- 3RD. SCENARIO (surprising!) – CONTRACT SEEMS TO WORK FINE
o 3rd. scenario characteristics
Typical characteristics of 3rd. scenario are:
– Contract operations show an adequate level of efficiency concerning the services provided and the contractual terms agreed
– Contract operations show an adequate level of effectiveness and flexibility concerning the dynamic requirements of business operations of the buyer organization
o Root causes of 3rd. scenario
There is only one simple and straight reason that results in an adjusted contract (both in terms of efficiency as well as effectiveness): the implementation according to the best practices of each of the steps of the IT outsourcing adoption process, from the definition of the business drivers through the contract governance.
However, the reader of this article will probably have one question: why a renegotiation is recommended here if the 3rd scenario seems to be so perfect?
The answer will be seen in the next section.
o Renegotiation objectives of the 3rd. scenario
First, there is no scenario that could be called perfect. Any scenario can be improved in some way and such improvement may be achieved through a renegotiation that will lead to still better and bigger outcomes to both parties. But … this is NOT the main reason that should motivate the renegotiation.
This scenario is unique because it may lead to a renegotiation that can simultaneously benefit both the buyer and the provider organizations. Are you surprised? Let us see:
– If we consider the provider’s viewpoint, the main objective of a renegotiation in this scenario will be the postponement of the contract termination date, ensuring additional revenue during a period of time to be agreed. For instance, let us imagine that in a 10-year IT outsourcing contract, only 3 years are left until the termination date. A 5-year extension would turn the remaining contract period from 3 years into 8 years, resulting in a 167% increase of the future planned revenue.
– Let us bring in some numbers to clarify the financial consequences of such renegotiation. Suppose that the monthly revenue of the contract is US$ 2 million. Such renegotiation would generate US$ 120 million of additional revenue to be charged to the buyer organization during the extended 60-months period.
– If we consider the buyer’s viewpoint, the main objective of a renegotiation in this scenario will be to get a discount on the current prices of the contract. Back to our hypothetical example: let us suppose that, as a compensation for the 5-year extension, the parties agree a 10% price decrease to be effective immediately and valid during the remaining 8 years (that is, not only during the 5-year extended period) of the contract lifetime. That is, the US$ 2 million monthly invoice will now be a US$ 1.8 million invoice. Thus, the accumulated decrease along the 3 remaining years of the current contract would be US$ 7.2 million (= 36 months x US$ 200,000). Moreover, after agreeing this 10% reduction, the provider will relinquish US$ 12 million along the 5 additional years of the renegotiated term, as it gets US$ 108 million of additional revenue and not US$ 120 million, as the previous item had stated.
– Anyway, it is now clear that from the contract renegotiation a mutual benefit to both parties may result. And by the way, it must be obviously noticed that the agreed 10% price reduction will be made effective without any loss of the quality indicators originally agreed in the contract.
– Furthermore, the parties should seize the opportunity brought by the renegotiation to revise and agree some improvements in the contractual processes, aiming at achieving an even higher degree of efficiency and effectiveness in the contract operations, deepening the positive characteristics of the so-called 3rd. scenario.
Have you lived (or do you live) one of the 3 scenarios here discussed? Do you agree that a renegotiation could help you? Enrich the discussion with your comments.
Alfredo Saad has been acting on IT Strategic Outsourcing Services area since 1997. In 2006 he published the book “IT Services Outsourcing” (Brasport Publishing House). Risk Manager of all IBM Strategic Outsourcing contracts in Brazil (2009-2014). From March 2014 on, he has been acting as an independent consultant, lecturer and writer on IT Outsourcing as the principal of his own company, Saad Consulting.