The extraordinary activity in the South African mobile voice and data communications market in the last six weeks has seen Cell C introducing straightforward and aggressive pricing for retail customers. This is in the face of historically complex pricing structures that average consumers struggle to fully understand. These have evolved from an industry that over the last 20 years has grappled with the challenge of how to price mobile telecommunications services. Cell C’s recent approach to market with what on the face of it appears to be a standard post-paid rate, per second billing, whether in or out of bundle, and for a range of contract durations, has gone some way to introducing clarity for consumers of mobile communications services. It will be very interesting to watch how the market reacts.
In light of this market activity we thought it was opportune to revisit one of the foundation issues for any outsourcing or managed services arrangement: how to ensure your deal remains competitive in a market where the services in question are very likely to become cheaper over time? The South African mobile communications industry provides an excellent example of a market which is now likely to move so quickly that unless your deal is crafted to evolve with the market as it moves, there is a high risk that it will become uncompetitive shortly after the ink is dry on the paper. The speed with which this market is moving amplifies the need for parties to these agreements to focus on the rights and obligations in their contracts to keep pace with a rapidly changing market landscape.
Benchmarking is the most typical mechanism included in outsourcing and managed services contracts. It is intended to give the customer the comfort of knowing it has enforceable rights to ensure that the supplier’s value proposition remains competitive. Benchmarking can be effective for large deals with a long term and for services that can easily be compared to a sample of the same or similar services within the relevant market. However, if any of these elements are not present, for example if the solution on a particular deal is extremely bespoke to the customer, it is one of a handful of deals in the relevant territory or volumes are unusually large or small, it can be very difficult to run a meaningful benchmarking exercise. A full benchmarking can also be cumbersome and expensive and as such is often not appropriate for a market where technology and pricing is evolving very quickly.
In order to try and ensure your benchmarking provision is practically enforceable, be careful of the pitfalls that are discussed in each of the following key elements to any benchmarking provision:
- What Do You Benchmark?
Most benchmarking clauses will allow the customer to compare the price of the services to what is available in the market and some will also allow the benchmarking of service performance. Customers should make sure they are entitled to benchmark the price for all or part of the services. It can be easier to compare parts of the overall service scope which are commonly available in the market place. Further, having to compare the entire service can make it difficult to find a representative sample of deals with the same or similar features across the whole of the scope.
- Who Does the Benchmarking and How Are They Chosen?
Generally a reputable third party benchmarker will be chosen to conduct the benchmarking but be careful of leaving the identity of the benchmarker up to the parties to agree at a later stage during the contract. If the parties cannot agree on the benchmarker later the benchmarking clause may, despite including model terms, never see the light of day if the parties simply don’t agree on who will conduct the benchmarking. If the customer does not have a unilateral right to choose the benchmarker, at a minimum you should agree a short list of the benchmarkers that both parties agree to at the outset and which the parties will choose from if the right to benchmark is ever exercised.
- How Often?
Most suppliers will resist benchmarking in the first 12 months of a contract on the basis that they need to be given the opportunity to establish the service. In most large deals this is not a concern for the customer as the chances of going back out to tender so soon after the execution of the contract are slim. However, this grace period can be problematic for markets that are evolving rapidly which is typical of ICT. If your deal is being entered into in the context of a rapidly changing market, be careful of signing up to a long grace period before the benchmarking rights can be exercised and if you have to, make sure that there are other mechanisms in the contract that provide you with protection, for example ‘market testing’ or ‘most favoured nations’ provisions (as discussed below).
- Normalising the Services
Although certain services that are typically outsourced are gradually moving along the spectrum towards commodity, it remains unusual for any two large outsourcing or managed services deals to be identical. In order for the benchmarker to conduct the benchmarking it will be necessary to normalise the services across a representative sample of deals. Suppliers prefer to be prescriptive about: (a) the elements of the deal that will be used by the benchmarker to normalise the services and (b) a minimum number of deals that need to be included in the clause for the sample to be representative. There is a natural tension in doing this: the more specific the elements of the deal that are used to normalise the services, the fewer deals there will be with each required element and before long the benchmarker will be struggling to find enough deals to meet the prescribed minimum number.
The South African mobile communications market is again a useful example in this context. It is rare for two operators to offer identical services and commercial packages to their customers. One deal can be comprised of a certain number of free minutes, reduced rates off peak, a shorter contract term, preferential data services and excellent network coverage while another will offer fewer free minutes but cheaper off net calls and a lock in to a longer contract period with a connection incentive bonus. If each of the elements that go to make up a commercial offer from the operators was strictly prescribed as necessary for a representative sample, and there was also a requirement for a minimum of six deals in the benchmarking exercise, it will become impossible for the benchmarker to find a representative sample. In these circumstances it is important to ensure that the contract refers to a more general comparison of the commercial value propositions taken as a whole across different suppliers, rather than isolating what can be compared down to narrowly defined and specific elements of each deal.
The elements of a deal that are typically used to normalise the services include the following:
- Scope – for example what equipment, geography, hours, end users etc. is/are being covered by the services;
- Volume – for example numbers of end users, devices, or servers;
- Service Levels – for example response and resolution times and availability levels.
- Client Constraints – are there unique restraints placed on the supplier by the customer that are not present in other representative deals?
Each of the elements above as well as any others required by the supplier need to be scrutinised carefully e to ensure that they do not make it impossible for benchmarkers to normalise the services across a minimum number of representative deals.
- Benchmarking with Teeth
The outcome of the benchmarking exercise has to allow the customer to enforce a price adjustment on the supplier, or otherwise exercise a right to terminate the agreement. If there is no such right and, for example, merely an agreement to agree what to do at the end of the exercise, there is little point in conducting the benchmarking in the first instance.
Streamlined Market Testing
Although a carefully drafted benchmarking clause with meaningful remedies can be used to good effect for the right deal, a full benchmarking can be cumbersome and expensive and not fit for the purposes of a deal for services in a rapidly evolving market. This is one reason why so few benchmarkings of outsourced or managed services are ever actually carried out in the ICT market. An alternative that some customers sometimes adopt is a short form market testing process whereby:
- The parties agree a set of commodity items that are susceptible to market testing because they are standard in the market place.
- Customer conducts a very simple market testing by gathering publicly available pricing information from different third party suppliers in the market place.
Customer presents the collated information to supplier and if the supplier’s price for the relevant commodity item(s) is not competitive, supplier will have the option to, for example:
- Adjust supplier’s price to come in line with the market; or
- Engage the cheaper third party supplier as a subcontractor to perform or provide the commodity item(s),
and if the supplier does neither of the above the customer will have the right to terminate the performance or provision of that commodity item and engage the relevant third party supplier directly.
This more streamlined process will work well for comparing commodity type services or products and can be a faster mechanism for ensuring your deal remains competitive.
Most Favoured Nations
Over the last five years our experience is that the market has shied away from most favoured customer or most favoured nations provisions on the basis that they are too aggressive against suppliers and difficult to enforce due to the confidentiality obligations suppliers owe to all of their customers.
However, the concept has recently started making something of a comeback as customers grapple with how they can keep their deals competitive without embarking on a full benchmarking. Most favoured nations status can afford a customer with some comfort that they will at least move to improved pricing and services as the supplier moves with the market. However, these clauses remain difficult to enforce practically as suppliers are legally bound not to disclose the commercially sensitive details of any one customer engagement to another customer and suppliers are careful to limit the application of this right by narrowly defining the parameters of the scope, volumes and service levels within which the customer can enjoy most favoured nations status.
Term and Exclusivity
Although they are more rare nowadays it goes without saying that an exclusive deal of 10 to 15 years without robust benchmarking rights is not going to allow your deal to be competitive. With the trend to multi-sourced environments, the lengths of time suppliers are being engaged for are becoming shorter to allow for greater flexibility to engage a different supplier if the incumbent is uncompetitive. Customers are also increasingly aware of the dangers of exclusivity in limiting the ability to engage a different supplier for some or all of the relevant services if necessary.
Shorter length agreements can be a very effective way to ensure that you have the flexibility in your contracts to take advantage of improvements in market pricing by moving to more a competitive supplier upon the expiry of the existing agreement. However, there is inevitably a balance to be struck between this benefit and the price discounts suppliers will offer for longer term engagements.
The termination for convenience rights in the contract and any associated termination charges should be considered in this context. It may be the case that if you have negotiated favourable termination charges and the market has moved aggressively since the commencement of the contract, that even with the cost of the termination charge there is still enough benefit to be derived from the more competitive pricing offered by a successor supplier. In some industries, including the enterprise mobile communications services sector, successor suppliers are becoming increasingly willing to cover the cost of the customer’s termination charges under the legacy contract.
A contractual mechanism that can be used to ensure the quality of services remains competitive is the concept of continuous improvement. Although this sounds like an obvious point that should be covered in all contracts, it is in fact notoriously difficult to bind suppliers to an obligation to continuously improve the services without the supplier being able to charge incrementally for any such improvement. It is key to ensure that the services and service levels are described and set out in a way that ensures the customer will receive what is expected from the outset. There are then different options for binding the supplier to an obligation to improve the services from that baseline. These include, for example, automatic year-on-year increases in service levels and/or automatic year–on-year reductions in price to ensure the supplier is incentivised to drive efficiency into the service.
As ever the objective of keeping your deal competitive remains one of the key items in negotiations on outsourcing deals. In markets such as the mobile communications market in South Africa, this is brought into even sharper focus. Those involved in the discussions on this point should consider carefully the contract levers available to meet this objective and the nuances involved with drafting these provisions.