Outsourcing Lifecycle Strategy: Using contract expiration to your advantage

1 Introduction

Many organizations have outsourced parts or all of their IT activities during the past few years. These deals often involved ambitious plans for cost savings, technology upgrades, innovation and the transfer of employees. All of these outsourcing contracts will sooner or later approach their expiration date. This raises an important question: how will IT delivery be continued after the expiration date? Having that expiration date come close can be felt like a challenge, or an opportunity for reflection, improvement, and possibly change. A time to ask: are we still on the right path? Does our sourcing strategy still apply? What will be the effect on the current service delivery? This paper discusses the contract expiration stage of outsourcing deals. It covers the decisions that have to be made, options available, risks and opportunities this provides to outsourcing clients, and how and when to address it.

For most organizations outsourcing means engaging in a long-term sourcing commitment. Every few years, that contract is bound to end. One would think this would mean the start of a new Sourcing Cycle. Surprisingly, we see more than 60% of the companies ‘just’ continue their current contracts with some minor changes. Continuation existing contracts is often considered least risky and the option that costs less time and effort. But will this help solve current issues, and thus will it not introduce new risks and high costs in the future. Opting for change provides opportunities, but could entail starting a huge program to achieve it. Everyone involved will have their opinion about what to do, arguing that you’re completely locked in by your current supplier right now or that you should switch regardless of the consequences simply because the current supplier is just unable to perform according to your expectations.

Usually there are more options available than simply extending and completely terminating a deal. These options provide you with other opportunities to improve on service, quality and costs.

2 Your options

When drafting possible scenarios specifically for your organizations’ sourcing deal, you will soon notice that the measures these scenarios consist of can be grouped into five generic options. These options are listed below.

2.1 Continuation

Outsourcing contracts, certainly those with short durations, often contain an option for continuation. This allows you to extend the current contract for a specified period. Some contracts even allow multiple continuations or rely on tacit continuation.

Continuation results in you getting the same services the same way and at the same conditions as currently apply, including additional agreements signed during the contract duration so far. In a way, it extends your status quo. This option is likely to be attractive if satisfaction is high, market conditions have deteriorated – e.g. if you probably would not be better off with a new deal – or when legal restrictions prohibit other options than continuation or re-tendering.

2.2 Rescope

Rescoping means extending the duration of the current cooperation while making adjustments to the scope of the agreement, by adding or removing responsibility for some services. An example could be transferring application management from in-house to a service provider. Common practice is also to reallocate some activities between service providers in multi-vendor settings based on lessons learned during the current contract term. This allows simplification of delivery, governance and service ownership, which can contribute to better service levels at lower costs.

The steps for rescoping resemble those for continuation, leaving most of the contract intact and renegotiating an additional appendix to the contract to cover the changes in allocation.

2.3 Renegotiate

By the end of the contract term the service delivery of your suppliers can have evolved to differ greatly from the terms and conditions that were originally contracted. Also, market conditions can very well have changed, price levels dropped or pricing models changed and technology evolved.

Renegotiation focuses on agreeing on new terms and conditions for roughly the same service scope as currently provided. These can include new standardization, efficiency, innovation or other targets for suppliers, usually at newly established prices. This often makes it an attractive approach when IT objectives or the service landscape have changed significantly, and after a first-time outsourcer has attained sufficient sourcing experience and capability to be interested in increasing the leverage on their outsourcing. It is, for example, not hard to imagine organizations being reluctant at first to commence offshoring of legacy application management, but being very interested after having gained trust and experience during that first sourcing cycle.

2.4 Re-tender

Re-tendering means soliciting completely new proposals. This will generally focus on other suppliers, but can just as well involve inviting your current ones to participate as well. The scale can differ from requesting quotes from one or a few preselected companies to publicly publishing a Request for Proposal, inviting anyone that complies with some basic criteria to respond.

Launching a good tender usually takes a significant amount of time and resources, and requires drafting the service requirements in detail. While this generally is a lot of work, a good tender does invoke healthy competition – guaranteeing the solicitor the best possible value for money available at this time and giving insight into market developments and propositions that you might be unfamiliar with so far. Fair competition is also the main reason for many governments to require re-tendering by law for all public institutions. Having to draft service requirements ahead of time also forces your organization to thoroughly evaluate, rethink and redefine its service portfolio. This optimizes the documents that will become the basis of the new contracts, and can lead to hard- and software consolidation plans and increased cost awareness across the organization.

2.5 (re-)internalization

Besides the before-mentioned options, moving back to an internal service provider could also be an option. In-house execution is an option that always deserves serious thought. Outsourcing has to make business sense and should not be conducted just because peers do so. If the market does not offer or fails to deliver the proper opportunities, have another look at the business case for internalization.

Advantages usually sought by outsourcing include lower cost by creating economy of scale, access to skills and knowledge not available in-house and a much larger, scalable and flexible human and technological resource capacity. Many companies however experience issues and additional hidden costs, like unclear time and materials billed and own governance costs, poor engineering skills, lacking of business knowledge and increased bureaucracy and rigidity. This can negate the advantages of outsourcing to such extend that internalization makes perfect business sense.

3 Defining your strategy

In order to gain advantage of contract expiration, you will need to have clear plans on what you wish to achieve and set objectives accordingly. Based on these objectives you can choose the right sourcing options for your organization. Unfortunately there simply is no one-size-fits-all decision model for choosing the future of expiring outsourcing contracts. In stead, objectives have to be challenged and prioritized. This leads to a preference of one or more options based on careful considerations of the opportunities and trade-off that each of them holds in store. In this chapter we will discuss the considerations to keep in mind.

3.1 Ten decision drivers

Specific circumstances and organizational characteristics make each situation unique. Still, most decision drivers are universally applicable. Most of the arguments for choosing the preferred option relate to one of ten types of decision drivers. The importance of these decision drivers varies for each specific organization makes the unique solution for an organization.

3.1.1 Your strategic objectives

A lot can change during the few years the outsourcing deal is in affect. Reexamining your strategy is essential for getting what you want and need in the coming years. Changed strategies can however result in different requirements and preferences with regard to the service providers in general, and the division and allocation of the outsourcing scope.

3.1.2 Your satisfaction

Building effective relationships between clients and suppliers often takes years. This makes satisfaction about your current suppliers a very good reason for wanting to continue cooperating. It allows you to take immediate advantage of the mutual investments in the existing relationship of the previous years. Switching suppliers unfortunately requires starting over to a large extent. Besides, why change a winning team?

3.1.3 Regulatory limitations

Government institutions in most countries are required by law to publicly tender contracts above a certain turnovecertain threshold. This limits renegotiation options and shows us the importance of including a good continuation option in any contract signed. Examining the continuation clauses of your contracts might help find ways for keeping the continuation, rescoping and renegotiation options open even when you think you are obliged by law to retender.

3.1.4 Supplier’s ambitions

Just like clients, vendors can change their strategy and focus during the contract. In a best-case scenario from the client’s perspective, the supplier is increasing its focus on the services you have already contracted with them and market segment your organization is in. Not uncommon however, a supplier moving away from the services it is currently providing you with, and telling you they are only interested in extending a new offer for parts of the current services, or maybe even none at all. There are several reasons why this could happen. Besides an actual change in strategy of the vendor or a change in management because your vendor merged or was acquired by a different firm. They also might have decided to only focus on smaller or larger size clients or deals. At the same time, it could also just be a cherry-picking attempt as part of the negotiation game. By now, they now best what part of the service delivery is profitable for them, and which parts are not.

3.1.5 Vendor lock-in

Some organizations face severe vendor lock-in. Obvious dependency on a supplier can be caused by anything ranging from depending on their proprietary products to ongoing involvement in key projects or a knowledge gap about architecture and systems amongst the client staff. Such vendor lock-in puts a serious limitation on the options for future strategies. At the same time, it is quite easy to overestimate the level of lock-in. If asked during a tender, several competitors of any vendor will probably be able to and be interested in presenting a positive business case that helps solve your current vendor lock-in issues.

3.1.6 Availability of alternatives

Choosing to change your supplier landscape is only an option if there are viable alternatives available on the market. If the current supplier you are evaluating is already considered to be the best in class, ask yourself what there is left to gain and how moving to a lesser rated supplier can help achieve your objectives. International presence and local support requirements as well as a scope requirement that is uncommon within the market can also lead to limitations in competition. Reconsidering your scale and scope definitions could help increase the available options and competition, leaving you with more options to pick from and better chances on getting a good deal.

3.1.7 Keeping operational risk manageable

Doing what you did before will most likely get you what you got before. On the other hand, change will inevitably mean less predictable results on the short term. Any change to your supplier landscape, or performance expectations, means risks for operational performance during the transition and hold no absolute guarantees for the long term. Improvements, on the other hand, simply cannot be achieved without change.

3.1.8 Staffing consequences

Re-internalization or adopting a radically different lot design or vendor management strategy can create serious gaps between the capacity and capabilities of your current sourcing management organizations and what will be required in the near future. The size of this gap and the level of confidence on being able to overcome this issue given the organizational characteristics and IT labor market conditions defines your level of freedom for making change happen in a responsible way.

3.1.9 Economic reality

The duration of IT outsourcing contracts still steadily decreases. While ten-year contracts were no exception a decade ago, three years is no exception today. This provides more flexibility for clients and increases the alignment of IT contracts and global economic cycles.

During economic downturn both clients and suppliers have a tendency to reduce costs. Clients typically do so by stretching service levels and postponing investments and projects. Suppliers often sacrifice customer satisfaction for shareholder returns by slashing any and all existing slack in the delivery of current contracts and reducing their headcount. During a downturn, choosing a supplier that both has a solid financial position and is expected to take the least radical measures could be smart. This could mean, even while being satisfied about the current one, switching to a different supplier – perhaps a smaller company or one that is privately owned and thus feels less short-term performance pressure from shareholders.

Besides cost cutting, clients nowadays also face a new economic threat: bankruptcy. For decades IT companies showed such promising growth rates and profits that bankruptcy never came to mind. The same thing applied to banks, until in 2008 and 2009 several giants collapsed during the financial crisis. The reality is also that technology companies are still very vulnerable for the downturns of regular economic cycles. This insight can be grounds for choosing a different sourcing strategy than used during the original outsourcing. Thoughts on single versus multiple vendors might change, fallback scenarios reviewed and alternate continuity guarantees sought.

3.1.10 The financial business case

Contract expiration is a good time to have a look at the original business case. In retrospect, how realistic was this business case? Has it been achieved? What are the lessons learned? Few organizations actually monitor their financial business case during the course of the contract. Looking back at the end the contract term will probably provide insights that will influence the financial objectives for the coming term that is about to be decided on.

Prices also tend to reduce rapidly in IT. Price levels and views on what were and were not financially viable solutions when the current contract was signed might be seriously outdated by now. Policies on budgets and views on IT investments will most likely also have changed in recent years. All possible financial aspects can be drivers for preferring certain sourcing options over others. Once you are actually exploring your options, the scenarios under consideration should also result in a realistic and acceptable business case.

3.2 Choosing your strategy

In order to be able to assess these drivers, an organization needs to look back on what plans and measures in your current contracts did and did not work, look ahead at what your business strives for in the next couple of years, and look around at how the supplier market has developed and what new business and technology opportunities have appeared since the previous deal was made.

The analysis will undoubtedly reveal the complexity and uncertainty accompanying the decision. This makes thoroughly establishing the importance of drivers crucial. It is not too difficult to draw a conclusion on all of them: we are or are not satisfied with our supplier, there are or are no real alternatives, we have or have not met our financial objectives, etcetera. Challenging their importance and selecting the most important few that will be deciding for your strategic decisions however, can be. This step is needed to be able to work towards a clear preference in options. As said before, each of your five options all have their pros and cons and you cannot always achieve all objectives and requests. Whether continuation, renegotiating, re-tendering or an other option is best for your organization, thus depends on what your most important decision drivers are.

4 The roadmap

The key to successfully managing a contract expiration program is taking the right steps and starting in time. The right time depends on the contracted notice period. In most contracts 3-6 months. Based on this notice period the starting time should be at last 1 year before expiration date. These start by defining your strategy. Part of the strategy is the definition of the sourcing process. The basic strategy to chose for re-negotiate, re-scope and what/if’s is defined. As said in the earlier paragraphs it includes looking back, but mostly requires looking ahead. In order to be able to source the right supplier landscape you will have to know what your organization needs and aspires in the short- and medium-term future, and which current issues would have to be addressed now and during the transition phase to get there.

The second phase is the selection process. While a tender is probably the first thing that comes to mind, it is actually the broader step in which the knock-out talks are held; rescoping and renegotiating also require engaging in serious talks in order to get agreement on the most important objectives and obstacles.

The fourth phase is called transfer, and is a post-contracting period in which the switch is made between how things are now and how you want it to become. That could contain transferring services and assets from your old to your new supplier, but could also mean executing a service improvement program when having made new arrangements with current suppliers. Once the tranfer objectives are reached (often called achieving current mode of operations, business as usual state or something similar), the final phase commences. This monitoring phase is actually ongoing, and continues all the way until after all the responsibilities of all parties within the new contracts end.

Of equal importance is getting your timing right. Starting too late means having to make concessions on the quality of the process, or even being limited in your available options due to time constraints.

The expected duration of the selection phase is a key variable when deciding on the required lead-time for the program. A European Tender for example usually takes significantly longer to complete than a private selection process. Choosing to rescope between or renegotiate with current suppliers could require far less time, but maintaining a sufficient buffer for retendering in case negotiations do not work out would be wise until the process reaches the stage where only some details still have to be worked out.

These considerations usually result in the need for commencing the strategy phase anywhere from nine to twelve months ahead of actual expiration, and finishing the contracting phase well ahead of that deadline. If you are planning to switch service providers, transfer human resources or make other changes in the supplier landscape that have potential staffing consequences, you should also expect the vendors to require additional time between signing the contact and the commencement of their responsibility for them to sort out these staffing issues. In order to safeguard service continuity, the new contracts however have to start no later than when the expiring ones end, making closely monitoring these deadlines during the process an absolute necessity.

5 The project team

Taking the right strategy decision is only one part of the work towards securing your outsourcing future. Tenders, negotiations, transfers and transition projects also require a project team and it is worth your while to think about the composition of the team that you will have to put together to handle this contract expiration opportunity.

A team should at least contain stakeholder representatives, vendor management officers and market, technology, HR, financial, procurement and legal experts. The actual balance between these roles depends on the roadmap step. Each one has its own focus and requires a different team composition.

The strategy phase – resulting in a ‘preferred scenario’ decision – requires talks with key business and IT stakeholders and your current suppliers about past and present experiences and future plans. These have to be combined with a legal assessment of the current contract and performance data and reports showing the trends and ‘glass ceilings’ of the last contract term. Because this requires experts that are able to work independently and unprejudiced with all parties, 3rd party consultants are often requested to partake in this analysis and help separate emotion from facts, find supporting data, get objectives clear, contribute information on markets and trends and benchmark supplier costs and performance with market peers.

Tendering and negotiating, two main possible selection phase activities, both require different team capabilities. Before actually tendering you will need to draft a ‘request for proposal’. This is not just a procurement and legal challenge, but also requires a lot of input from the IT department. So besides procurement and legal experts, IT expertise is required to collect, review and if not available define Service levels, service catalogues, architecture standards, etc. Accuracy is key at this time, for mistakes or omissions made during the preparation might not surface until contracts are signed and things go wrong during the service delivery. Repairs then require going through the lengthy and expensive task of changing or amending the contract.

Negotiating is a different capability altogether, focusing mainly on commercial interests and legal liability instead of technical aspects. This is by far the field in which procurement and legal officers are expected to take the lead.

Once the transition phase starts the re-contracting project team can be discontinued and responsibilities can be assigned to a new transition project team. Clear goals on the duration and objectives of a transition phase should already have been set during contracting and oversight by someone with good project management capabilities is now essential for achieving your objectives.

Close monitoring of the transition on behalf of the client is needed to assure timely and correct delivery. In order to keep the project and the regular operations manageable, clear separation between the oversight and decision making of transitional and the regular operational activities is recommended. This applies to improvement plans of existing suppliers and transfer of service to a new supplier alike.

Unfortunately many organizations put a lot of effort in and focus on the selection process and contracting, but fail to recognize the importance of a good execution of the contract for the overall business case and satisfaction. If insufficient attention is paid to the transitional project and governance the results of a good contract expiration project will likely still be disappointing.

When the transition project is completed the sourcing management organization has to be ready to take over control of the achieved “to be” situation.

6 The result

This paper discussed the contract expiration phase of outsourcing deals. Outsourcing contracts result in a service lifecycle of several years. During these years, only fairly minor adjustments can be made to the services that are provided to you. The contract expiration however, allows you to make large or even radical changes that are very difficult to achieve during the contract execution. This provides you with opportunities for change, and risks requiring addressing alike.

What happens if you ‘just’ continue your current contract? While clearly a low-risk solution for the short term, you might face the consequences later on. For one, sourcing best practices still rapidly evolve. So while competitors are driving innovation and effectiveness by applying the latest methods and views with their sourcing partners, you might be losing the lead because you are still limiting your suppliers to solely behave like traditional vendors. Even more harmful might be that while your business evolves, adopts new strategies and develops new products, IT is slowly ‘disconnecting’ because its service providers’ contracts still focus on the objectives set eight years ago.

Disappointed clients might feel the urge to ruthlessly choose to say goodbye to their current supplier and re-tender. Though this is understandable when you are disappointed, it might not always be in the best interest of your organization. One has to keep in mind that poor performance is usually the result of mistakes by both sides, and thus ‘just’ switching suppliers might not solve that much. In stead, by looking at the risks involved, likelihood of benefits actually being gained with other suppliers and the willingness of both parties to work on issues you might just conclude that combining the current long-term relationship with some rescoping or renegotiation is best for everyone.

The most important of reasons to thoroughly look at your options at contract expiration however, is to make use of opportunities that are already there. One of these is that in recent years IT sourcing has evolved and matured. Increasingly, outsourcing deals focus not on activity execution but on results. Their designed is moving from processes to customer services and extend from just IT to including the business processes it is used for as well. Truly treating a new deal as just that will also push suppliers to really think about what they can offer, what innovations would be beneficial to your business and listen to your ambitions. Serious reconsideration at the expiration of every decent size contract allows you to keep your suppliers sharp, align the way you get your services provided to you with the latest thinking on the role and positioning of IT within the organization and truly monitor the value of offshoring as an investment throughout its lifecycle.

Don’t let your outsourcing contract become your legacy problem. In stead, use this moment to get your organization ready for the coming business issues and solve current sourcing issues. Use your contract expiration to your advantage!