Outsourcing agreements: to renew or not to renew?

While it’s tempting to re-enter a deal you’re used to, consider all of the options before getting comfortable again

By Glen Wedel and Yvon Audette

Your multi-year outsourcing agreement is approaching the end of its term. Are you satisfied with your vendor and the services you received? Probably you are... and you’re not. They’ve done many things well, but there were also problems. And your business is very different than it was when the contract started. Just renewing the arrangement would be the easiest thing (that’s often what the vendor wants), but would it be in your company’s best interest?

In business today, it’s common for finance executives to be responsible for renewing outsourcing contracts. Before the first agreement was signed, chances are that finance invested a lot of effort, including defining the scope of services, defining service level requirements, identifying cost drivers, requests for proposal, selecting the vendor, contract negotiation, and relationship management. A renewal is no less important; it deserves the same care and attention to produce the benefits you expect.

Renewing is just one of many options

Many questions beg to be answered during this review process. Has your business strategy changed, or do you expect it to change over the renewal term? Even if your strategy hasn’t changed, has your operating model? Do you expect it to change over the renewal term? How is the competitive environment evolving? If the answers to these questions indicate a changing climate, odds are that your outsourcing arrangement needs to reflect that. Take comfort in the fact that renewing is just one of many options you have.

To gain perspective, the first thing to do is to conduct a thorough, conscientious review of performance over the current contract term. This should include a quantitative assessment of the vendor’s performance against the terms of the deal, as well as a qualitative assessment of the relationship using tools such as internal customer satisfaction surveys. What has your organization learned from the experience with that particular vendor? Look for ‘do-wells’ and gaps in the services.

Take it to a strategic level

Renewal involves both strategic and tactical considerations. First of all, take the matter to a strategic level; that is, decide whether this outsourcing model is still right for the business. For example, you may have made changes to the overall business strategy that makes the outsourced service more of a core competency. If this is true, and the risk of outsourcing has risen, you could bring the service into a shared service arrangement or repatriate portions of the services currently outsourced.

On the other hand, you may want to consider offshoring all or portions of the outsourced services for additional cost savings, provided the additional risk can be managed.

A third option is a joint venture that shares the service among several independent companies. And finally, if you don’t believe the current vendor is a good strategic fit, you could re-tender under a similar model to the one you have now.

Tactical considerations demand equal attention

The retrospective and strategic analyses give you a fairly good idea of how the existing outsourcer has performed relative to expectations, and whether the existing outsourcing model still fits your business. If the current outsourcing model is still relevant, your next step is tactical: to envision the ideal outsourcing arrangement for your business today and how you expect it to develop over the renewal term. Here are some of the things you might want to build into that arrangement:

Scope of services

Many outsourcing contracts have had to be changed mid-stream, often to add expensive services that weren’t anticipated. This can result from a few significant changes or the cumulative effect of many smaller ones. Renewal is the ideal time to refine the scope of services, whether expanding the scope, pulling back some of the services in-house, or dividing them among other outsourcers that can do a better job.

Service levels

Are the service levels established several years ago still relevant today? Several factors can drive the need to modify, add or delete services, including:

• Changes to the importance of the process or service relative to the business;
• Changes to the process itself; and
• The introduction of new technology.

Service levels need to be closely aligned with the things your business really cares about. Renewal is the best time to address any inconsistencies. Otherwise, you may find yourself making course corrections during the renewal term when you will probably have less bargaining power.

Cost drivers

What are the cost drivers in the outsourcing arrangement, and how have they changed over the years? If the outsourcer has been able to automate some of the work and reduce overhead expenses, or subcontract some of the work offshore, how is this reflected in the fees you pay? Are you proposing to change the service levels? If so, this too could affect your perception of cost drivers. There are many other cost drivers in an outsourcing relationship, and it helps to examine them all.

Sarbanes-Oxley and other compliance considerations

Any agreement struck more than three or four years ago probably didn’t account for Sarbanes-Oxley legislation (or Canadian equivalent Bill 198) that requires CEOs and CFOs to certify financial controls over financial reporting. Many outsourcers input directly to the financial and other information systems of user organizations, and their control systems have a material impact on the financial statements of their clients.

The requirements of privacy legislation must be factored into outsourcing agreements as well. If customer personal information is shared with an outsourcer, that vendor should have safeguards in place to protect it — especially when personal information is transferred across national borders. Ultimately, the organization must review the terms of the outsourcing deal against applicable regulatory requirements and determine the impact on the outsourcing arrangement.

Change control

Various organizational, process, and regulatory reviews pointed out to many user organizations how little control they had over vital changes to an outsourcing contract. New contracts should give user organizations much more flexibility to make changes, especially when they involve essential issues like risk and compliance.

Governance

Evaluate the existing governance structure that was set up at the time of the original contract. Organizations often separate operational outsourcing governance from contractual outsourcing governance. If your organization’s existing governance model was formed prior to new regulatory and legislative requirements, changes may be required to address these new realities.

From an operations point of view, vendor management offices sometimes need to improve their handling of business requirements. Renewal gives user organizations an opportunity to evaluate how requests for changes to the outsourced services are controlled or scheduled. It’s a good time to apply governance changes and eliminate the ‘pain points’ from the former agreement.

Request for out-of-scope services

One underestimated area of negotiation is how the parties will deal with out-of-scope services: organization-driven changes to processes or systems that increase fees to the vendor. Often, these changes are project driven. Out-of-scope services are a high margin proposition for vendors, so they often encourage change processes that allow costs to rise. Renewal offers organizations the chance to review the request process for out-of-scope services, and possibly get better hourly rates for these services based on historical volume.

Value for money

It’s always important to evaluate cost-for-service in any renewal agreement before it’s enacted. By simply renewing an existing contract, you risk paying above market rates or receiving less than leading service when compared to others in the market. The original tendering process gave your organization a benchmark for the market at that time; now you have the option of re-tendering the agreement, but watch out — competing outsourcers may only be willing to participate if the incumbent is excluded from the process.

Another option is to undertake a benchmarking study for comparable services. If this is pursued, Canadian organizations need to be careful about the quality of non-Canadian benchmarking data. These benchmarks commonly include offshore outsourcing, which could result in some apples-to-oranges comparisons. Customized benchmarking studies can be more reliable.

Roll up those sleeves

The retrospective analysis, strategic analysis and tactical analysis recommended here can seem daunting, but compared with many years of potentially overpriced and inadequate service, it’s a wise investment. The organization that doesn’t perform an adequate level of due diligence at renewal can be at the mercy of an outsourcer. That’s not what any financial executive wants, especially when dealing with such important and costly commitments.

And remember, if re-tendering is a possibility, you probably need to do so before your current deal expires. Most organizations start evaluating options 18-24 months ahead of their renewal date. So it may be time to roll up those sleeves again. The clock is ticking.

Glen Wedel is a sourcing lead and Yvon Audette is an IT effectiveness lead at KPMG.

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