The perils of renegotiation
01 November 2009 |
In the current market, where both sides in an outsourcing contract are conscious of the risks to their business, skillful negotiation is needed at contract renewal time
The perils of renegotiation are not unique to the carrier business – Deloitte Consulting estimates that $200 billion in outsourcing contracts are up for renegotiation every year. But this year is special: both customers and suppliers are under pressure financially. This means that negotiations need to be creative and hard-nosed at the same time. The balance between carrot and stick is crucial for both sides.
Outsourcing consultants Equaterra suggests a renegotiating team with experience in “the art of the deal”, with a positive tone and the desire to create a deal that benefits both sides. Yet in the current market, when both sides are conscious of the risks to their business, contract negotiations can become about what concessions they can extract – which might, in turn, create the problems the negotiations are trying to solve.
David Skinner, a partner in the law firm Morrison & Foerster and a member of its technology transactions group and global sourcing group, has acted on both sides of the deal during negotiations. He sees both sides re-evaluating the risks they are taking. “Both new and existing contracts are being affected. There has been a huge change, especially in the last 14 months. Customers are worrying about their business, about credit risk of the suppliers.”
Weakness from carriers in previous negotiations, Skinner says, means that many of them are now looking at contracts where they feel the supplier is “getting away with murder”. This can poison renegotiations unless they approach the deal calmly – and don’t try to use lawyers to try to bully suppliers. “True, some suppliers have been getting unreasonable, cutting their costs. Our responsibility is to say to them, we can see what you are doing, and rebalance the contract. A lot of people use M&A lawyers to do this negotiation, but their idea is to cheat the other side and run off. If you cheat the other side in this business, it will come out in the wash.”
For those customers who have outsourced a large part of the business to a supplier who then uses subcontractors, he adds, one of the renegotiation tactics that may be useful is to have tighter control over who will be doing the work. “Now you have to think: will the supplier be subcontracting or cutting service to meet its own financial goals? Maybe also you can specify key subcontractors, and also the type of service degradation that would cause a subcontractor to step in.” Maybe even deal directly with the subcontractor, he says.
Mitigating risk is one way to avoid problems, Skinner adds, but also creativity pays when negotiating the structure of the deal. “Many customers may be facing insolvency or Chapter 11, and are staring down the barrel. In these situations it’s possible to go to the suppliers and to say that you want a really low service charge in year one. You will make up for that in years three to five, but it makes it possible to get some early wins.”
John Enstone, a partner at law firm Faegre & Benson, also sees many carriers coming to renegotiation using the stick more than the carrot, “driven mostly by the fact that suppliers will be cutting corners. Tougher remedies are being put into contracts. It’s a buyers’ market”.
According to Enstone, carriers who think that an outsourcing renegotiation might be an opportunity to slash costs often regret the decision: when they make it impossible for the supplier to supply the service at the contracted price and make a profit, then either the supplier or the service will suffer. “For many carriers it makes perfect sense today to go for the cheapest solution and not worry too much about the quality of the supplier. That’s a false economy, even when there is urgency. It has increased the emphasis on financial gain rather than quality. There are far more finance directors looking for a quick financial win.”
But he warns that carriers might end up paying for their ability to drive prices down, because suppliers will also drive down their costs to protect their margin. It might be more effective to monitor the value of the work your outsourcing supplier is doing with more care, he says, and drive value rather than cost reduction.
“Savvy customers are taking the opportunity to watch for the signs of cost cutting. Two years ago you would have given the supplier a call to see if they could sort it out. Now customers are right on it immediately,” Enstone says.
Learn from experience
In the current market, use a detailed monthly oversight process of the quality of the work and who is doing it, he says, and jump on any problems immediately. Encourage the supplier to give you early warnings of a problem, and if you are concerned have a weekly report on the health of the supplier and the state of the contract. Finance problems in outsourcing suppliers are like cancer, he says: discover them too late, and they are impossible to cut out. Even if you have to lend your supplier money to keep it in business, “and get your pound of flesh later”, it might be the least negative option.
Finally, he warns, if your outsourcing arrangement has problems, don’t pretend that it is just an operating problem. “This is exactly the point at which the board needs to be told. It’s a substantial risk factor, and if the terms need to be redrafted, that means concessions will have to be made by both the customer and the supplier.”
Skinner regrets that many carriers do not learn from experience: the art of the deal is too often considered to be the art of getting a low price. “The trouble is that too many of these deals are still sold to senior people who don’t have to think about them in detail.”
But the most important lesson, Skinner says: “Never do a deal on the golf course.”
Outsourcing without lawyers
Twelve months ago Arbinet’s core business was to manage interconnect through its exchange. Its new offering, the Arbinet Private Exchange, offers a far greater set of services around interconnect. According to Dan Powdermaker, SVP of sales and marketing at Arbinet, it’s a way for carriers who want to outsource the pain of running their international voice business, but not the entire business, to get the best of both worlds.
For Powdermaker, the selling point of the system is that it offers the opportunity to outsource without the contractual problems, commitments and endless negotiations which inflate the price of outsourcing and spoil the margins. “BT realised its structure is not conducive to carrying international voice. They have come up with a very complicated structure and contract to outsource that,” Powdermaker says. “We offer a much simpler way to handle interconnects. They can do it without lawyers, without investment bankers if they want to.”
The reason that lawyers don’t need to be involved is that the long-term commitments that lawyers delight in negotiating and often unravelling are entirely absent. “It is a low-cost, quick way to implement our service using online tools. We handle all the back office. With private exchange, they retain complete control. Their only commitment is to pay for the traffic they send, and they can do it for two months or for two years. We don’t mind. It doesn’t have to be permanent,” he says.
Of course, Arbinet would prefer that the business is permanent, and he offers another structural benefit that outsourcing – or traditional bilateral agreements – cannot. “We have the capability to send traffic and give visibility. In a bilateral deal, deals are done for between three and six months – but you don’t know what is happening in the interim. It’s just one way that we make it easy to negotiate – you can even do it online if you want. The other point is the credit side: we will do your settlement. A settlement dispute can go on for years.”
Powdermaker accepts that the idea will not work well for everyone, and that a significant number of carriers will outsource their entire international voice business. Yet he is hoping that carriers who want peace of mind, the guarantee that they can improve service and rates, but who do not want to enter into a year of negotiation and pay lawyers’ fees will at least try Arbinet’s service – whether it is for two years or two months.