,” says Arnold. “This can be true even if there is bleeding, but there is usually some configuration on the rebid, with a shift in scope and operating models, and it is worth taking a one month exercise to assess what was learned in the previous contract.”
Arnold says that KPMG is not seeing a significant shift to insourcing, despite dissatisfaction in some areas. This suggests that the dropping contract size, the greater number of contracts, and the overall decline in contract value – (ISG estimates that the number of awards grew 2% in 2013, while the total value dropped 18% to $18.7 billion) – are an indication of how a maturing market can deliver value even as it fragments. That is, as long as you know your way around.
“There are a lot of moving parts on pricing, and they are not all perfectly interrelated,” says Arnold. “Often benchmarks for resources don’t match the inflation rate, or the price of a help desk call remains the same, perhaps even declines.”
That said, Arnold insists that cost is rarely a driver in a renegotiation. The real emphasis is on making things work better.
“There are three broad assessment categories: operational challenges within the relationship; then a sense of industry bench-marking to make sure you are doing well; and finally cost.”
The second two areas are where a third party can help by suggesting how a deal should work, and what that deal should then cost. With IT infrastructure and some of the simpler sourcing offerings now ‘table stakes,’ the discussion shifts to industry-specific differentiators in areas such as regulatory issues for life sciences and financial services.
“These are a relatively small subset, but the client might not know how much they do – or should – cost. They also then get into a liability discussion with the provider, which is always a touchy area. Sometimes they will open up the risk file, but at other times it is written in stone.”
For Arnold, buyers aren’t resistant to business processes outsourcing so much as they suffer from living in silos. When renegotiating, the important thing is to advance beyond where you were in the last agreement.
“The silos shift, and you can’t stay stagnant,” he says. “If that happens you cannot progress your business services capabilities, and you cannot progress.”