By Tim Lloyd
Managing Partner, Alsbridge Europe
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Q: Why do outsourcing suppliers prefer longer contract terms?

TL: The suppliers would argue that a longer deal term reflects a commitment to partnership – both sides are going to work together for the long-term. It gives them both a planning horizon in which they can make the best decisions, and provides security and commitment for stakeholders on both sides. All of which may be true, but it is also the case that a long deal-term provides the supplier with secure annuity revenue, which is critical to business valuation. It puts back the need for incurring sales costs to win the renewal, and it results in a captive client that arguably doesn’t need the attention of the “A Team”, thus releasing those resources to chase the always-sexier new business.

Q: So what should be considered when determining the right contract length?

TL: A little obvious perhaps, but to determine what the right deal length is we have to consider what we are trying to achieve through outsourcing. Most outsourcing deals are driven by some combination of these three factors:

• Reduce cost
• Drive business change
• Access skills, resources or know-how

Q: What length of contract will best help achieve these objectives then, starting with cost?

TL: So, cost first. A long contract term may mean suppliers offer better prices in return for the commitment, and may mean that start-up and transformation costs can be amortised over the term of the deal, which both argue for longer term deals. On the other hand, you can only measure cost reduction against current and reasonably foreseeable future costs. How do you know that the deal you strike today will still be the most cost-effective deal in 8 years time? Economies change, businesses change, suppliers change, technology changes – its easy to look back and see that a deal based on 1998 solution sets is unlikely to be the best in 2006.

Q: What about if the driving force behind outsourcing is business change?

TL: Change probably needs to be delivered within 1-3 years, or it won’t happen. It would therefore seem to make sense to match the deal term to the time needed to make the change and bed it down. This means shorter rather than longer deals – 3 to 5 years probably.

Q: And what if the driving force is access to skills and resources?

TL: Access to skills, technology, know-how. Even more reason for caution here, as we face the unknowable future. What will be needed in 5 to 10 years time, and how can it be best delivered? In 1998 for example outsourcing finance to Ireland or the UK was leading edge – for the last few years a solution based on on-shore delivery has been unlikely to be competitive, but what if you were locked into a 10-year deal based on this model?

Q: What is the trend right now?

TL: The trend seems to be for shorter deal terms – these give the client the most options. So long as the deal term is long enough to deliver the required change and to structure the economics so that both sides achieve what they need, then it is long enough. At the end of the term the client has options, which is always better than not – renew if it is still the best deal and supplier; renegotiate if the supplier is good but the deal is out of date; change if the supplier isn’t still the best choice.