REASONS FOR RENEGOTIATING

This posting originally appeared on Slaw at http://www.slaw.ca/2010/11/29/reasons-for-renegotiating%c2%a0/.

In his July 30, 2010 posting, Plus Ça Change at http://www.slaw.ca/2010/07/30/plus-ca-change-2/, Dan Logan of Torys talked about the difficulty of addressing the implications of change as part of a long term outsourcing arrangement. Dan referred to the results of a recent Gartner Group survey that indicated:

* 55% of organizations have renegotiated their outsourcing agreement terms within the lifetime of the contract;
* 15% of the renegotiations occurred within the first year;
* 23% of the organizations did not expect to enter into the renegotiations; and
* nearly 8 in 10 outsourcings will go through renegotiations.

The Gartner Group survey identified one of the major issues leading to this level of contract renegotiation as a lack of sufficient flexibility in the outsourcing contract to accommodate the unforeseen changes. Dan’s July posting, and his follow on posting on October 13, 2010, Managing Change in Contracts, used this point from the Gartner Group survey (the absence of the flexibility necessary to accommodate change) as the launch pad for an examination about anticipating and accommodating change in an outsourcing. They are worth the time to read and I don’t want to repeat or disagree with his analysis.

It is not just ineffective change processes or unanticipated issues that give rise to the necessity to renegotiate an outsourcing agreement. At least as frequently, the requirement to renegotiate an agreement stems from the failure to resolve issues at the operational level on a regular basis: the issues then fester, or the consequences of the failure to resolve an issue expand to infect the relationship, reaching the point where the unresolved issues overwhelm the ability of the normal governance processes to accommodate them. What I want to look at, in this posting, are three sets of circumstances that inhibit the ability of the parties to resolve issues effectively at the operational level and that, in my experience, have been significant factors leading to the renegotiation of an outsourcing agreement.

I. Lack of Continuity of Key Personnel

The lack of continuity of the key personnel of the service provider and customer can set up the conditions leading to a renegotiation. In an outsourcing transaction, relationship history and an ongoing commitment to the arrangement can be as much a factor in resolving issues as the contract wording itself. If the representatives of both parties have the same history, understand the compromises that were made on contentious issues and appreciate the points that were left unresolved, they have the opportunity to resolve issues more quickly, if for no other reason than that there will be a shorter learning curve. And if the key personnel are also committed to working on the transaction for an extended period of time, they are more likely to take a longer term view of the outsourcing relationship. The shorter learning curve and longer term perspective may more easily allow the two parties to resolve issues in the best interests of the outsourcing.

Conversely, when the parties’ representatives do not have the history of the outsourcing relationship and are there only for the short term, they are more likely to approach issues on a standalone basis and seek a “win-lose” solution. As in a gun fight, there isn’t much motivation or inclination to compromise. Minor irritants that should be resolved as part of normal day-to-day operating or governance procedures quickly evolve to become major problems that are not easily dealt with as part of regular governance procedures and that can require a renegotiation or contract restructuring to resolve.

There are clear benefits to the outsourcing transaction, therefore, if both the service provider and the customer commit to maintaining continuity in their key personnel. Unfortunately however, in most outsourcings, the commitments around key personnel are one-sided. Customers will typically include “Key Supplier Personnel” clauses in their agreements that require the service provider to identify its key management, technical and perhaps business personnel and that restrict the service provider’s ability to replace these personnel. Yet the outsourcing agreements that include any corresponding commitment on the part of the customer appear to be few and far between. This is to the detriment of the parties’ ability to resolve issues in the relationship.

II. Misalignment of Interests

Outsourcing relationships almost always impact more than just the customer and the service provider. For each party, there will be a coterie of other persons who are interested in or impacted by the outsourcing, e.g. for the customer, its stakeholders may include other business units within the customer, affiliated entities, clients or other contractors. If the parties do not deal with the interests of these stakeholders in the outsourcing agreement in an appropriate manner, they may be creating circumstances in which normal operational procedures are unable to deal with day-to-day issues and a renegotiation is the only option.

These circumstances are best illustrated by an example. Consider an application development agreement between a government entity and a private sector service provider. While one government ministry is the contracting party and responsible for the costs of the development, the resulting application will be used by, say, three other government ministries. In recognition of the critical interest that the three other government ministries have in the functionality of the application, the service provider agrees with its government ministry customer to establish an Executive Committee comprised of representatives of the three other government ministries and that the Executive Committee’s approval will be required at critical junctures in the application development, e.g. for approval of the functional and technical specifications.

In these circumstances, it may be extraordinarily difficult for the government customer and the service provider to resolve the issues that inevitably arise in an application development. The principal interest of the Executive Committee is the functionality of the application and this interest is not tempered by the practical concerns around costs that often motivate the parties to reach an equitable resolution.

While this is a hypothetical example, the underlying problem it is meant to illustrate is not. The customer and the service provider have created a situation in which the interests of the parties are misaligned and where the normal governance procedures may not be adequate or able to resolve the resulting issues.

III. The Dangling Change Process

It is customary for outsourcing contracts to include comprehensive change processes dealing with all varieties of change from minor production changes right up to mandatory changes that allow the customer, in urgent situations, to mandate implementation of a change. One of the purposes of the change processes is to allow the parties to deal with unanticipated change and avoid the necessity of renegotiating the agreement. In at least one respect however, most change processes fall short of this objective.

The change processes normally require the service provider to submit a change proposal for the customer’s review and consideration within a specified period of time of the customer’s request or on the service provider’s own initiative. The customer then has a defined review period within which to accept the service provider’s change proposal, to reject it or to request that the change proposal be amended. It now appears to be the norm (arguably unlike the 1990’s) that where the customer does not accept the service provider’s change proposal within the applicable review period, the change proposal is deemed to be rejected.

That is usually the end of the matter as far as the change processes are concerned. They do not deal with the consequences of the customer’s failure to accept the service provider’s change proposal. And those consequences can be very severe, e.g. the idling of teams of software developers, significant delays in development or the failure to implement new systems in a timely fashion. These are just the sort of consequences that can easily lead to the necessity to renegotiate aspects of the outsourcing agreement.

The outsourcing agreement should include, as part of the change processes, specific procedures for dealing with change requests that are not accepted by the customer. It should no longer be sufficient just to say that the change proposal is deemed to be rejected. Instead, in the interests of dealing with issues as part of normal governance, the change processes should require immediate escalation within governance of: (i) any change proposal that is not addressed by the customer during the applicable review period; and (ii) change proposals that are identified by the service provider as “Essential” that are not accepted by the customer.

IV. Conclusion

The three sets of circumstances identified above were not suggested by any proper survey so they may lack the statistical validity of the Gartner Group results. Still, they identify issues, in addition to inadequate change management processes, that drive the parties into renegotiating their outsourcing and that should, therefore, be dealt with as part of the agreement.