Negotiating the contract: Commit
Aims and objectives
The primary objective of this phase is to get the deal ‘across the line’. Many of the activities that were initiated in the previous phases are completed during the Commit phase, culminating in the signing of the outsourcing agreement.
Whilst the deal team is focusing on securing the best deal value, significant internal effort is required to manage stakeholders and achieve the executive buy-in that is necessary for contract signature.
During this phase the vendors will increase the pressure on due diligence and try to use this process to gain an advantage.
Throughout all of this activity the client should remember that the objective is usually not a deal with the smallest initial price but a deal which provides optimal long term benefit to both parties.
The development and negotiation of the outsource agreement is at the centre of the Commit phase activities, from drafting the terms and conditions to contract signature.
The exact process that is followed can vary greatly from deal to deal with a balance needing to be struck between internal preparation and vendor engagement. Typically, a degree of internal preparation will take place which can include drafting of the first version of the terms and conditions, development of the negotiation strategy and further definition of the services being procured.
While the deal team are negotiating, vendor due diligence activities will increase in volume, with additional requests being driven from the negotiations and additional detail being sought across all areas.
In parallel to the deal activities, a series of critical internal activities are taking place:
- Effective stakeholder management is crucial in order to gain direction for the negotiations and ultimately approval for contract signature
- The design of the retained organisation needs to be finalised and the plan for the transition of staff developed (if applicable) with any necessary consultations taking place
- Security and control also need to be taken into account with security (and where appropriate risk and regulatory) approval being a pre-requisite for contract signature
Throughout this phase it is common for external support to be sought from law firms, specialist consultants, bench-markers and other professional advisors.
The main inputs, outputs and activities of this phase are shown below:
The extent to which the development of terms and conditions (T&Cs) takes place internally and how much is completed as part of the negotiations can vary. It
is often best for a full set of T&Cs to be developed internally, building on the legal and commercial requirements set out in the previous phases. This is then sent to the shortlisted bidders as the starting point for the negotiations.
The T&Cs should be developed with the broader deal in mind and the emphasis should be representative of the client’s objectives and risk appetite.
It is recommended that legal advisors are chosen who have experience in the specific type of outsourcing and template contracts are used to accelerate the process.
The process for defining the services is driven by the level of understanding that the client has of their requirements. In some cases (for example, a second generation outsource), it may be possible to use existing service definitions as the basis. In other cases the negotiation process is used to jointly create the solution with the bidders.
In all cases it is important to differentiate between the service definition (i.e. the requirements) and the solution (i.e. how each bidder is proposing to meet the requirements). The service definition is typically drafted by the client while the solution is provided by the vendors.
In addition to the ongoing services (e.g. business processes), the service definition will also describe any transition, transformation and exit requirements.
Typical pricing model elements
The pricing model should include all foreseeable charges and cater for all likely scenarios in order to provide predictability to the contract (and good long term value to the client). Figure 4.1 demonstrates some typical components of a pricing model.
In addition to the charges, it is not uncommon for a pricing model to include some information on the composition of the charges. For example, breakdown of charges into people, property, hardware and software. This can aid the client in understanding cost drivers, comparing solutions and facilitating the negotiation.
There is often a temptation to create a very complex pricing model which is ultimately difficult to manage. The aim should be for the model to align with the client’s business objectives whilst incentivising good behaviours for both parties.
A key component of the service definition is the Service Level Agreements (SLAs). The SLAs describe the performance level at which the services should be provided and can include the vendor’s performance in delivering projects (e.g. a transformation programme).
The call-out box below provides some guidance on building a service level and credits regime. Service credits are additional days of service or monetary credit given to the customer at no charge for performance below the SLA.
Building the commercial deal includes both the definition of the commercial parameters of the deal and the drafting of the contract schedules that represent them.
The specific commercial parameters vary but typically include the term of the contract, any phasing of the contract (e.g. transition, transform, operate, exit), the service credits regime, exit conditions, key transformation milestones, people and assets transfer, the pricing model (as described previously), financial engineering and benchmarking.
Most of these commercial parameters influence each other and must be considered together in order to create an effective commercial deal. It is recommended that the dependencies between the parameters and the desired outcomes are decided in advance of the negotiations and included in the negotiation strategy
A negotiation strategy is a powerful tool that enables the deal team to drive effective negotiation. In its simplest form it documents and prioritises the desired outcomes. In a sophisticated form the negotiation strategy will not only define the priority outcomes but also set out how these will be achieved.
It is common for the negotiation strategy to be tiered, with the highest tiers setting the overall direction of the negotiations (e.g. long term cost reduction) and the lowest tiers describing the specific and measurable objectives and levers (e.g. a minimum cost reduction of 20% is required in year 2).
It is critical for the negotiation strategy to be developed in advance of the negotiations and to be signed off by the appropriate sponsors. This will force discussions and decision making to take place outside of the pressure of the negotiations and will equip the deal team with the authority to negotiate.
The negotiation strategy also provides direction for the creation of the terms and conditions, the services and the commercial deal.
The vendor due diligence activities which began in the Evaluate phase will complete during the Commit phase. As the vendors’ solutions are developed and the negotiations commence the vendors will carry out broader and deeper due diligence
It should be noted that the vendors’ propositions are dependent on the findings of their due diligence and as such failure to support it sufficiently can result in exclusions being included in the contract (e.g. if additional third parties are identified post signature then the client is liable for additional charges) as well as the vendors including a risk premium in their charges.
It is recommended that a dedicated due diligence team is mobilised to support the vendors’ due diligence and should perform three functions:
- Proactive gathering of due diligence data that the vendors are expected to require. This is especially important for data that requires long lead times (e.g. typically 3rd party contracts information)
- Responding to vendor requests for due diligence information and activities
- Logging and managing responses to vendor questions
An electronic data room can be used as an effective way of disseminating large amounts of data.
The negotiation period is usually time constrained, expensive and results in many significant decisions
As such it is critical that all preceding steps have been completed thoroughly. A signed-off negotiation plan, services and T&Cs and a robust commercial deal are instrumental to success.
During the negotiations, effective project management and efficient communication between the negotiating teams are the key drivers for a successful client driven negotiation.
The close of the negotiations is often signified by the vendors submitting their best and final offers (BAFO) on the basis of the contract that has been negotiated. At this point the client will evaluate the deals holistically and decide which vendor to proceed with.
The evaluation criteria used during the Evaluate phase can be used if still appropriate or can be revised to reflect the final priorities. The evaluation should take into account all aspects of the contract including legal, commercial, price, service and vendors’ solution, the client’s due diligence, as well as softer aspects such as the confidence of the deal team in the capability and solution of the vendor. Typically a detailed evaluation will take place by the broader team and the results provided to the deal sponsor/board for the final decision.
Throughout the negotiation process, the business case should be used to understand the overall impact of commercial and solution decisions.
As the negotiation progresses, the hypotheses in the business case will be replaced by the vendors’ solutions and offers and the overall value of each deal can be weighted against the original criteria.
Often the business case will be incorporated into the tool used to facilitate the financial negotiations and ultimately the financial evaluation of the proposals.
The business case represents the value that the outsource deal will bring to the client over the duration of the term. Typically the value profile will vary throughout the term and will be dependent on vendor and client actions as well as external influences.
A value delivery roadmap will document how and when value will be delivered and demonstrate how the total value of the business case will be achieved. It should be used to guide operations and ensure that the value is extracted.
Lack of focus on value delivery very often results in deals which do not deliver the benefits that the parties envisaged at the time of negotiations.
The final step prior to contract signature is the executive approval of the contract. In order to achieve this approval the project team should be managing its stakeholders throughout the course of the Commit phase.
This includes regular updates, deal review sessions, evaluation outcomes presentations and decision making workshops.
The objective of this activity is to ensure that the key stakeholders are fully informed throughout the process, that the deal receives timely guidance and that approval to sign is granted.
Depending on the organisational circumstances, this activity can be significant and can require a dedicated team.
The design of the retained organisation should be finalised during the Commit phase (see Figure 4.2 for a typical high level retained organisation structure). It should reflect any changes to the solutions and overall deal that transpire during the negotiations and should include the timeline for implementing the design.
In many cases elements of the retained organisation should be in place shortly after contract signature and as such it is common for members of the retained organisation to be part of the deal team.
Once the design is finalised, communications to any in-scope and out-of-scope staff should be managed and any engagements with the unions and works councils completed. Note that in many countries there are clear legal guidelines and limitations placed on the ability of any outsourcing deal to be completed without a statutory period of consultation being completed so this may well be on the critical path to contract signature. It is important that these activities begin early during the process in order for the client to manage any impacts.
Security and control
The outcome of the deal is likely to involve some degree of transfer of security and/or controls between the client and the vendor or between the incumbent vendor and their replacement. Obviously this transfer can create a risk of loss of control or reductions in
the effectiveness of the security functions (either permanently or temporarily). In addition, the location and storage of data may need to meet regulatory or legal requirements and this must be fully understood prior to the completion of any deal.
Therefore negotiation of a clear commitment that the vendor’s solution for security, control and data management meets the necessary requirements is key to de-risking the deal. In addition, a clear understanding of the transition and transformation plan relating to these security aspects is equally important.
The scope of this activity can cover controls across personnel, policies, standards, physical security and technical security.
Transition and transformation planning
A critical element of the commit phase is to agree a well structured approach to transition and transformation planning that is acceptable to both parties.
The vendor’s transition and transformation plans must be closely scrutinised during this phase. This scrutiny must look at the achievability of the plans alongside the dependencies with the client’s plans and constraints. However, the detailed plans must also be analysed from a commercial perspective to ensure that milestones are aligned to proposed payments and related terms of the deal.
These areas will often form a major part of negotiations as the client and the vendor seek to define an approach and plan that is acceptable for both.