Focusing on relationship-based contracting when outsourcing is being restructured or renewed, tests the underlying business assumptions and helps to reset the relationship.

by Akiba Stern

In his July 2006 FAO Today article on the process of inclusion, my business partner Ed Hansen wrote that getting favorable terms will not guarantee success in an outsourcing transaction. Rather, success is mostly dependent on the customer’s relationship with the provider, and, if that relationship is principally determined by a contract, and not the other way around, the transaction has a high probability of failing.

Many recent articles have recommended that outsourcing customers “refresh” their outsourcing contracts on a regular basis (even as often as once a year). If Ed is correct (and I think that he is), why incur the effort and expense of a contract refresh before contract renewal, or even at the time of renewal? I have heard outsourcing customers say that if “things are pretty good” at renewal, they would rather leave their existing contracts in place (except to lower the pricing), rely on governance and their relationship with the provider, and forgo the expense of refreshing the contract.

The contract is, however, an indispensable feature of the relationship. While contract-based relationships are more likely to fail and relationship-based contracts are more likely to succeed, success is not guaranteed. Even the strongest outsourcing relationship needs a contract that reflects the parties’ current commercial understanding. Things change, people come and go, and the relationship faces constant challenges. A refreshed contract allows the relationship to continue to have a solid underpinning.

Ed’s article stressed using a contracting process that tests the relationship before contract negotiations take place. Renewal is a good opportunity to employ a contracting process that tests the underlying business assumptions that were first baked into the contract and to reset the relationship in light of experience and changed circumstances.

Regular outsourcing contract refreshes are a must. Indeed, we find that many contracts quickly fall out of date. Most provider organizations are trained to record each small change to the outsourcing contract as a “change order,” even where scope and performance obligations are not being meaningfully changed. Most outsourcing customers do not establish good documentation habits. Given these behaviors by providers and customers, it quickly becomes a massive undertaking to refresh a contract.

Regrettably, our experience suggests that except at renewal, most executives charged with managing an outsourcing relationship are not prepared to expend the time,
energy, money, and political capital needed to champion an outsourcing contract refresh. And, without a champion, these initiatives simply do not happen.

However, the outsourcing press is reporting that many first-generation outsourcing contracts are currently being renewed or will soon come up for renewal.

Hence, for many organizations, now is a very good time to begin a process that, as I stated previously, tests the underlying business assumptions and resets the relationship.

One of my favorite experiences with an outsourcing contract was a renewal. Our client decided to renegotiate with the incumbent provider. But they had challenges:

• The pricing in the contract was no longer at market;

• Our client’s users were clamoring for alternative service offerings at different prices;

• Years of constant change orders made it a challenge to determine scope; and

• Deficiencies with the service levels had been noted but not documented.

Fortunately:
• The teams that negotiated and managed the first agreement were still in place;

• After an initial year of pain, the environment had stabilized;

• Good governance practices were followed—SLA, volume metrics, and trends were tracked, reported, and discussed monthly; and

• Trust had been established and reinforced over time due to regular candid (albeit sometimes firm) discussions between the parties.

So, how did we handle the challenges? Our client informally benchmarked price and with their knowledge of costs persuaded the provider to deliver a market price. Although the client’s geographies made it impossible to deliver all of the alternative service offerings that the users wanted without significantly higher costs, the provider made some key adjustments that gave the business community enough choices to pass muster. The scope document was refreshed, and SLA deficiencies were addressed and documented. That renewal served both parties well for several years.