Today’s savvy IT leaders go into outsourcing decisions thinking about the business value of a potential deal—from scope to service levels to price. But they’re overlooking the value of thecontract terms that can make or break an outsourcing engagement, says Brad Peterson, partner in the outsourcing practice of law firm Mayer Brown. By estimating the dollar value of the most important commitments, options and incentives clauses in the agreement, customers could make much smarter decisions about how to set up the relationship, but few do.
"For the most part, customers haven’t thought of valuing contract terms or wouldn’t know how to go about it," says Peterson. "Some believe that terms are a ‘soft’ benefit and, thus, impossible to value accurately. Also, procurements teams are often compensated based on ‘savings’ without regard to whether the contract will allow them to realize that savings." But you can bet your IT service provider has a dollar amount assigned to every term that might make it to the negotiating table.
If customers don’t price out contract terms, they may end up pushing hard on terms with little value while overlooking those that could cause deal degradation down the line. Many IT leaders today, for example, are driving hard bargains on limits of liability for data breaches that are unlikely to occur, says Peterson. Meanwhile, they happily sign off on "sole remedy" language that limits the customer’s recourse when a vendor fails to meet its responsibilities. "Customers might be impressed by the strong promises at the start of a contract and miss the fact that the ‘sole remedy’ clause means that those promises don’t provide value," Peterson says.
Estimating contract terms isn’t easy. Even experienced third-party advisors don’t do it; consultants have limited understanding of the legal language and lawyers lack the business background to run the numbers. But valuing contract terms at zero can lead to surprise charges, lack of control, inability to exit, or compliance failures. One of Peterson’s clients, for example, had previously opted for a yearly software license as part of an outsourcing arrangement in order to skirt the perpetual license fees. A few years in, the software had become a fundamental part of the client’s business and the annual fee jumped 20 percent. "They asked us what they could do and, because their price lock lasted only three years, the contract was no help," Peterson says.
It might be a mistake to invest the level of resources required to nail down an exact value for every term, customers can focus on negotiations where there are clear choices to make—like the choice between two providers or between a price cut and better terms. "Start with a high-level look at key terms and then build a more detailed view," says Peterson. "You need to balance the value of better results with the cost of analysis." In many cases, IT leaders have already gathered or created data as part of making the business case for outsourcing that can help evaluate contract terms. For example, if the value of the desired business outcome is estimated, that estimate can be used to put a dollar figure on any terms that effects the the probability of achieving that outcome.