May 04, 2009, 11:13 AM — Beleaguered companies are seeking new targets to reduce costs, everything from legal and HR services to business processes and R&D are headed the way of the contact center-overseas. "Many C-level executives are in deal fever mode," says Dane Anderson, vice president of IT Services and Sourcing Technology & Service Provider Research at Gartner. "They feel they have to do something so it's Ready-Fire-Aim all the way."
Aiming after the shot usually means missing the target altogether. But failing to define the target has equally disastrous effects.
"You have to look at the 'who, what, why, when, where, how' and drill down from there," says Anderson. "Don't say 'we need to cut costs' think instead 'we need to cut costs by 15 percent in the next three months,' or whatever the case may be, because specific targets will lead you to the specific actions you need to take."
Defining Cheap
"In the current economic environment, companies are increasingly being driven by commercial considerations as opposed to technical factors," says Anupam Govil, chairman of the Global Sourcing Forum + Expo, a large trade show and forum focusing exclusively on outsourcing. "Hence the definition of a good deal has changed over the last 12 months to imply one that provides more value at lower prices."
However, driving the vendor to rock-bottom prices does not a good deal make. If your deal does not sufficiently profit the vendor, the vendor may extract profits in ways that are not in your best interest.
"It is a business reality that vendors that operate on very low margins, and thereby offer the lowest bids, often cut corners in areas that eventually effect quality, scalability and reliability," explains Govil. " A successful outsourcing agreement has to create win-win solutions for both the buyer and vendor."
A good deal then begins by defining cheap as not the lowest cost, but the best bargain for the desired results.
"Companies that are evaluating the concept of business process outsourcing should strategically define the objective to go beyond the 'cost saving' model," advises Anthony Rossabi, vice president of Carrier Services, North America for Tata Communications. "The organizations should take this opportunity to create a cost effective platform which enables them to transform existing business and launch new services. The key to success will be to leverage vendor technical and process skills, productivity improvement by measuring service levels, redefining the processes, automation and effective governance."
Defining a Good Outsourcing Deal Overall
While end-goals differ from company to company and from deal to deal, there are some general guidelines to follow to ensure you are achieving best advantage in outsourcing negotiations. According to Steve Martin, a partner at outsourcing advisory firm Pace Harmon, these are the top elements to look for:
1. No Minimum Commitments
Companies should not enter into offshore agreements that contain minimum volume or revenue commitments. These deals are mostly labor-based and therefore no minimum commitment is necessary or appropriate. Companies should, however, negotiate a tiered discount schedule that leverages volume discounts for increased utilization and spend. The offshore outsourcing vendor should be earning its client's business based on performance, not on pre-negotiated commitments.
2. Termination for Convenience (without material early termination fees)
This best practice is important because it allows a company to terminate an offshoring agreement before the end of the agreement for any reason and without having to pay a significant termination fee. This eliminates potential scuffles over the excuses for terminating the contract, whether they are related to performance, cultural issues, distance or other areas that just may not be "good fits." Even if the terms of the agreement are technically fulfilled, e.g., compliance with service levels, a company may still not be happy with other aspects of the deal and want a way out. Of course vendors will push back on this, claiming that they need to be compensated for stranded costs, e.g., the cost of hiring staff to fill positions, severance, etc. Savvy customers will argue that in an ADM outsourcing deal, capital investments are low and stranded costs are typically not material. Paying them for actual stranded costs is reasonable and appropriate, but paying them for expected profits and lost opportunities is not.
3. Length & Flexibility of Deal
Assuming there is a good termination of convenience clause, a good deal will consist of an initial term of two to three years with two to four successive one-year extension options that the customer can exercise at its own discretion. In addition, all terms of the deal, including price (subject to favorable renegotiation provisions) remain the same.
4. Currency Options
Considering the various currency implications, including hedging, banding, and reviewing average exchange rates, companies shouldn't automatically proceed with a decision to pay for their deal in dollars. While offshore providers will gladly walk their customers into that option as it usually favors the outsourcer's financial interest, companies should take a close look at which currency payment structure option makes the most financial sense for its particular risk profile, fiscal approach, and treasury policy. A good deal will preserve the integrity of the deal and take into account the international implications of payment. Leveraging local currency is usually a beneficial option for deals in emerging markets, especially with local labor being a large portion of the total cost and local currencies devaluing against the dollar over time.
5. Key Personnel
Companies should ensure that as many resources (from the vendor) as reasonably practical fall into the category designated as "Key Personnel." Companies' rights with respect to Key Personnel include provisions that allow them to interview (and even approve) vendor resources for their projects, cite dissatisfaction with performance and terminate resources if necessary, limit the vendor's ability to replace those resources at their own discretion. Key Personnel provisions provide companies more control over quality control of their labor assets.
6. Intellectual Property Rights
A best practice for protecting intellectual property, such as when software is being developed, is to build in clear provisions enforcing the company's ownership of the software, preventing the outsourcer from using the software again for other purposes, or providing it to competitors. The appropriate disclaimers and provisions, which vary from country to country, should be included.
7. Meaningful SLAs
A good deal has service level agreements (SLAs) that tie directly to the outsourcer's performance levels and moreover are focused on those areas that create positive business impact for the company. Meaningful SLAs are tightly tied to business outcomes.
8. Benchmarking
Staying competitive with the market is key and should be done each year to ensure fair and reasonable pricing. This practice keeps the outsourced vendor aligned with the market. One such approach is the so-called "baseball negotiation" clause where during the benchmarking period, both the vendor and customer assert their estimated market rate and then negotiate. If the two parties are at opposite ends of the spectrum, then a third-party may come in and pick one or the other's proposal-forcing both sides to exercise integrity as they realize that the other party's estimate may be chosen.
9. Productivity Improvements
This item is particularly vital in offshore engagements because they are more labor-based, with the real value provided by the outsourcer being one of improved technology, process and methodology. The customer should negotiate for annual, minimum cost decreases that will require the outsourcer to drive productivity in order to preserve its margins. This will align the incentives of the parties and create benefits for both.
In other words, to bag the best deal: Pick a target, choose a weapon, set the sights, steady your aim, and for your own sake, don't rush the shot. In this economy, one shot may be all you've got.
This story edited by Shawna McAlearney. Follow me on Twitter @ms_shawna
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