Negotiating the contract: Commit

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.

Overview

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.

Activities

The main inputs, outputs and activities of this phase are shown below:

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Deal structuring

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

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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.

Vendor management

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.

Business case

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.

People

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.

Operating model

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.