Renegotiating outsourcing contracts a valid cost cutting tactic?
Rick Simmonds
As the downturn and the credit crunch continue to bite, organisations are increasingly looking to cut costs aggressively. Outsourcing contracts can look like a promising area in which to attack costs – after all, the things which make cost-cutting difficult (dealing with the people issues, and maintaining service and productivity) are the problem of the supplier (sort of…). Perhaps all it takes is a determination to cuts contract costs by, say, 20% - and with a bit of hard negotiation it is done. Well, perhaps.
The first thing to do is to establish whether it is feasible to cut costs in any particular contract. There are two dimensions: does the contract provide for some sort of renegotiation – benchmarking, volume changes, continual improvement, partial termination etc? If so, determine which areas can be addressed. Secondly, and more fundamentally – what is the balance of power between the parties, and, if the client is, or is perceived to be, more powerful, can a cost reduction be demanded? The most effective lever clients have is the threat of termination – but that can only be effective within sight of a break point, say within 2 years. Without that, power imbalances are less effective – there may be leverage around relationships, reputation and referrals, but these are relatively soft.
There are two ways in which costs in outsourcing arrangements can be cut.
The first is in reducing the volume of services being used. If the contract has truly variable pricing, or allows for partial termination then this should happen (or perhaps should have happened – clients can be lax in exercising contractual rights) fairly automatically – although it may be necessary to change or remove any minimum revenue commitment. But if the contract doesn’t provide for this, then it will need to be negotiated, and this can be difficult if the client does not have some specific leverage. A variation on reducing the volume of services is to reduce the quality – bringing down service level requirements can have a significant effect on price.
The other main area is to seek a reduction in unit prices and rates. Again, the contract may provide for these, in which case the contractual provisions should be addressed. If there are no provisions for cost reductions the rules above apply – negotiation with whatever leverage can be applied.
The main question, however is not CAN organisations look to renegotiate their contracts when times are hard, but SHOULD they? It probably isn’t in their long-term interest to negotiate down costs if as a result they undermine the economics of the deal and make it unsustainable for the supplier. Deals where the supplier doesn’t make money never last, and when deals fail it is always the client who suffers, as critical services are destabilised. However, if the re-negotiation (whether facilitated or not by the contract) is underpinned by legitimacy – for example recognising that falling costs of technology have not been passed on, or that the supplier has benefitted from a price which is above market norms, or that volumes and therefore costs have fallen – then the demand for cost reduction is both fair and sustainable, and indeed it is probably the obligation of any client to seek it.
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