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    Keeping your Outsourcing Agreement Flexible and Change Friendly

    Author: Simpson Grierson       

    "There is nothing permanent except change"
    Heraclitus
     

    Over the past decade, businesses have had varying degrees of success with outsourcing arrangements. Outsourcing is uncharted territory for many organisations and it can involve handing over control of an important business process of an organisation. We have all heard of the outsourcing deals that have gone wrong, leaving the parties disappointed and frustrated. A well constructed outsourcing agreement will help your organisation avoid some of the pitfalls of outsourcing.

    There are a variety of issues that need to be addressed in your outsourcing agreement to improve the likelihood of its success. These range from managing the transition of existing infrastructure to measuring and assessing the vendor's performance against agreed service levels. One of the most significant issues (and often one of the most difficult to address) is ensuring your outsourcing agreement is flexible enough to accommodate the many changes that may occur in your requirements throughout the life of your outsourcing arrangement. In this article, we look at some of the key contractual mechanisms that can be used to maximise both the flexibility and "change friendliness" of your outsourcing agreement.

    Price Model

    The degree of flexibility that may be available under an outsourcing agreement can be influenced by the pricing model the outsourcing agreement is based on. For example, while a fixed price model might be attractive as it is simple to calculate and creates certainty in financial forecasting, it leaves little room to manage the changes that may occur during the life of the outsourcing agreement.

    Your pricing model should ideally anticipate and deal with the cost impact of changing resource requirements and evolving technology. It is also important to ensure that services are not bundled and priced together. Where services are bundled and priced together, pricing is often less transparent. It is more difficult to add and remove services from the contract, and more difficult to compare the quality and cost of your IT services with those of other organisations. It is important, therefore, to analyse and define the various components of the services and put a price tag on each. It can also be helpful to group the various service deliverables into service towers, which are easily removed from the scope of the outsourcing agreement if the vendor is not performing satisfactorily, or if the customer ceases to have a need for a particular service factor because of changes to its business applications.

    There are as many pricing models as there are outsourcing agreements, each tailored to the specific circumstances and concerns of the vendor and customer. The main point to remember is that the pricing model you use will impact on how your outsourcing agreement deals with flexibility and change.


    Contract Term

    A simple way to ensure that your outsourced services remain flexible is to enter a shorter-term agreement. Although a ten year term is not uncommon for outsourcing arrangements (particularly larger scale ones), shorter terms (for example, three years) with options of renewal on the part of the customer are more likely to result in the services remaining flexible and contestable. But you need to be aware that shorter terms may lead to higher prices as vendors will have a potentially shorter period over which to recover their costs in entering the relationship.

    Scope, Change Management Procedures and Additional Services

    Outsourcing agreements need to clearly define the scope of services covered so they contain robust change management procedures to allow for changes to the scope of services defined and the potential need for additional services. Some changes (for example, fluctuating resource requirements), can be anticipated and specific procedures included to deal with them. However, more general change management processes are required where the nature or impact of changes cannot be addressed up front. Change management processes should be developed to deal with minor as well as major changes. A formal agreement variation may be appropriate for the addition of a new service, whereas a less formal change control process could be included to deal with the implementation of, say, a new software update.

    Service Levels

    Service levels are recognised as a critical performance measurement in outsourcing agreements. Vendors can be incentivised to achieve or exceed service levels through the use of fee bonuses and rebates, and by introducing a mechanism for the continuous improvement of service levels over the term of the agreement. For example, service levels can be revised annually. If the baseline service levels are exceeded during the year, the baseline for the following year can be moved up by an agreed percentage of the difference between the previous baseline and the actual level of service. If actual performance does not exceed the baseline service levels, the service levels do not change. The customer gets the benefit of improved service levels and the vendor is not being asked to perform to a level greater than what has already been achieved.


    Benchmarking

    Benchmarking provisions could be helpful in your outsourcing agreement to give extra flexibility and allow for change. Benchmarking will ensure that the pricing of the services remains competitive against comparable vendors throughout the life of the outsourcing agreement. Benchmarking provisions should detail the frequency of benchmarking; the components of the services to be benchmarked; the benchmarking criteria and measurement; the benchmarking costs (whether they will be shared or whether one party bears responsibility); and any consequences on completion of a benchmarking exercise. However, benchmarking provisions are only effective where the pricing is transparent and is tied to specific services. As mentioned above, if the services are bundled and priced together it will be very difficult to accurately benchmark particular facets of the services.

    Technology Evolution

    "The only constant is change" is a well-known statement and this holds true for the technology at the heart of your outsourcing agreement. Your outsourcing agreement should include mechanisms to deal with evolving technology. Issues to consider include which party will be responsible for the cost of the technology evolution and what standard of technology evolution will apply. Obviously if the vendor is obliged to search out new technologies and carry the risk of evolving technologies this will be reflected in the price.

    One way to ensure that technology evolution is seamless is to formalise technology evolution processes. These processes may include a requirement for the vendor to attend meetings at regular intervals; require the vendor to review and report at specific intervals; and detailing a process for implementing technology evolution. In order for these provisions to be effective, there must be a clear definition of the vendor's responsibilities including the nature and timing of relevant deliverables. An "incentive" for the vendor to be pro-active in technology evolution would be for the customer to hold back a portion of the service charges, and pay these when the vendor has met its technology evolution requirements.

    Conclusion

    Key factors to consider in order for your outsourcing agreement to be flexible and able to deal with change include:

  • the appropriate pricing model;

  • the term of the agreement;

  • adequate change management provisions;

  • flexible service levels;

  • benchmarking provisions; and

  • technology evolution provisions.



  • In our experience, if these factors are considered and provided for at the outset, your outsourcing agreement is more likely to accommodate the degree of flexibility and change friendliness you may require during the term of your outsourcing relationship. This means that your changing business requirements are more likely to be met and your outsourcing arrangement will likely be less costly than less flexible arrangements.

    Key Issues:
  • Perhaps the most important factor in managing change in your outsourcing agreement is selecting the right pricing model


  • Good outsourcing agreements clearly define the scope of services and contain robust change management procedures.


  • Service providers should be incentivised to achieve and exceed agreed service levels and service levels should make allowance for change.



  • This is a general summary only and should not be taken as a substitute for specific advice.

    Contact
    Michael Sage, Partner: michael.sage@simpsongrierson.com
    Karen Ngan, Partner: karen.ngan@simpsongrierson.com
    Don Holborow, Partner: don.holborow@simpsongrierson.com
    Sarah White, Associate: sarah.white@simpsongrierson.com
    Marc Cropper, Associate: marc.cropper@simpsongrierson.com

    x-tech group Simpson Grierson Web site: x-tech group Simpson Grierson



    April, 2002

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