An ITO relationship will stand the test of time with a well-designed sourcing strategy and supporting contract. Sounds like motherhood, but the “well designed” aspect generally relates to anticipating classes of change that will occur during the term.
During the past several years, TPI has advised on renewal strategies and associated negotiations for many of the larger ITO agreements signed in the 1995-1999 period. While these agreements were awarded to differing service providers, most of them ran to term without undue litigation or termination. Sure, there were areas of unfulfilled expectations, but the level of satisfaction through these first-generation agreements is usually quite high.
Long-term ITO agreements are commonly renegotiated, often multiple times, reflecting changing circumstances, scope, and pricing levels. As a generalization, we’ve found that 10-year ITO contracts in the latter years of their term includes pricing that can be up to 20-30 percent higher than the prevailing market. One principal reason for this is the fact that many early-generation deals employed financial engineering to garner higher proportional cost savings in the early years, allowing for higher relative pricing in the latter years. As such, the back-end periods of these contracts are more profitable for the service providers.
For this reason, a client facing the prospects of a successor agreement needs to evaluate the prevailing market, not merely to accept some incremental improvement in pricing based on the trailing years of the predecessor agreement. Incumbent providers should not be retained on the basis of predecessor agreements. A review of the current market conditions – meaning pricing, contract terms, and scope of services – is essential. We’ve observed that some clients can become complacent and trapped by the perception that the transfer of responsibility and institutional knowledge between IT service providers, or repatriation, becomes costly.
So how do clients address this? For these reasons, and others, the most successful renewal approaches for larger-scale and longer-duration ITO agreements include:
- The pricing of the existing contract should be compared to the prevailing market for like services in order to gauge the range of anticipated future pricing;
- The client’s negotiating leverage and feasible alternatives should be objectively and thoroughly assessed.
- Competitive tension may have to be introduced for some aspect of the services in order to create a viable alternative to the incumbent. This may take the form of awarding certain services to a second provider prior to the initiation of the recompete/renewal process;
- The incumbent provider should be engaged with a structured and deliberate process for the renewal of its agreement, with acknowledgement of the various scenarios available to the parties;
- All aspects of the relationship should be examined in addition to pricing, including contract terms, service performance and governance; and
- A plausible alternative service strategy must be designed, socialized internally, and prepared for implementation. It is highly problematic to enter into a contract renewal process without being totally prepared to take another course of action if the provider is found to be uncooperative.
We suggest preparing early for the renewal of a large ITO relationship – and be prepared to make some tough decisions.