Changes to the Global Economy Prompt Renegotiation of Outsourcing Contracts

There have been significant technological and economic developments over the last few years. Business operations have changed significantly when compared to when companies originally signed their outsourcing contracts …

Diego Schargorodsky of HP says there is 80 percent contract renewal rate.

There have been significant technological and economic developments over the last few years. Business operations have changed significantly when compared to when companies originally signed their outsourcing contracts over a decade ago. Budgets have been cut, new technology has been introduced and the market has taken on a much more competitive nature.  Changes to fiscal and labor regulations and even natural phenomenon have all had an impact.

These developments are causing businesses to reevaluate the situation and renegotiate their outsourcing contracts, establishing new, more flexible terms that enable them to continue operating profitably on both a local and global scale.  In fact, experts are recommending implementing shorter, more flexible contracts that allow for changes to be made as the market develops.

Factors that can lead to a contract renegotiation or termination include, when the outsourcer fails to meet service standards or violates contract clauses, financial instability and changes brought about by mergers and acquisitions. According to the survey carried out by the Information Services Group (ISG), companies are seeing only 72% of the anticipated value from their outsourcing contracts. While this may, in part, be down to the outsourcing providers themselves, it can also be aggravated by unreasonable client expectations.

According to Diego Schargorodsky, Applications Manager at HP’s Latin American Enterprise Systems, the renegotiated contracts are becoming shorter and shorter, currently as low as five years or less and there is an 80% contract renewal rate. “Generally, in Latin America, clients that have decided to employ outsourcing services stick with them and do not go back to in-sourcing,” Schargorodsky said.

Knowing How to Negotiate

 Renegotiating a contract is far from simple. “Renegotiating a contract or changing providers is a complicated process,” stated Javier Corte, CIO at the Puebla State Popular Autonomous University (UPAEP), one of the leading higher education institutions in the state. A provider will do anything possible in order to keep a client, as, “for an IT business, signing an outsourcing contract is considered one of the best earners, even if profit margins are relatively low,” Corte said. The situation becomes even more competitive if a third party is involved.

What factors are prompting businesses to renegotiate their outsourcing contracts and who should get involved in the process?  Knowing how to negotiate is a skill that is vital to becoming a successful business or IT executive, something that should always be taken into account when making contractual changes. The business should put together a multidisciplinary team, made up of personnel that possess significant experience and knowhow. This team should be in charge of reviewing each aspect of the outsourcing contract up for renegotiation or renewal.

When compiling this team one of the first steps is to find staff members who have a clear understanding of what the operation involves and that are sensitive to changes within the outsourcing field. Ruben Davalos, Human Resources and State Obligations Associate at KPMG Mexico, recommends that, “a representative from the user company’s business unit should always be present.” The user area can carry out the most objective provider performance evaluation and their findings will be invaluable when establishing new terms.

Corte, from UPAEP, recommends that the Operations Manager (COO) also be present as his department needs to be aware of any changes or adjustments brought about by the new contract or provider. “It’s like when you go over to a new version of ERP; there is always a somewhat painful adjustment period, as you get used to the new system,” Corte added.

The Project Management department should also be involved in the process, as well as the Human Resources department, as it is highly likely that there will be changes to personnel involving reassignment to other departments or even some personnel being absorbed by the provider.

The Legal Department, or a consultant able to understand the legal ramifications should definitely be involved.  “When you realize that the contract is not what you expected, that the clauses were not well defined, you have to go over them with a fine toothcomb, and it is always best if a third party, able to understand the small print, be present,” Corte said.

Depending on the structure of the business, departments that can also get involved in the process are Purchasing, Accounting, the Treasury Office and, of course, Information Systems. Once complete the team should devise a negotiation strategy.

Ensuring Flexibility

 It is commonly acknowledged that the contracts drawn up a few years ago lack flexibility.  Flexibility, according to specialists, is invaluable as it allows for the inevitable changes that will come about during the contract’s validity. It is also a key element when renegotiating.  So, in order to reduce the internal and external pressure experienced over the course of any business relationship of this type, it is vital you sign short-term agreements regulating the levels of service and long-term agreements regulating other factors.

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On signing a new agreement, you should also establish the terms for rescinding a contract should the need arise. “Speaking colloquially, divorce clauses are established the moment you sign your wedding vows,” Corte warned. “You know right from the start that the relationship with the service provider is not going to be for life, and it is wise to prepare for the separation.”

Flexibility should allow for any changes made to labor and fiscal regulations. According to Davalos from KPMG, businesses are advised to take regulations from the subcontracting division of the new Federal Work Law into account, as well as amendments made to the Social Security Law.  “You have to fulfill certain requirements, so these should be taken into consideration when renewing outsourcing contracts or contracting new providers,” Davalos said.

According to HP’s Schargorodsky, it is vitally importance that you clearly define the objectives of the renewal:  “It is important to take these objectives into account so that you can evaluate whether they are being met, both while contract is in place and once it has come to an end.  If the objectives are unclear it is very difficult to tell whether the process will be successful or not.”

Schargorodsky highlights the importance of an effective changeover administration. He also recommends an internal campaign, making known all that the new status involves for the company as a whole. This helps define objectives, and highlights the benefits that the changeover will bring, something that should help combat any opposition to the changes.

Stick or Twist?

 Is it best to stick with your current provider or risk a change? When renegotiating with any outsourcing provider, specialists recommend getting additional quotes as others could offer better prices or levels of service. Alternatively, they suggest asking the current provider to come up with more competitive terms.

“We often open renewal procedures up to outside competitors. If you decide to do this, you have to clearly define the situation right from the start … This is done through a verification process as it is very important all competitors are given an equal footing,” Schargorodsky explained. He added that some contracts include incentive programs offering financial remuneration as objectives are met.

However, working with new providers has its pitfalls. “When you change service providers it often proves costly. This is because there is always a learning curve involved,” said KPMG Mexico’s Ruben Davalos. And if the previous provider leaves on bad terms the transition is often difficult, both for the new provider and the business itself. “This is why many businesses choose to renegotiate terms with the current provider rather than taking on a new provider,” Davalos added.

Corte agreed: “Your current provider knows your organization. And this offers huge advantages to both parties.” Corte is of the opinion that outsourcing is an effective practice that is set to stay. “Once the business becomes familiar with the outsourcing process they are better able to renegotiate more favorable terms for future contracts,” he concluded.

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