If you have an outsourcing contract, the chances are that at some stage you will need to consider some form of renegotiation. Up to three quarters of all outsourcing deals are renegotiated, and this figure is rising. In a year when a record number of contracts are due to expire, the profile and significance of renegotiation is set to rise. So what is renegotiation, what is driving its growing importance, and how can you take advantage of it?

Avoiding the nuclear option

Renegotiation is a dialogue to agree major change with your existing outsourcing supplier, and represents the first step in trying to redefine an outsourcing contract. Critically renegotiation stops short of the ‘nuclear option’ of re-competition - going back to the market to re-tender your requirements in the marketplace. Given the massive cost and disruption that re-tendering and exit can entail (not only finding a new supplier, but simultaneously managing the exit of the old), renegotiation is usually the smarter way to fundamentally redefine an outsourcing contract.

The 4 key triggers of renegotiation

Underlying almost all renegotiation are four basic triggers:

• Firstly, and most obviously, is the timing factor. With contract expiry imminent, the outsourcing client needs either to agree an extension with the current supplier, find a new supplier, or prepare to bring the work back in-house.

• Secondly, there is the issue of underperformance. This isn’t always about pricing (although a recent Gartner survey showed that 40% of companies thought that they were ‘paying too much for the outsourced capabilities’). It can equally encompass situations where there have been persistent shortcomings in service, failure to meet key performance indicators over an extended period or underperformance against the market. Underperformance in these various forms may or may not entitle the client to legal or financial penalties, but they certainly can provide a reason to renegotiate.

• A third and related type of trigger is contract flaws, which often can only be resolved through renegotiation. This could entail providing coverage of for omissions in the original contract, or addressing the ‘unintended behaviours’ that can result from poor drafting. An example of this trigger was the EDS - US Navy Marine Corps contract, which went through extensive renegotiations in 2004 to restructure and simplify the service level regime.

• Finally, major business change is an important driver of renegotiation. Any good outsourcing relationship should be equipped to deal with day-to-day change, in terms of minor scope extensions, or adjustments to service levels or pricing. But when a proposed change has the potential to fundamentally alter the nature of the relationship, renegotiation can be essential. For example, when the client acquires a new business, moves into a new market or hires a new CEO, the basic assumptions the existing deal may no longer apply, and supplier, client or both parties may wish to replan the way ahead. This trigger has resulted in a number of high profile renegotiation situations in recent years, such as the JP Morgan Chase - IBM ITO deal (resulting in bring work back inhouse) and Powergen - Vertex (resulting in litigation). This trigger can also encompass the need to apply technology or legislative innovations not foreseen in the original agreement, such as new compliance requirements (who pays for Sarbanes Oxley or MiFID?), or new technology solutions.

The dynamics of deal-making

Given these drivers, renegotiation remains a complex challenge. Ideally client and supplier will have a frank and constructive relationship, far removed from the brinkmanship and posturing that unfortunately characterises so much of outsourcing deal-making. Successful outsourcing relies on building sustainable relationships with suppliers, not screwing out every last concession, and smart negotiators will seek to ensure the future outsourcing relationship will be underpinned by clear mutual benefit on both sides.

Ultimately though, the final result of renegotiation will depend on the negotiating position of both parties, which will be largely determined by the alternative options available to the client (in the jargon, this is often called understanding the BATNA, the Best Alternative to a Negotiated Agreement). If, for example, the client could easily re-tender the work to a range of other suppliers, a failure to agree in renegotiation would still leave viable alternatives, a good basis for influencing the renegotiation outcome. In cases where one or both of the parties have very attractive alternative options, the renegotiation is not likely to ever get off the ground. In all other cases, the parties will need to spend time negotiating the point at which their interests and position intersect.

Building your options

Improving your renegotiating power by developing alternative sourcing options is a long term task, starting before the original contract is signed, and continuing throughout the deal. The following broad concepts are the most important considerations:

1. Build in competition and transparency

Minimise reliance on proprietary systems and software, and make use of industry standard processes, tools and benchmarking. Wherever possible, try to promote a multi-sourcing approach, by not relying entirely on a single provider to supply all your needs for a given function.

2. Minimise the contractual barriers to exit

Ensure that the master contract provides a clear and equitable basis for termination, both for ‘cause’ and for ‘convenience’. This should include providing a fair mechanism for compensating the supplier for premature exit. Clarify the responsibilities in terms of transfer or retention of IP and personnel.

3. Retain expertise

Don’t lose the ability to understand the functional and technical detail of the deal. Run a contract management office that retains a complete grasp of the outsourced activities.

Managing the process

In addition to building up your sourcing options over the long term, the actual process of renegotiation needs to be well managed. The first consideration is getting the timing right. Considering that a renegotiation activity can last from 2-6 months depending on the complexity of the situation, and that 12-18 months contingency is needed to run a retendering process, starting a renegotiation later than 18-24 months before expiry seriously reduces the clients negotiating leverage.

The starting point for the renegotiation process is establishing a clear set of goals, and identifying those of the supplier – in some situations, it will be possible to agree a joint statement of objectives shared by supplier and client. The objectives will provide an agenda for the renegotiation, and should focus only on the killer issues to be addressed. This ideally should be built on a clear picture of the longer term requirements of the business (What IT / Finance / HR services will the business need in 2,5,10 years? What is the overall sourcing strategy?).

Finally before commencing the renegotiation, the client needs to plan the terms of engagement with the supplier, clearly setting out fair rules, such as the number of people to be involved, and the timeline for concluding (or calling off) the renegotiation.

A clear and disciplined approach for the renegotiation sessions themselves is essential. Central to this is the use of a single, jointly edited version of the contract, capturing revisions to the agreement in real time. Progress will rely heavily on the quality of the underlying relationship between client and supplier, as mistrust or tactical games will delay or derail agreement. Senior client and supplier involvement is another vital element, symbolically emphasising mutual commitment to the process, whilst minimising decision-making delays.

A renegotiation revolution?

Renegotiation is not a panacea for all outsourcing ills. Redrawing a contract is no replacement for maintaining a constructive relationship with your supplier. And in many cases where problems persist, termination and re-tendering may well be the right answer.

But although re-tendering continues to get all the headlines, on the ground dozens of forward-looking firms are turning to renegotiation to refine and extend their sourcing strategies. As deals get shorter, and as firms get better informed and more sophisticated in their outsourcing thinking, look out for a silent revolution in attitudes. Renegotiation will no longer be a niche activity, it will emerge as a central skill for all businesses engaged in outsourcing.

About the Author

Paul Morrison is a Senior Manager at Alsbridge, specialist advisers on outsourcing, offshoring and shared services. Paul works with clients in a range of sectors, helping them to develop robust and sustainable offshoring and sourcing strategies. His activities include feasibility assessment, business case development, location selection and contract negotiation.

Previously Paul was Director of Offshore Advisory Services at Percept, a consultancy he helped to set up and run, specialising in advising on the reputational implications of offshore outsourcing. Prior to this, Paul was a technology sector strategy consultant at Accenture.

Paul is a Director at the National Outsourcing Association, and also sits on the Outsourcing and Offshoring Committee at Intellect, the UK’s High Tech Industry trade association. Paul writes and speaks on a range of globalisation issues, most recently in ‘Technology and Offshore Sourcing Strategies’ (Palgrave). Paul can be contacted at paul.morrison@alsbridge.eu.