As a customer, one of the biggest challenges in any long term IT service relationship is to maintain a competitive deal and to ensure that you continue to obtain the level of service that you require throughout the life of the contract.
Over a number of years, customers have moved away from long term outsourcing arrangements towards shorter term specific service contracts. One of the reasons for this is to enable the customer to revisit the arrangement in 2 or 3 years and exit if it no longer meets the customer’s requirements. Contractual flexibility, evolution of services and ongoing productivity improvements are difficult concepts to build into a negotiated arrangement when there is limited visibility of the changes that may arise over the following years.
However, the cost of transition and tendering for a new service provider often results in existing contracts being renewed even though they no longer really meet the customer’s requirements. As a result, customers are often finding themselves in a long term arrangement that was drafted for a short term.
So, what can you do to help achieve:
- Flexibility to meet changing requirements?
- Evolution of services in line with industry, technology and regulatory environments?
- Efficiency in the provision of the services over time?
- Control over business outcomes notwithstanding the engagement of a third party supplier?
These are complex issues and in the first article in this series we consider flexibility and 5 tools to assist an IT customer to maintain value in an IT service arrangements – whether a short or long term arrangement.
Five tools for achieving flexibility
IT services, in particular, need to change over time.
Even a three year contract needs to be able to expand, narrow, refocus and shift with changing business requirements. This flexibility needs to be achieved through terms and processes that are sufficiently certain to be contractually enforceable and to minimise disputes.
Flexibility is not just a boilerplate clause that you can build into the contract to tick a box. There is no “magic bullet”.
Flexibility has to be considered for all aspects of the contract depending on the individual circumstances. Where is flexibility required for this contract, and what provisions are intended to remain static? The answer will differ depending on the services, the customer, the supplier and the specific requirements.
Here are 5 tools you can use to achieve flexibility:
- Service description
- Pricing structure
- Segmentation of services
- Termination for convenience
- Change control provisions
But these are standard provisions, I hear you say!
That’s right. None of these concepts are new or innovative. The key is to build flexibility in using these provisions in a tailored way to support your specific requirements for a particular contract. Let’s consider them in more detail.
Service Description – what are you buying?
At the core of flexibility for any contract will be the description of services.
Are you buying support for 3 core applications, or are you buying support capability with the flexibility to add and remove applications and vary the level of service depending on your requirements? Both answers are right for particular services. It is important you understand what you are trying to achieve from the contract.
The services themselves must be sufficiently flexible to deal with the types of changes in your environment and your business that are likely to occur during the life of the contract. Adding, removing and upgrading underlying hardware and software should be easy, contemplated and should not require renegotiation or a change control notice. The pricing will also need to support the flexibility that is built into the service description (see below).
When crafting the service description, build in options to the extent that it makes sense, but be careful about creating a structure that is overly complex. Limitless customisations and options can result in inefficiency, increased management and often confusion.
Another common way of increasing flexibility is to include a process for agreeing projects or additional statements of work as new work and new requirements are identified. These provisions are “an agreement to agree”, but at least the main contractual terms have been pre-agreed.
It may also be appropriate to incorporate into the description of the services a fluid obligation relating to services ordinarily provided in the industry. These types of obligations are not always appropriate and we consider these in more detail in part two of this article which will explore evolution in more detail.
Pricing structure – what are you paying for & how will the pricing change?
The pricing structure should support the flexibility outlined in the service description. A pricing model that allows for volumetric changes for increased or decreased assets is a common way of achieving this.
However, it is also important to understand how the pricing is built up.
Savings is a key driver in the current environment and customers are keen to get a fixed price that is as low as possible for the level of service they require. The upfront business benefit of this structure is clear. The risk is that, over time, changes will be required and lack of transparency will leave the customer in a poor negotiating position and can result in the benefit of the original pricing being eroded.
While a bundled price, where you pay a monthly aggregate fee for all services, creates certainty, it doesn’t naturally provide flexibility. It is important to understand the various components behind that fixed fee. This will help to break out or change the fees applicable to a particular service as required. It also enables you to compare the cost of individual components against the market.
The trick is to get the right level of detail. Ultimately, you generally won’t want a contract where fees are charged on a task by task basis. But if you have a fixed fee, broken down by key service component, that can be adjusted by an agreed amount for substantial changes in volume, then you have a much better chance of reaching a fair price for any agreed variations.
By having a clear and transparent pricing structure, your agreement will be more flexible and adaptable to change. You will be able to define and analyse the cost impact of removing an individual component of the service from scope. You will also be better equipped to compare the quality and cost of your services with other providers in the market.
Other pricing structures that can help support flexibility are:
- Pricing of alternative services and service options (as outlined in the service description) – for example, Gold, Silver or Bronze service depending on the underlying business requirements;
- Predefining costs of likely resources (eg T&M rates for variations or project work);
- Agreed caps on charges payable in circumstances of termination for convenience.
There are a range of different pricing structures available and what works well on one deal may not be the best model on another. Whatever pricing model you choose, it is important to understand how the price may need to change and ensure that the pricing mechanism is sufficiently flexible to accommodate anticipated changes.
Segmentation of services – What parts of the service can stand alone?
Flexibility can also be achieved by breaking the services into natural “groups” of services and ensuring the customer has right to terminate any service group for convenience. This will enable the customer to reshape the services provided under the agreement as necessary to meet its business requirements.
A good way to segment services is to identify the smallest sensible group of services that you may contract separately, if there was a supplier who could do so more cheaply or better than others in the market.
Some common IT service groupings include application maintenance, infrastructure services, service desk, desktop services and networking services. However, as services evolve and change, these groups and the subsets of the applicable services will change also. For example, for cloud computing services, it may be a group of applications, or it may be a single application. There may be “value add” services on top of the cloud services that you can take or leave depending on your requirements. If you initially decide to contract for these services, make it clear that they are separate services that can be dealt with separately from the base services.
Think about the services you are contracting for, and what parts of those services you may wish to bring in house, split out to another supplier, or sacrifice to achieve cost savings. The description, pricing and service standards applicable to each group of services should be clearly segmented for ease of treatment.
The segmentation of services must then be accompanied by a clear right to terminate services separately both for cause, and for convenience (see below).
There may be a host of reasons why you may wish to terminate an individual component of the services, whilst sticking with the service provider for other services. It may be that the supplier is no longer investing in one aspect of the services, has never done a very good job at some of the services but delivers quality services in other areas, is particularly expensive for some of the services that can be procured more cheaply from other companies, that another supplier has a particularly innovative solution that can deliver real competitive advantage to your business or simply that you can live without those services in exchange for a cost saving.
Whatever the reason, smart segmentation of services and a right to terminate for convenience in part can be important tools in being able to reshape your contracting strategy to meet changing requirements.
Termination for convenience – The ultimate in flexibility
As outlined above, a right to terminate for convenience is an important tool in ensuring flexibility. Having the right to walk away from an individual service component or the contract as a whole, may help to keep a degree of negotiating leverage when dealing with changes in circumstances.
A right to terminate for convenience may involve a cost to compensate the supplier for any sunk costs not recovered due to the early termination of those services. However, it is important that these amounts are agreed upfront. This will enable the customer to analyse the business case for any change, including the cost of exiting the current arrangement (in whole or in part).
Ultimately, a right to termination may only be necessary as leverage to ensure the supplier offers its best proposal for any renegotiation or change in scope. If the supplier is unable to deliver a solution to meet the customer’s needs, the customer has a clear right to remove the applicable services from scope or terminate the whole agreement, as required to meet its requirements.
Change control – A process for dealing with change
Change control provisions are pretty standard in IT service contracts. However, change control provisions are not all created equal.
Consider whether the customer should be entitled to require a change (subject to costs) and whether the supplier should be entitled to require a change. In each case it depends on the nature of the services being sought. In genuine cloud computing, it is appropriate for the supplier to change the services but for the customer to have no right to change the services. However, in standard IT service contracts the reverse would be more common.
Further, to the extent that agreed rates and processes can be set out in the contract, this increases the likelihood of the parties having a joint and agreed approach to the change process and neither party will be substantially disadvantaged as a result of a change.
These are some of the ways in which flexibility can be built into a contract. None of them are fail safe, and all depend on critical thought being applied in the preparation of the contract.
In the next article we will consider specific mechanisms that can be used to help support:
- Efficiency and