IT Outsourcing – The Contract
IT outsourcing – the use of external providers to deliver IT services has been around for decades. Over the years, I have reviewed, negotiated and written many different outsourcing contacts. Whilst the scope and the cost vary, many aspects of the contract remain the same.
I have looked at everything from a simple contract for a single service – to a multi-million pound, multi-national contract for end to end service provision. When contracting for any services, these are the things that i always bear in mind.
IT Outsourcing – Scope
You know what the service is that you want to source but you need to be clear when documenting deliverables and the scope in the contract. Too prescriptive and the supplier might look for additional cost of anything not specified or look to transfer liability when things go wrong – as they were only following your instructions.
On the flip-side a scoping statement that is too loose can be subject to [mis]interpretation by either side. Often the teams that manage the relationships both commercially and, more importantly, operationally, are not the team that wrote the IT Sourcing contract.
When writing the scope and deliverables pay attention to
- Customer Location (where can the customer consume the services and what happens if a new location is added or an office moves location)
- Supplier Location (Where is the supplier delivering the service from. How does that affect regulatory requirements like GDPR safe-shore agreements and what happens if the supplier wants to change location – either temporarily during a disaster recovery event or more permanently)
- Are there any limits to the service – either time or volume (service hours, total number of units, incidents, calls etc)
- Are there industry standards that can be referenced to ensure understanding (e.g. ITIL framework when contracting for ITSM process like incident or problem management).
- Exclusions. It might be important to document what is not covered in the contract (using terms acceptable to your legal review, like – ‘for the avoidance of doubt,’)
- Dependency on the customer to deliver a service. (e.g. The Customer shall provide to the Supplier all administrative passwords as requested by the Supplier at the Contract Commencement date).
So as a Service manager I love a good TLA (Three-Letter Acronym) and am so deeply embedded with the ITIL framework that I use terms like incident, problem and normal changes without stopping to think what they mean.
If the supplier of your IT Outsourcing agreement is not as familiar or you use terms specific to your organisation’s sector, they need to be defined up-front in the contract definitions section.
Governance and Reporting
Any good service contract is likely to contain a definition of what good service feels like. That might be written as an SLA (e.g. x % of incidents closed in y hours) or just a KPI metric (e.g. % calls abandoned).
To be effective the IT Sourcing agreement should also define how the SLA/KPIs are measured and reported. Any exclusions to the measures and what happens when the targets are missed (contract remedies).
Contract remedies might be as simple as agreeing a rectification plan to bring service back to the expected level or may involve financial penalties through Service Credits where a % of the monthly fee is at risk.
More complex agreements might also offer the Supplier the chance to earn back, where credits due to service failures can be offset by over performance in future months.
Tightly defining the governance and reporting structure, the contractual targets and remedies and associated processes up-front will save a lot of heartache later. They should also be linked to scope exclusions. I loose count of the number of times I have been presented with an SLA exception as s component is old and out of vendor support, or out of scope of the agreement due to the location in which they were used, or because of the obscure type of operating system.
Paying for Services
The IT Sourcing contract should outline all costs and payment terms. generally speaking there are three different ways that costs can be articulated:-
Where the Supplier offers a firm price for the scope of work agreed in the contract. This is usually offered only when the supplier can exhaustively costs the scope and has control over any variables that might affect the effort required in delivery (or prices in the risk of any variance).
Fixed cost gives you certainty of costs – as long as the scope is well enough defined to avoid any surprises.
Time and Materials
My least favourite type of contract has the Supplier paid on a T&M basis. The Supplier will record hours worked and be reimbursed by reference to a rate card. Materials such as Software licenses may be billed as a pass through charge with an administrative % added on to the base cost.
A PxQ (price multiplied by quantity) arrangement is quite common for services where the Customer can add or remove units, at a fixed price per unit. For example a per server costs of support or per incident cost of the service desk.
There are, of course, many permutations of these simple billing structures. Most commonly I see a hybrid model of fixed plus variable costs.
Open book – where the Supplier bills the costs that they have incurred, plus an agreed margin are less prevalent as most suppliers use pooled resources across multiple Customer accounts so struggle to give visibility of costs. Similarly the use of target cost contracts – where a fixed price is agreed and the scope varies to meet the price point is quite uncommon.
When considering the pricing model, a good outcome for the Customer should include:-
- No price increases linked to RPI, CPI or COLA
- Price reductions linked to efficiency gains
- No minimum commitment
- Allowing for the business to grow or shrink without financial penalty
- Allowing for new services to be added as technology evolves over the contract term
Advanced contracting terms might also include the use of
- Benchmarking – to compare Supplier costs to the market (especially for long term IT Outsourcing agreements)
- Amortizing costs – where the Supplier makes up-front investment on behalf of the Customer (e.g. to replace old technology) and recovers the cost over the term of the agreement
- Non-exclusivity – allowing the Customer to go to market for projects over a certain size for example to maintain commercial tension with the supplier.
Any new Service manager will tell you that they never look at the contract and the day that it comes out of the drawer something has gone wrong. Whilst an admiral aspiration and even achievable at the operational level, complex IT outsourcing agreements are prone to misunderstanding and the pressure on both the Customer and Supplier to reduce costs and maxmise profits are bound to lead to tension.
A well defined contract with proper legal review will pay dividends in the long run. Remember Supplier’s have to eat and we should never begrudge them that, a successful partnership that benefits both organisations is always the best outcome – but we don’t want them to feast at our expense.