Rethinking the Long Term Sourcing Deal
Historically, outsourcing agreements included terms typically lasting five to seven years or even longer - with additional years tacked on as options exercisable only by the customer. But several factors suggest that a customer should think twice and at least consider shorter term deals with its service providers:
- The Deteriorating Business Case: At the end of a 5 year deal, the customer is often overpaying for the contracted services. This is true despite what appeared to be a great deal at the outset and various protections built into the agreement, including fixed declining pricing, benchmark rights and pricing reviews. Reasons for this phenomenon include:
- Non-labor IT costs decrease more rapidly than the declining price baked into the agreement, especially when measured over 5+ years
- Customer needs to change and add services while being fairly captive to the established provider, resulting in above-market pricing for these additional services
- "Band aid" additions of new scope during the term of the agreement, leading to sub-optimal solutions and inefficient pricing
- Questionable "change order" practices by service providers, such as charging for in-scope services as additional services
Of course, there are downsides to shorter deals.
- First, the customer often will get a better price from the service provider in exchange for a longer term deal with a higher total contract value (but, as noted previously, these long term prices are often out-of-market before the end of the term).
- Second, the customer may miss the opportunity to shift the longer-term risk of inflation and foreign exchange rates to the service provider.
- Last, customers often can exit their longer-term deals early through payment of a reasonably low "termination for convenience" fee. So the customer can maintain some of the long-term protections while still having an option to shorten the deal at a relatively economical price (especially in the out years).