Introduction
Corporate memories are notoriously short. This is often a significant cause of discontent with outsourcing arrangements which may last for five, seven or even ten years and beyond.
Benefits delivered in the first year of a deal will be taken for granted by the end of the second year, if not sooner. A cursory review of a service charge payable in the third or fourth year of a typical outsourcing arrangement may lead customers suffering from corporate amnesia to ask why they are paying above market rates. Often the answer is that the customer required savings relative to their internal budget and, typically, an immediate reduction in spend on signature of the contract. To achieve these savings, suppliers will almost certainly have to make significant up-front investments. If the customer also requires an immediate price reduction, suppliers have to charge well below their actual costs in the early years of outsourcing arrangements. Generally, suppliers will only start to break even and make any margin in the later years of the arrangement which is precisely when many customers will be dusting down benchmarking and most favoured pricing clauses.
Corporate amnesia is not just a challenge for suppliers. Suppliers tend to be better at managing outsourced relationships than customers. In practice this often means that where elements of the outsourcing are left to be agreed after contract signature or where changes are made to the outsourced services, suppliers are generally better able to secure outcomes which are more supplier friendly than the original negotiating teams would have intended. This is partly due to the fact that after the contract is signed the balance of negotiating power swings heavily in favour of the supplier as the incumbent provider. However and particularly in the later years of outsourcings it is often in part due to customers forgetting the benefits and protections that they secured in the original contract. Indeed, when customers seek assistance from their legal advisors to renegotiate contracts to include "additional" protections and benefits, it is not uncommon to find that some of these "additional" protections and benefits are already addressed to some extent in the existing contract. The length, complexity and duration of outsourcing contracts mean that customers understandably sometimes forget the protections and benefits in the contract.
Ultimately it is the job of a contract negotiation team to negotiate a contract that facilities the survival of a long term relationship, rather than a contract that contains the seeds of its own destruction. In a similar way it is the job of a contract management team to be alive to the risks to the long term relationship, one of which is the damage wrought by corporate amnesia, and to consider how they can best be avoided.
Against that background this article considers how to tackle the challenge of corporate amnesia in long term outsourcing arrangements.
Continuity
Continuity is one antidote. By ensuring that some of those who were involved in the negotiation of the contract remain as members of the customer's team and the supplier's account management team, the nuances of the deal are more likely to be remembered and interpreted to reflect the original intention of the parties. Similarly, changes are more likely to be implemented consistently with the existing deal rather than unintentionally cutting across it.
Of course, it isn't always possible to assign members of negotiating teams to run the contract. Frequently suppliers will have an entirely separate division responsible for account management with little or no overlap with contract negotiating teams - managing an outsourcing account requires a different skill set to selling and negotiating. The same is true on the customer side - indeed customers are often positively encouraged not to assume that those who have the skills required to run a department also have the skills required to run a contract and a relationship. On top of that, even if negotiators are available to help manage the outsourcing arrangement, the length of the arrangement means that teams will inevitably change and knowledge will be lost.
One way to address this is to prepare a short summary of why particular positions and compromises were reached soon after the signing, when memories are fresh. The summary could, for example, cover the assumptions underlying the service charges payable over the term, including the financial base case, any smoothing of charges and an explanation of those provisions in the contract which on their own may seem "unfair" or at least outside of the normal range of compromises reached. By keeping a record of the background to the actual outcome - certainly for the more significant issues - provisions which appear one-sided in isolation will be better understood when revisited in the future and one side is less likely to feel hard done-by.
After a lengthy negotiation and contract signature, the temptation is of course to celebrate with something bubbly, put the contract in the drawer or on the top shelf and then move on to the next big thing. However, if completed shortly after contract signature, with the details fresh in minds, the production of such an invaluable guide by the negotiating team can be a relatively painless exercise and of disproportionate value to the management team and to the long term relationship.
How to avoid the question: "What have you done for me lately?"
Despite the continuing growth of the market for outsourced services, there is still widespread dissatisfaction with outsourcing arrangements. This is no doubt in part due to the common tensions described above and the challenge of corporate amnesia. However, it is also down to the prevalence of overly restrictive contracts, which set the wrong incentives for suppliers and therefore fail to deliver maximum value to customers.
Take service levels. Much time, effort and emotion is expended when negotiating service levels and service credit arrangements in outsourcing transactions. Indeed, service credits and the amount of the supplier's fee which is at risk are regular features on the final "big issues" list in negotiations. A well-drafted service level regime is undoubtedly a useful tool for achieving successful outsourcing arrangements. However, many customers, who are happy that their suppliers are meeting contracted service levels, nevertheless consider that they are not receiving value for money. A common cause of this discontent is that many service level regimes measure what is easy to measure, rather than what actually matters for the business. Furthermore service level regimes agreed at the beginning of a lengthy outsourcing arrangement can quickly become out of step with changing business requirements and improvements in technologies and processes.
There are several ways to tackle these challenges. Firstly, through good governance. Customers are generally reluctant to give suppliers access to their business users. However, by ensuring that the parties meet regularly and that this access is given (with a chaperone where necessary!), suppliers can acquire a much better understanding of the customers' business needs. This in turn enables suppliers proactively to recommend improvements and changes which will benefit the business, rather than simply reacting to the customer's proposals or coming up with contractually required recommendations on an abstract basis. A better understanding of the customer's business can turn suppliers into catalysts for change rather than barriers to it.
Continuous improvement obligations are frequently wheeled out by advisors to address the problem of service levels becoming out of step with technological developments and competitor performance over the period of a long term contract. Unfortunately whilst these provisions serve a purpose they are not themselves a solution to customer discontent since too often they tend to focus only on improving existing service levels. If the existing service levels being measured don't correspond with what delivers value to the business then continuous improvement won't solve the problem.
Another approach is to include gainshare or other bonus incentives in the contract. One of the flaws of the standard fixed price contract is the absence of any incentives for the supplier either to exceed service levels or to find additional savings or revenue for the customer. Suppliers are unwilling to share savings from efficiencies or economies of scale in their own operations, since those savings are the basis for their profit and may, in any event, be squeezed by benchmarking or commitments to future reductions in price.
Gainshare can provide a valuable incentive. Customers may be more willing to offer incentives to suppliers if they can accept that sharing unexpected revenues or savings from innovations or exceptional performance is, in a sense, "free" - the customer is paying the supplier from funds which the customer would not otherwise possess.
Of course, there are significant challenges in implementing gainshare arrangements in outsourcing deals, which is probably why they are still relatively rare in practice. The key initial challenge is establishing what savings or revenues are part of the supplier's normal day-job and what are exceptional and therefore appropriate to be shared between the parties. Corporate amnesia is another hurdle. Savings or benefits delivered through gainshare in the first year of a five year contract are unlikely to be remembered after the books are closed for the initial year. Customers can quickly grow to resent gainshare arrangements which generate significant revenues for the supplier. "New" revenue streams or cost savings are soon taken for granted as part of the basic service and all that is noticed is the cost element of gainshare - the part that the supplier gets to keep. Therefore, specific gainshare arrangements tend to have a limited shelf life, and are often limited to (sometimes declining,) shares of savings or additional revenue in the first year or two after a particular innovation. However, despite these challenges, gainshare and bonus arrangements can provide genuine incentives for suppliers to innovate and deliver increased value for the customer.
Conclusion
Outsourcing contracts are lengthy, complex creatures. They can take months to negotiate and (hopefully) last for years. Negotiators rarely stay involved for very long after signature. Even if they do, memories of complex compromises and deal structures fade over time. However, by following a few simple rules such as preparing a contemporaneous note explaining the key characteristics of a deal, the common tensions caused by corporate amnesia can be eased. Good governance and forward looking incentives for innovation such as gainshare arrangements are further antidotes to the widespread malaise in outsourcing arrangements.
About the authors
Ross McKean is a partner in Baker & McKenzie's London technology group and a member of Baker & McKenzie's global outsourcing and offshoring practice group. Ross has extensive experience of non-contentious and contentious IT, outsourcing, communications and telecommunications projects.
He focuses in particular on advising user and supplier clients in regulated sectors, notably the financial services and telecommunications industry sectors. Ross' recent disclosable transactions include: advising the mobile multi media company 3 on the outsourcing of its network management and IT functions to Ericsson - this deal was one of the largest outsourcing deals completed in the UK in 2005; advising Jones Lang LaSalle on the outsourcing of its European IT function and subsequently on the outsourcing of its global accounts payable function; and advising a multinational bank on the outsourcing of its IT and telecommunications services across seven jurisdictions.
Ross talks and writes frequently on outsourcing and all aspects of IT and communications law and is a regular contributor to PLC magazine.
Contact: ross.mckean@bakernet.com ddi +44 (0)20 7919 1231.
Richard Hawtin is a partner in Baker & McKenzie's London technology group and a member of Baker & McKenzie’s global outsourcing and offshoring practice group. He has particular experience of major outsourcing agreements and offshoring arrangements.
His experience includes: acting for the supplier on a BPO in the financial services sector; acting for Fujitsu on its successful bid for NHS IT contracts; acting for a major offshore bank in the negotiation of agreements for the outsourcing of its IT and telecommunications needs on a global basis; acting for Nortel Networks in relation to Cable & Wireless’ global voice over IP transaction; acting for ntl on its IT outsourcing to IBM in the UK and Ireland; and acting on a pan-European technology outsourcing for one of the largest pharmaceutical companies.
He speaks and writes on a range of outsourcing, offshoring and technology law related issues. He is the legal director of the National Outsourcing Association.
Contact: richard.hawtin@bakernet.com ddi +44 (0)20 7919 1597. |
