Pulling the Renegotiation Levers

Dale Hearn of TPI’s Financial Analysis Services Group will be "blogging about the bottom line" this week.

Of the many factors that come into play during sourcing decision-making, financial drivers within the existing contract are critical.

Companies must decide whether to renegotiate their contract with their current provider (re-source), choose a new service provider, or bring the services back in house (in-source). Several clients that I worked with over the past couple of years made a conscience decision to renegotiate with their current service provider based solely on the overall financial implications of the deal.  For more information, check out my colleague's whitepaper.

Service levels, client satisfaction surveys, balance of trade issues, and executive relationships all had an impact in renegotiations, but the most important factors for these clients were based on the NPV (net present value) and profit margins over the term of the deal.

History shows that most companies with outsourcing agreements will undergo significant restructuring during the term, a majority within the first 3 to 4 years, and most (75 percent) with the incumbent service provider.  Furthermore, most of the remainder is re-sourced rather than in-sourced, and only a very small number are in such trouble that litigation is pursued.

When renegotiating a contract, companies should consider financial flexibility and control as part of the overall process.  Providers may not like this approach, but it will pay significant dividends in the long-run for the client.  Examples of financial leverage include eliminating exclusivity restrictions, reducing termination for convenience costs, rights to use third parties, benchmarking rights and lower minimum commitments.

Service providers might be reluctant, especially when financial benefits are reaped by their client, but they know financial drivers are not the only factors when renegotiating a contract.  Other dynamics must be considered, such as increased service incentives, ability to add or change service levels (increased revenues to the supplier), and the potential for a healthy relationship that fosters and facilitates future growth or international expansion.

Renegotiation should be approached as a normal and necessary adjustment to changing conditions.  Financial flexibility and effective management of the supplier relationship are key to the long-term success of a deal.