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.
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