Understanding What You Need

Many outsourcing contract negotiations start with customer’s paper. While this may not necessarily be objectionable, both parties must understand and remember what the objectives of the deal are. The problem in using a party’s standard template agreement is that those standard clauses may have little relevance to the outsourcing deal. While some customers may believe it is always “better” to get the supplier to agree to “more favourable” terms and conditions in the contract, the reality is that the customer is always the one who ends up paying for such additions.

For example, it is not unusual to see extensive provisions in outsourcing contracts addressing audit rights. The problem is that those provisions are sometimes drafted by legal team who may have little understanding as to what their technical and management teams are expecting from the supplier. An example that I often see is that the customer’s legal representative always insists on a very broad audit right which would include a standard SAS-70 Type II report and a custom SAS-70 report on an annual basis. Since customers in an outsourcing relationship are more interested in “controlling” cost, they would ask suppliers to build those necessary costs into their cost model. SAS-70 audits are not cheap, and depending on the scope, it may very well be hundreds of thousands of dollars per report. While the cost of a custom SAS-70 would not be determined until the scope is determined at the time the audit is performed, the supplier may have to do a best estimate on what the potential cost will be and include the cost in the pricing. The issue is that if the customer is performing a custom SAS-70, chances are a standard SAS-70 audit report may not be needed. To ask for all the audit reports for no additional cost in the outsourcing contract means supplier will have to factor in those costs in building the cost model. This means that the customer may be paying for something it does not need.

Another example is to ask for extensive performance measurements and corresponding service level credits for failing to achieve the performance targets. Customers sometimes may be under an impression that it is better to ask for performance measurements that cover a broad range of activities. To monitor every aspect of performance not only increases the cost of managing the project, but also require the supplier to build additional cost into its cost model as a contingency for having to pay service level credits. The measurement should be focusing on the ones that would have significant impact on the customer’s operation if supplier fails to perform, because a certain percentage of the service level credits the supplier is asked to pay will be included as part of the service fee. Once again, customer should not be asking for something it does not need. 

We need to understand what the objective of the outsourcing deal is, what the solution is, and what the needs of the parties are. There will need to be collaboration among cross-functional teams in any outsourcing contract negotiation. The business and technical requirements will need to be translated into the legal contract. We need to step back and consider whether it is something that the client really needs and whether the deal supports our position. Don’t forget there is no such thing as a free lunch. Supplier always charges the customer for what they ask. Clients do not want to pay for something that ends up being a waste and they certainly do not want to prolong contract negotiation on issues that are not even relevant.

Comments

  1. If you look at a contract as a codification of relationship for a business interaction then it becomes obvious that ‘efficiencies’ delivered by employing a standard contract often lead to significant costs due to a failure to recognize the unique objectives, resource or process requirements to accomplish the contracted work.

    The contract displaces the work as the ‘objective’ and most probably because lawyers know clauses better than work.

    Cheers,
    Nick @ResonantView