In part one of this three-part tip, Andy Sealock, managing director at outsourcing advisory firm Pace Harmon, outlined...
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the strategic mistake many CIOs make when deciding which IT functions to outsource and which to keep in-house. Here, Sealock, who specializes in planning, fixing and terminating large, complex IT outsourcing transactions, expounds on the ins and outs of writing a future-proof IT outsourcing contract, which includes the requisite levers for terminating the deal.
No one sets out to write a bad IT outsourcing contract. Best practices are well-known and widely available. "I still see terrible deals all over the place," Sealock said. Bad contracts tend to fall short in two areas: statements of work (SOWs) and service-level agreements (SLAs.)
"The biggest problem I've seen with deals are SOWs that are ambiguous about what the service provider will and won't do for the price contracted for," Sealock said. Contract disputes ensue; costs go up. "If you forget something in the SOW, you have to write an addendum which then allows the service provider to ask for more money."
A close cousin of the poorly-worded SOW is the impotent SLA. "These are SLAs where you don't have a lever to incentivize the service provider to turn in the performance and quality you want," Sealock said. The result is that "you're living with a service that is not as high quality as you expected -- and you and your users just suffer through it."
Start with the RFP
The remedy for these two contractual errors begins at the request for proposal (RFP) stage. "You should be writing your RFPs with SOW requirements and SLAs that are contract-ready," Sealock said. Contract-ready means the RFP will state that the selected service provider must deliver certain activities (SOW), at a specified level of performance (SLA) at a certain price. "These three components have to be interlocked," he said. Change one and the others also must change.
"Not having that nailed down has led to more disputes and unraveling of big ITO deals than anything else I have seen," Sealock said.
Getting each part of an IT outsourcing contract nailed down is labor-intensive. Pace Harmon, for example, "takes a shot" at writing the SLAs but at some point brings in the client's subject matter experts to go through the document line by line. "It's not easy, it's a grind," Sealock said.
A word of caution: If the price per unit of work seems too good to be true, it probably is. Service providers eager to break into an industry are known to agree to a price point that is too low to meet the agreed-upon SLA. Once on the job and under pressure to improve margins, the service provider will start cutting corners.
Another reason to get the alignment right on SOW, SLA and price? The cost and risks associated with transitioning away from the service provider, either by insourcing the work or resourcing it to another service provider are high. "Service providers count on that. Once they've got you, they've got you and know there is a degree of inertia in moving away from the incumbent," Sealock said.
Exit strategies for IT outsourcing contracts
To counteract that inertia -- and incentivize your provider to perform -- Pace Harmon advises clients to include contract provisions that will make it easier to get out of the contract.
"First, you're saying right in the contract that if they screw up too badly, you will leave them, either by insourcing the work or taking it to another contractor," Sealock said, enumerating some of the "basic ways to make it easy to do that:"
- Stay away from minimum revenue commitments, or make the revenue commitment easy to reach.
- Keep terms of engagement relatively short "with a lot of flexibility around whether to extend or not."
- Include contract "default triggers" that can be activated "sooner rather than later" if the provider falls short of requirements.
Most corporate lawyers know to get those things into IT outsourcing contracts, Sealock said. Less obvious are the contract provisions for "knowledge transfer" should clients decide to insource or resource the work.
Andy SealockPace Harmon
"It mostly comes down to really getting requirements in there with teeth that commit the service provider to turn over all the detailed information you need to operate -- for example, the runbooks their techs use on a daily basis," Sealock said.
In addition, the IT outsourcing contracts should get "hard core commitments" from the provider on knowledge transfer sessions, including provisions for job shadowing the incumbent's employees to watch how they do their jobs. "These are things you can hold over your provider's head to make them perform better, so you don't have to transition away from them," Sealock said.
What are the odds of a service provider acceding to these demands? Sealock said that by putting the requirements in the RFP, CIOs weed out vendors who are unwilling to meet the terms of the IT outsourcing contract.
"We like to have these requirements wrapped up and settled before we even make an award and enter in to negotiations. That way you have the competitive leverage to say, 'If you don't agree to those terms, we are going to someone else,'" he said.
Go to part three of this three-part tip to read Sealock's advice for improving the third area where CIOs need help on de-risking their IT outsourcing deals: post-deal governance.
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