Negotiating outsourcing agreements is often likened to the marriage process, and one can see the force of the analogy – there are exchanges of promises/vows, all in the expectation of a long-term relationship and in the sure knowledge of a high degree of mutual dependence. However, there is a significant different in that every outsourcing transaction has a finite term which is likely to be far short of a human lifespan, and increasingly one sees organisations who are inclined to swap one provider for another well within the originally envisaged term of the agreement. Why might this happen, and what are the legal issues which such a strategy might present?
The Key Drivers
There is no single reason why an outsourcing transaction might require renegotiation or early termination. The usual suspects include the following.
(a) A change in ownership/merger on the part of the customer. If, for example, the two merged entities both have outsourced functions, additional synergies and costs savings may well be achievable by bringing them together.
(b) A change in ownership on the part of the supplier. There is always a risk that the new owner is persona non grata with the customer by reason of some past bad experience or project failure, such that there is executive-level pressure to bring the relationship to an end.
(c) Changes in business strategy. For example, a shift in corporate approach may result in a previous drive to offshore services being reversed (a trend recently observed in connection with many services focused on call centres).
(d) Changes in market practice. What is seen as being incapable of being outsourced and what is seen as cost effective to outsource, may change by reason of the development of new approaches or technologies. By way of example, infrastructure management services were until recently seen as being very much ‘on shore’ responsibilities, but the rapid development of secure and high quality telecoms links has revolutionised the provision of remote IM-related services, in particular from more established offshore service locations such as India.
(e) Uncompetitive prices/service levels. Particularly vis-à-vis the longer term ‘mega deals’, what appeared to be a good price and set of service levels at the time of contract signature may rapidly appear less so, as new technologies or processes enable tasks to be undertaken faster, cheaper and/or better.
(f) Failed projects. Unfortunately, some projects may fail to meet expectations or even lurch towards catastrophe, leaving a customer with little option but to look elsewhere for a new provider.
(g) Natural expiry. It may be the case that the originally envisaged term of the agreement is coming to an end and, rather than simply renewing the contract, the customer wants to test what the market has to offer.
All of these different drivers will impact upon both the renegotiation process to be adopted, and the likely issues which will arise.
The Challenges to Renegotiation
The first and most obvious issue to address is how you convince the other party to agree to make changes to what will usually have been an exhaustively negotiated agreement, which may still have several more years to run. Concerns that impact upon one party may not affect the other, who may accordingly be keen to retain the status quo.
The reality is that there will usually be at least some incentive for each party to enter into discussions regarding renegotiation of the outsourcing contract. Being such complex agreements, there will usually be some areas where a party will feel that it missed something or where things aren’t quite working as they had intended, and which could accordingly be ‘tidied up’ by way of a renegotiation process. There may also be the prospect (for the supplier) of more work, whether by an extension to the contract term or in other areas of the customer’s business.
But the process will undoubtedly be easier if the original contract included some levers or triggers to facilitate renegotiations, if necessary. For example, in longer-term deals one would ordinarily expect there to be benchmarking provisions, whereby the supplier’s services and charges can be compared against those of comparable suppliers and for similar projects (ideally, from the customer’s perspective, linked to automatic adjustments to the fees in the event that the report shows that the supplier is not in fact in line with the rest of the market). Even if the benchmarking process is not in fact initiated, the fact that it could be initiated will frequently be a sufficient incentive to get the parties to the renegotiation table.
Similarly, having defined ‘break points’ in the contract or rights of termination on notice or for convenience can be a hook for discussions regarding renegotiations. Although the supplier would usually expect to be paid some kind of termination fee in such circumstances, it may be more concerned about the prospect of losing the client account in the longer term, and therefore be willing to come back to the table to discuss potential changes rather than have the customer terminate the contract.
If it seems that the current supplier does not want to ‘play ball’, the customer may face practical difficulties in extricating itself. For example, its current contract may not have been drafted in such a way as to require the supplier to provide information regarding its current service levels or cost structure etc for the purposes of setting a basis for a retender process, which may make it difficult for the customer to provide all the information which any other potential supplier may require in order to price for its services accurately. Better drafted contracts will have foreseen these issues and included positive obligations upon the supplier to assist with the re-tendering process, but the unfortunate reality is that many of the older and ‘first generation’ outsourcing agreements are woefully silent on such matters.
The Process
If a renegotiation is proposed, the prime objective must be to develop a clear view as to why such a renegotiation is felt to be necessary, and what result it is intended to achieve. This may seem self-evident, but all too often the process can take on a life of its own and the original intent of the parties may be lost.
Although this prime objective will inevitably form the initial focus of the discussions, one should not forget that the renegotiations are also an important opportunity to take stock and evaluate whether the contract has in fact lived up to expectations in terms of the way in which it has dealt with various issues. For example, a service level regime which looked great on paper during the original negotiations may have turned out to be clunky and difficult to operate in practice, so that a change may be to both parties’ advantage, now that there is an opportunity to broach the subject.
This in turn highlights an important point; renegotiation involves two parties, both of whom will have their own ‘hot’ points to try to cover. The process to be adapted must accordingly recognise the need to address the other side’s issues as well as your own, whilst hopefully setting down at least some boundaries as to how far the original contract provisions can be re-opened. For example, if the renegotiation process is focussing primarily upon charges and service levels, there is less obvious reason (other than pure horse-trading) why the parties should get embroiled in discussions about drafting issues on the terms and conditions. The parties should accordingly endeavour to set out some basic ground rules for the renegotiation, including:
· which parts of the deal are to be focussed upon during the renegotiations;
· what each party’s key concerns are;
· who is to be involved on each side; and
· what the anticipated timeframe for the renegotiations will be.
Throughout all of this, each party has to have a clear view as to its BATNA – or Best Alternative To A Negotiated Agreement. For example, if the customer cannot achieve its desired outcome from the renegotiation process, is the ‘fit’ of the original contract to its current requirements so bad that a termination will ensue? What is the minimum outcome which must be gained from the renegotiations which will be necessary in order to make it preferable to allow the contract to continue (bearing in mind the inevitable cost and disruption that will ensue from a switch to a new supplier)? Knowing what ‘Plan B’ may be will inevitably play a major role in determining how hard to push in the renegotiations themselves.
Conclusion
It would be a mistake to think that renegotiations are simply questions of ‘tweaking’ existing arrangements. Although they can often be completed swiftly and amicably, the fact that the parties know both each other and the nature of the services that much better than they are likely to have done when negotiating the original contract can often bring issues into stark relief, and make such highlighted issues more difficult to resolve than they might have been during the original negotiations. Whilst renegotiations may frequently be inevitable and will hopefully be to the benefit of both parties, they are accordingly not to be undertaken lightly, or without careful preparation.
Kit Burden is Co-Head of the Technology & Sourcing Group at DLA Piper.
