Nearshore Americas

Yes, I Fully Expect to Pay Less on Renewal

We have all heard it before: “Prices are going up.” At renewal time, the vendor will explain the reasons, but the key message is that the price pressures always seem to trend up.
But you don’t have to accept that paradigm when it comes time to renew your IT contracts. There is even a business equation that can support that assertion.
What does a vendor have to do to win business? It has to invest — sometimes it has to invest a lot. Whether it be spending for proposal generation, discovery loops, the movement of people, recruitment, organizational change, or other initial care elements of a client, there can be a considerable costs that the vendor must incur to win business. This is even more pronounced if it is the company’s first engagement with your firm.
If a vendor wants to be commercially viable over a long period of time, it has to recoup these costs somewhere along the way. It has to include enough price in the contract to recover those investment expenses. Recovery can be accomplished numerous ways, including a “recovery price point,” creativity in project cost allocation and distribution, and the hope that downstream work opportunities follow. It could also upsell additional products and capabilities.
Regardless of how, for a vendor to achieve the margins it expects to make overall, these investment costs must be recovered. A vendors’ profitability at any given point in time changes over the duration of the project. Usually the most profitable part of a project is toward the end, after any initial transition, start-up, and ramp-up costs have been completed. By this point, the vendors’ engine is usually running the most efficiently. Ultimately, to be profitable across the life of the engagement, the project has to be running at a higher-than-desired margin somewhere during the lifecycle (again, usually at the end) to make up for the upfront investment.
That is why renewal time is so important to the supplier. If a client renews at the same rate, it means the vendor should enjoy a higher margin in year two. This is because there would little to no recurring investment costs at this point to maintain the current model. Any cost increases the vendor experiences during the year, perhaps due to inflation, should be counteracted by all the efficiency and productivity savings the vendor advertised at proposal time and implemented throughout year one. And if that isn’t the case, I would look for another vendor.
So what should a contract renewal look like? Should there be an uptick of costs due to inflation? Should there be additional costs due to salary pressures? Should I expect higher costs due to T&L expense or Visa costs? Baking such costs into the agreement will be your vendors’ preference. But it should not be yours.
Consider the genesis of the contract. Consider that you hired the vendor to do this work and it put the staffing model together to accomplish the task based on all known aspects of the project at the outset. They should be continuing to manage that staffing throughout the project, making adjustments and implementing productivity and efficiency gains over time. This is a primary approach any vendor should make to improve its margins. But at some point, I, as the client, want to share in those gains. I expect those improvements to counteract the cost pressures they incur to serve me as a client.
I expect the vendor to manage its resources to maximize cost efficiencies and this, in turn, should be passed to me at renewal time. But even more than this, the key reason that renewals should cost less — not more — is because the cost to win the business is already sunk. There are far fewer expenses to maintain business than there are to win business. And as we know, when the vendor does not have to invest at the same rate it did to win the business in the first place, its overall costs go down and its margin goes up. That vendor benefit, on top of all the productivity and efficiencies implemented during the project, should outweigh the always-discussed rising price pressures of inflation and “costs of doing business” — and then some. Again, if that is not the case, then consider whether you have the right vendor.
And that is why I expect renewals to come in at the same price — or less. This assumption is, of course, based on the work scope not changing. But even if work scope does change, don’t let the noise surrounding scope modification change your belief that renewal costs should trend downward.
So now, when vendors challenges you on renewal price, you can enter the conversation equipped with these common-sense concepts to challenge them back.
Vendors always talk about how great they are and how they will provide you with the perfect combination of innovation, productivity, and efficiency that will maximize their value to you. I have no doubt they are being genuine when claiming they can deliver value-add when they are selling their services. But it is up to you to insist on actually receiving these promises throughout all projects. As a rule of thumb, shooting for 8%-10% deflation is not out of the question and a good measuring stick for how good your vendors are. Past experience suggests this is reasonable. Consider entering in such goals and expectations for the out years at contract creation.
The best part about this rationale is that you don’t even need to measure these specific savings. You just need to let the vendor know that you intend to pay X-percent less for the same services at renewal for the reasons above. Make your vendor demonstrate — and execute — the claims they advertised in their marketing. You, not just the vendor, should reap benefits of the vendor’s performance against these claims. That is why you should always expect costs to go down at renewal time.

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Tim Norton

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