Conclusion: Much can happen during the course of an IT services agreement, causing parties to re-evaluate an arrangement, and seek change or termination. A prudent approach to IT outsourcing arrangements recognises the long-term likelihood of changed circumstances and provides both parties the option of re-assessing and if necessary changing the services agreement. The agreement should have a shared vision, coupled with a precise legal framework and processes to allow for parties to affect the most desirable solution: review of the current arrangement, followed by renegotiation or termination.

Observations: Driven by their respective business motivations, suppliers and clients are typically enthusiastic at the outset when entering an outsourcing arrangement: the supplier is anxious to close the deal while the client aims to deliver cost savings with improved service to the organisation. However, much change can happen during life of an agreement, causing parties to re-evaluate the arrangement and seek change or termination.

Most large, long term outsourcing deals are renegotiated within the first two to three years¹. Changes in the organisation, the external environment or the supplier/client relationship can prompt both sides to seek an opportunity to renegotiate or terminate the agreement. Suppliers and clients develop an improved understanding of what is involved in maintaining the agreement, services may become more complex or expensive, or potential conflicts require more precise legal and practical mechanisms to allow parties to reconsider the relationship during the course of the agreement.

A prudent approach to IT outsourcing arrangements recognises the long-term likelihood of changed circumstances, so:

When establishing a supplier/client relationship both parties should…

Define Needs           Legal Framework     Practical Infrastructure

Keep in mind that suppliers and clients have competing interests. While the agreement requires a shared interest in order to be successful, as a party to the contract, you should embed a viable review, renegotiation and termination strategy to serve your interests, which are well defined at the outset.   Establish precise legal mechanisms to deal with renegotiation and termination.   Ensure the organisation possesses the infrastructure and processes to manage any re-evaluation of the agreement.

Define Needs

One recent trend in sourcing management is an increased emphasis on preliminary review and planning processes. By conducting an initial review of the current environment and carefully planning sourcing activities, customers possess a more detailed requirements specification, can adopt a more appropriate strategic sourcing model and a ultimately, have a better comparison of supplier alternatives. BHP Steel is currently planning a phased approach in overhauling its enterprise-wide systems, starting with financial systems, followed by customer management, and manufacturing system. Insurance Australia Group recently conducted an extensive review of its internal infrastructure prior to deciding what sourcing strategy to adopt.

Expressions of Interest are often used to market test the types of products and services suppliers can offer, comparing potential solutions to organisational requirements, and short-listing potential suppliers. By conducting a preliminary review to identify its needs, customers possess a more detailed definition of what they will request from suppliers. An ongoing review system allows the client to determine whether its needs are being met during the course of the agreement.

Legal Framework

Customers must establish a precise legal framework to enable a re-evaluation of the agreement should the need arise. The safest option is to engage a third party that is experienced in balancing competing supplier/customer interests and can use them to handle initial negotiations, because:

Suppliers will want…

Clients will want…

Precise service descriptions to cement the relationship.   Exclusivity or a requirement for the client to purchase further services.   Limited supplier termination triggers.             Flexibility to terminate customer contract.     Limited transition and knowledge transfer obligations.   Service level reassessment based on benchmarking.   A long-term commitment to cover costs.

Flexible service descriptions to deliver anticipated business benefits.   To leave its options open.     Broader supplier termination triggers including technical and business issues that adversely affect service delivery or potentially cause service deterioration. (for instance, significant employee departure or business/fiscal problems).   Limited supplier rights to terminate contract, such as failure to pay undisputed amounts.   The provision of a transition period to a new vendor and extensive knowledge transfer.   Service level reassessment to increase based on quality of service and equipment available.   A variable pricing model that allows for fluctuations.

A more mature sourcing market has created a heightened awareness of the risks associated with inflexible arrangements in outsourcing contracts. Earlier agreements did not provide the necessary protections to allow for renegotiation or termination. These mechanisms are becoming more common as clients draw on professionals to negotiate and manage these agreements, and clients have a clearer of their needs.

Practical Infrastructure

While the necessary legal protections are more commonly adopted in agreements, practical mechanisms and processes to facilitate renegotiation or termination are often overlooked. Organisations often do not possess the necessary management structure or external resources to resolve any issues that might have arisen during a review, and pursue renegotiation or termination. While up to 50% of Australian users are dissatisfied with the conduct of their sourcing transaction, according to the Institute of International Research only 20% of organisations switch suppliers and fewer take IT back in house². Clients are often reluctant to alter the existing environment during the life of a contract, despite dissatisfaction with existing arrangements because of the expense or complexities when altering IT infrastructure.

Reliance on a termination for convenience clause and payment of penalties is the least desirable and often an expensive alternative. A viable exit strategy must be developed at the outset of the agreement. Renegotiation must be recognised as a necessary part of the sourcing transaction and organisations should prepare for adjustments to accommodate changing conditions in a variable marketplace. The transaction must provide a follow through for the legal framework: pre-conceived notions of available alternatives to allow the client to seek and affect the most desirable solution when agreement re-evaluation is desired.