How to negotiate an IT-outsourcing contract

Note: This is an article co-authored by Mr. Moss and Alexandra Wipert, which has appeared in numerous other publications.

Ask anyone how long it takes to negotiate an outsourcing deal, and the answer will likely be the same: much too long. In fact, some would say, the outsourcing will take at least as long to negotiate as you have time available to negotiate, and probably longer.

But think about that gloomy proposition for a moment, and consider turning it to your advantage. If you limit the time you have available to negotiate your outsourcing deal and place a few more boundaries around how you conduct the negotiations, it is possible to complete your outsourcing agreement in a comparatively short timeframe.

In recent years, the practice of outsourcing information technology services has been transformed from a fairly risky undertaking to an almost standard business practice. The focus has shifted from whether a business should trust an outside supplier to provide its critical IT services to how to get an outsourcing relationship in place as quickly and efficiently as possible. As more businesses experience outsourcing first-hand, the reaction to the negotiation process is now not “Did we do the right thing?” but “Why did it take so long?”

Outsourcing transactions can often take many months to negotiate, regardless of the size of the deal. While customers will take as much time to negotiate an outsourcing deal as is necessary to protect their interests, and suppliers will attempt to do the same, many individuals involved in outsourcing deals — including the consultants that often broker these transactions — feel a tremendous amount of frustration that negotiating the deal is such a time-consuming and expensive process. Many times, the participants direct this frustration at their lawyers.

How to Avoid the Frustration: The Timeline

Despite substantial evidence to the contrary, there is a way for a customer to negotiate an outsourcing agreement efficiently while simultaneously limiting the risk to which it is exposed in the final agreement.

The key to avoiding drawn-out negotiations is to create a structured timeline and procedure for conducting negotiations. Then, each side must stick to the calendar; neither side can deviate from the timeline. Adhering to the following guidelines will enable you to shorten the length of negotiations, enhance your leverage, and negotiate better business terms for your outsourcing deal:

  • Prepare a detailed Request for Proposal (RFP) describing your requirements;
  • Prepare a complete draft agreement, including exhibits, to distribute prior to negotiations;
  • Require the supplier to respond to the draft agreement in an issue paper format;
  • Limit the time for negotiations by number of days and hours per day; and
  • Stick to the established procedures.

Enforcing this process and schedule will maximize your leverage while preventing the supplier from increasing its own leverage by dragging out the negotiations. With only a few minor modifications, you can use this process for public or private sector transactions, negotiations with a single supplier, and simultaneous negotiations with multiple suppliers.

Do Your Homework

As the clichÈ goes, it pays to do your homework. The first step in laying the groundwork for a quick negotiation is the preparation of a very detailed, well thought-out RFP. Outsourcing negotiations are often protracted because confusion arises around the types and levels of services that the customer expects the supplier to provide. When drafting the RFP, sit down with the business and technical people who are directly involved with the services that are being outsourced to ensure you clearly and accurately describe in the RFP all the tasks and services you expect the supplier to perform. Get your legal counsel involved in the process, because the description of services should be in wording that could be used verbatim as the statement-of-work exhibit to the actual outsourcing agreement.

You may not be able to accurately scope all of the services if, for example, you are asking the supplier to provide services that you have not received before or that have been provided to you by other service providers. In that case, you may want to ask the supplier to include a statement of work for those services in its response to the RFP. If you have problems with the supplier’s proposed solution for the new services, you will have the opportunity within the negotiation process to discuss those problems and to require the supplier to submit a revised proposal for those services.

As part of the process of drafting the RFP, work with your legal counsel to draft a “model agreement.” The model agreement should contain all of the documents that you will need to complete the outsourcing transaction, including the terms and conditions, the statement of work, and the format (if not the specific pricing provisions) of the pricing schedule. You may choose to provide the supplier with your draft agreement as part of the RFP, or you may provide it a certain number of days in advance of commencing negotiations with the supplier to ensure that each supplier has the same number of days to prepare for the negotiations.

There may be documents (or specific provisions in documents) that you are not able to prepare in advance because the content will differ for each supplier. If the supplier is making the first offer concerning pricing or other substantive provisions, leave these items blank. In these cases, you may request that the supplier prepare and submit those documents as part of its response to the RFP, but you can also push this step back into the negotiation process.

We recommend that you make sure the draft agreement starts from a reasonable, middle-of-the-road position. It is difficult to negotiate an outsourcing transaction in a tight timeframe unless the document that you are starting from is one that both sides feel is relatively fair and even-handed. Preparing the draft agreement prior to negotiations will enable you to clearly articulate and protect your position and to prevent time-consuming exchanges with the supplier related to drafting a statement of work or other exhibits.

Rules of the Road

We recommend that you competitively bid and negotiate any outsourcing project that you choose to undertake, because it will provide you with the opportunity to get the best deal on the best possible terms. This is a manageable task if you use the process we are describing.

You should also include with the RFP the guidelines you will use to conduct your negotiations. These vary depending on whether you are negotiating a public or private sector deal, and whether you will be negotiating with a single supplier or multiple suppliers. The negotiation procedures included in the RFP should describe the process you will use to select a supplier and the schedule you will follow throughout the process.

If there are special ground rules that you will adhere to while negotiating the outsourcing agreement, spell these out in the negotiation guidelines. In a public sector deal, for example, where state and local laws govern the procurement process, it is important to state in the negotiation guidelines that each supplier’s negotiations will be kept confidential and separate from the other suppliers, and that concessions made by one supplier in negotiations will not be used as a leverage tool in other negotiations.

There are a few fundamental ground rules to establishing a negotiation procedure that will apply to you regardless of the type of deal you are negotiating. First, establish a schedule for the negotiations. State in the negotiation guidelines the total number of days of negotiation that each supplier will receive, the number of rounds of negotiations you will conduct, the number of days in each round of negotiations, and the specific hours during those days when you will negotiate with the supplier.

Each supplier should receive an equal number of days of negotiations and an equal number of days off for preparation before the next round of negotiations. If you have enough time before you need the supplier to begin providing services, you can schedule the negotiations with the respective suppliers consecutively, rather than concurrently, which has the added benefit of enabling you to use the same team of business and legal people for all of the negotiations, rather than having to assign a different team to each supplier (see example in chart).

Round 1 Issue Papers Due Round 1 Negotiations Round 2 Documents Due Round 2 Negotiations Final Offer Due
Supplier A October 1 October 8 – 11 October 17 October 22 – 23 November 2
Supplier B October 8 October 15 – 18 October 24 October 29 – 30 November 9

Start and end each day of negotiation on time according to the schedule. Adhering to these time limitations is especially important in a competitive-bid or public sector situation where the suppliers should receive fair and equal treatment.

Submitting Issue Papers

Second, establish the process for the negotiations. Prior to the first round of negotiations, require the supplier to submit “issue papers.” Each issue paper should contain the exact language changes that the supplier wishes to make to a particular paragraph or provision in the draft agreement and the reason for the requested change. (You may decide to do this as part of the supplier’s response to the RFP to get a sense for the supplier’s major contractual issues.) If a supplier does not submit an issue paper requesting changes for a specific provision of the draft agreement, the supplier will be considered to have agreed to that provision as you initially provided it.

In a single-supplier situation, the supplier will be motivated to minimize its changes by the nature of the process — it will not want to look like it is requesting an excessive number of changes. In a competitive-bid situation, the issue papers will motivate each supplier to minimize its number of requested changes in order to remain competitive with the other suppliers.

The first round of negotiations is an opportunity for you to discuss and attempt to reach agreement on the issue papers. It is unlikely that you will be able to resolve all of the issue papers during the first round, but if you have extra time, you may want to discuss the other documents or information provided by the supplier as part of its response to the RFP (e.g., pricing information). You may choose to allow the supplier to submit additional issue papers prior to round two of the negotiations for discussion during the second round. In addition, discuss any exhibits to the agreement that the supplier was asked to prepare, and negotiate the terms of those documents.

By the end of the final round of negotiations, you and each supplier should have concluded your discussions and agreed to take one of three positions on the changes proposed in each issue paper:

  1. Agreed (as the issue paper may have been modified during the course of the negotiations);
  2. Incorporated by the supplier without agreement (either in the original form or as modified by the supplier); or
  3. Withdrawn by the supplier.

Your negotiation guidelines should specify the default position you will take if you and the supplier fail to agree on taking one of these three positions with respect to any issue paper. The most reasonable position would be to incorporate the supplier’s latest version of the issue paper (as it may have been modified during negotiations) into the draft agreement without agreement.

You may consider giving the supplier additional time following the completion of the negotiations to submit its final proposal on those exhibits that are prepared solely by the supplier, such as a final pricing proposal. In a public sector transaction or in negotiations with multiple suppliers, you may want to consider documents that are prepared solely by the supplier as “incorporated without agreement,” as you do not want to be accused of pushing too hard with one supplier, or not hard enough with another, if you agree to different prices with different suppliers. This is a position you may also want to adopt with respect to provisions of the draft agreement itself that are traditionally considered highly controversial or substantive, such as the limit of liability.

After the final round of negotiations, incorporate all of the issue papers and exhibits into the draft agreement to create a complete set of final documents. Give the supplier a certain number of days to review those documents and to agree with how you incorporated the changes. The negotiation procedures should specify the process you will use to ensure that you and the supplier agree on the incorporated changes.

Consider the complete set of final documents the supplier’s best and final offer (BAFO) for your evaluation in selecting the winning supplier. The supplier should execute this document prior to submitting it to you. In a single-bid situation, you may want to reserve for yourself the right to respond to the supplier’s BAFO with your own best and final offer. If the supplier rejects that offer, you have the option to accept the supplier’s BAFO or to rebid the project to other suppliers. Once you have selected your supplier, you will have a final set of documents to sign. Then, you can focus on implementing your outsourcing arrangement.

We cannot emphasize this point enough: in order to successfully employ this strategy to negotiate an outsourcing agreement, you need to clearly think through and articulate the negotiation guidelines in advance of the negotiations. Then, you must strictly enforce those guidelines during negotiations. This may mean, for example, ending negotiations according to the schedule abruptly — even in the middle of a statement being made by a supplier or its counsel — at 5:30 p.m. While this may seem unnatural, especially in a process that traditionally may extend long into the evening, strictly enforcing the rules will prevent the supplier from transforming the negotiations into a “typical” outsourcing negotiation and will have the added benefit of providing your business and legal team enough time to properly record and draft the outcome of the day’s negotiations and prepare for subsequent negotiations.

Managing Risk

While IT outsourcing is becoming more prevalent, there are still many risks associated with putting your IT services in the hands of an outside company. Negotiations add further elements of risk to the process of completing an outsourcing agreement, since prolonging negotiations may cost you time, money, and leverage (not to mention defections of key personnel), and often will result in your moving farther away from your preferred positions. If you manage the negotiation process to limit the time period for negotiations and the types of responses that you receive from potential suppliers, you may find that entering an outsourcing arrangement is neither as risky nor as time-consuming as you anticipated.


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