Renegotiating Outsourcing Contracts: What Works and Why

As outsourcing decision-makers gird for another year of engaging with IT and BPO suppliers, it is a good time to reflect on what has worked well over the past twelve months and what could be improved. This is as true for outsourcing contracts as it is for everything else in our lives.

The transition from one year to the next is a good time for companies to ask themselves whether their outsourcing relationships remain fit for purpose and whether they are getting the best value for money from their suppliers. If the answers to these questions are negative, then perhaps it is time to renegotiate the contract.

This article considers the reasons parties renegotiate, and best practices for preparing for and conducting a renegotiation.

Reasons to renegotiate

Parties will usually renegotiate coming up to contract expiry. However, there are various reasons why a customer might want to renegotiate mid-term as well. These include:

• Dissatisfaction with the service provided: the outsourcing agreement should provide mechanisms to measure and remedy sub-standard service levels as and when they occur. Even so, over time, a customer can become dissatisfied with the service it is receiving in a way that is simply not measured by the metrics set out in the service level agreement. A renegotiation can provide a forum to address that dissatisfaction.
• Technology issues: in the time since the contract was first signed, there may have been improvements in technology, and the customer might want the agreement to be updated to take account of those innovations.
• Poor relationship management: the customer may feel like the honeymoon period is over and it is no longer receiving the supplier’s full and proper attention.
• Financial reasons: the customer’s procurement team may come under pressure to cut costs, particularly in a difficult economic climate. Or the customer may believe that the supplier’s pricing is now out of sync with the rest of the market.
• Business change: the existing agreement may no longer reflect the customer’s operational reality. The nature of the customer’s business may have changed, which could impact its demand for the outsourced services or its requirements.

Some of the above issues can be dealt with through the contract’s change governance procedures, but others may be so broad that it is better to renegotiate the agreement than get caught up in an endless cycle of piecemeal adjustments. Obviously, if the issues are chronic, then the customer should be looking at its termination options and its replacement/step in rights rather than renegotiating.

When considering its motivations for renegotiating the contract, the customer should be careful to look at the whole picture. If a customer understands the root cause or causes underlying its desire to renegotiate, then it will be better positioned to address them through the renegotiation process.

For example, low satisfaction with the supplier’s performance may not necessarily be the supplier’s fault. It may be that the contract was poorly structured at the outset, the customer has not actively managed the relationship to keep the supplier aware of its changing needs, or poor communication between the parties has led to a situation where the customer holds unrealistic expectations because it does not understand the challenges facing the supplier.

A renegotiation provides an opportunity to reset the relationship and get it back on track if it has wandered off course. It is not about tearing up the original agreement and starting from scratch, it is about taking the lessons learned from the early years of the relationship and making improvements.

In some cases, a customer will have an automatic right to renegotiate built into the terms of the original agreement. However, even if no such right arises, the customer is still entitled to ask the supplier to renegotiate. The supplier may refuse, but often it will say yes. The supplier may be content to reconsider its position in light of market forces or business changes, or the supplier may want to negotiate out or modify some obligations that have proved overly onerous in practice.  The supplier might also see the renegotiation as an opportunity to sell the customer new or additional services. Finally, the supplier may be prepared to renegotiate simply because an outright refusal would lead to tension and might damage the relationship in the long term.

Whatever the supplier’s reason for agreeing to renegotiate, the customer would be well advised to remember that both parties will be coming to the table expecting to improve their position in some way. Approaching the discussions with the attitude that “you give and I take,” is the fastest way to deadlock.

Choosing the team

When forming its renegotiating team, the customer might want to consider retaining an outsourcing advisory firm. They can advise on market pricing and standard commercial terms. Likewise, external legal counsel can advise on the nuances of the contract language and give an overview of what is standard across the industry. However, external advisors should only compliment and support the customer’s internal team. They should not replace them.

The customer’s employees have lived and breathed this contract since its inception and will better understand the customer’s needs than any external advisor. An external lawyer or consultant can make recommendations, but it is for the customer to decide what points to push and what to concede.

When the customer’s procurement department is leading the renegotiations, they must seek out the input and support of all key internal stakeholders. The renegotiating team should have senior management buy in at the outset so they understand the parameters of their authority. There is nothing worse that spending days or weeks hammering out a handshake agreement with the supplier only for the renegotiating team to find that it cannot sell the deal internally. Not only is it a waste of everyone’s time, but it can also give the supplier the impression that the customer is not negotiating in good faith. After all, this is supposed to be a mutually beneficial relationship, one that requires a degree of trust.

The renegotiating team should also consult with the people “at the coalface” – i.e. those individuals that deal with the supplier on a regular basis. They understand how the relationship works in practice and what needs improving.

Preparing for a renegotiation

Once the negotiating team is formed, there are various steps that they should take before even sitting down with the supplier. These include:

• Speaking to senior management to understand the customer’s overall objectives for the relationship, both in the near and long term.
• Critically assessing the existing arrangement against these objectives. It is important to understand what is working well just as much as what needs clarified, amended or scrapped. Otherwise, there is a risk of throwing the baby out with the bathwater.
• Carrying out research on pricing, prevailing market conditions and best practices. For example, is the supplier making the most of innovations in technology and recent business learning? What is standard within the industry? There are advantages to keeping the description of the services within industry standards. The more bespoke the services a customer requires, the less the supplier is able to leverage its existing knowledge, processes and technologies, which only drives up the price. This research can be done in house or with the assistance of an external consultant.
• Creating a position statement and setting priorities. It is fine for a customer to create an exhaustive wish list of everything it wants. However, it must be realistic and accept that it is unlikely to get everything on that list. The object is not to win as many of these points as possible, but to win on the most important points. Setting an internal position statement that sorts the “must haves” from the “nice to haves” will keep the renegotiating team focused on the issues that really matter.
• Brainstorming from the supplier’s point of view. It is worth spending some time considering the supplier’s position. What might the supplier’s objectives for this renegotiation be? This exercise will help the renegotiating team to anticipate what the supplier might ask for so they can be prepared with a response. It also helps them to indentify what “sweeteners” they can offer to extract concessions from the supplier. For example, when asking for price cut on specific services, the customer might be willing, in return, to expand the scope of services or extend the term.  That way, the supplier’s margins might drop, but their overall revenue might stay the same or grow. Simply playing hardball and forcing price cuts without offering anything in return may not be sustainable in the medium to long term. That being said, it is important to carry out some updated due diligence on the supplier before committing to an extended term or handing over more services to them. This is because the position may have changed since the original due diligence was carried out.

Conducting a renegotiation.

After the internal preparations are complete, the customer should sit down with the supplier and agree a timeline and framework for the renegotiations. A renegotiation should be a focused and, if possible, time-bound activity. Allowing renegotiations to drag on distracts everyone from their main jobs and could negatively impact the relationship.

There are many negotiating tactics, and entire books have been dedicated to this subject. However, one of the most effective tactics is to have an open, constructive and fact-based dialogue. If the customer is well prepared, comes to the table with persuasive evidence on pricing and industry standards, and is willing to make some concessions, it will probably not need to resort to dramatic negotiating tricks.

That being said, a sensible customer will shop around and investigate both viable economic activities and their termination rights should the renegotiations prove unsuccessful. Speaking to competitors not only provides a benchmark but also creates leverage, should it be needed.

The customer should also demand a similar openness and fact-based approach from the supplier. For example, the supplier should be asked to give a clear breakdown of its pricing so the customer can understand how much relates to services and how much to infrastructure. The customer does not want to be covering more than its fair share of the supplier’s infrastructure costs.

Done right, a renegotiation should be an opportunity to make a good relationship even better by leveraging the experience of the past to create a stronger relationship for the future. Isn’t that a positive thought as we get ready to say goodbye to one year and welcome another?

This article was originally published by NSAM sister publication Global Delivery Report