What Can You Learn About Outsourcing from Coney Island?

This week’s news included stories about nine famous businesses on the boardwalk at Coney Island that are closing down because their leases were not renewed by the new property managers.  After several rounds of discussions, these businesses, including Ruby’s and Shoot the Freak, are being given just two weeks to pack up and leave.

What lesson can you learn from this that is relevant to outsourcing?  Simply that, if you are a customer in an outsourcing transaction, you need to structure your agreement so that you are not given a rapid and graceless exit at the end of the deal.

A great deal of attention is typically paid to the provisions governing the transition in.  Of course, the transition in is the first step after signing the deal, and it is staring you right in the face as you are negotiating.  As part of the negotiations, the parties normally talk about what transition planning needs to occur, what things need to get done and how long it will take before the new supplier can go live in production.  While that information is readily available, it is only logical that this information should be used to estimate what the back end transition out of the contract will be.

There will be various ways that the supplier can end the contract – by giving notice of non-renewal, termination for cause or perhaps some other basis for termination.  The notice periods are not necessarily critical, provided that the client does not have to make a decision to keep or not keep the supplier.  Where the client does need to make a decision – for example a notice of a price increase that the client must accept if it wants to renew – then the notice period must be long enough to allow the client to take the necessary steps.  If those steps include an RFP process, as much as six months notice (or even more for very large deals) may be an appropriate notice period.

Regardless of the length of the notice period, the important thing is that the contract should not end at the conclusion of the notice period.  Yes, I said the contract should NOT end at the end of the notice period for termination or non-renewal.

At the end of the typical contract notice period, the customer may not have had sufficient time to select a replacement vendor and allow that vendor to be ready to take over performance of the services.  Accordingly, the supplier should be required to continue to perform the services at the then-current pricing (perhaps with an adjustment for inflation), for a sufficient period of time to allow the client to transition performance to a new provider.  This is typically called a transition assistance period.  The more flexibility that can be obtained in the length of the transition assistance period, the better.  I have run into a number of instances in complex transactions where the transition from one vendor to another took months (and in a couple instances, more than a year) longer than expected.  If the customer had not had the ability to require the former incumbent to continue to perform until the transition over to the new vendor was completed, the client would have been in a desperate situation.  About as desperate as being given two weeks to move your business.

Take It Or Leave It

When I write posts for this blog, I normally try not to take the supplier-side or customer-side view, but instead try to show both viewpoints and a possible way forward.  I recently worked on a transaction that did not end up going through, and the positions that the supplier took struck me as being worth discussing.

The deal had to do with an outsourced managed service.  The supplier was trying to structure their service as being a product offering and not subject to negotiation.  For some managed services, this sort of utility model can make a great deal of sense for both the customer and the supplier.  Where maintaining rigid consistency in how the service is delivered will yield cost and quality benefits, many customers will see the value in trading away flexibility or customization for a good price and reliable service.  The growing number of utility models for various IT services is a boon for many of the consumers of these services, who have no trouble for fitting into the cookie cutter model.  For those business consumers for whom flexibility is more important, there are plenty of more flexible solutions, which will obviously be more expensive but may be a better value.

The vendor’s rigid approach to negotiating the services and service levels was not surprising to me.  This was consistent with their business model.  What was puzzling was the vendor’s insistence on several positions that are, in my mind, completely inconsistent with each other and show a complete lack of interest in being fair to the customer.  Specifically, the vendor’s bottom-line, walk away positions were:  (i) the vendor could change the service descriptions at any time with what amounted to six months’ notice, (ii) the customer had to commit to a three year contract with very high termination costs, and (iii) the customer could not terminate for cause unless availability was below 95% for three straight months, for a mission critical service that should have 99.9% availability.  I think that these positions can be translated fairly to mean:  (i) the vendor can change the deal any time it wants by removing or changing services, and (ii) no matter how the vendor changes the services and how bad performance is (with only the faintest of outer boundaries), you are stuck and can only terminate by paying the balance of the contract.

For small businesses, this sort of take or leave it and customer-be-damned approach is something that is all too common.  However, I was shocked to see a supplier in a competitive industry dealing with a large customer take such an astonishingly tone-deaf position.

This situation illustrates what happens when a vendor selection is made in a non-competitive procurement.  The vendor we were dealing with might have been just as truculent if it were going up against other competitors.  However, in a competitive process the customer would have had the option of comparing the terms, pricing and customer care exhibited by that supplier against the same factors for other suppliers.  In the end, the vendor with the “my way or the highway” approach might have won because of much better pricing.  If that were the case, then the customer at least would have been more satisfied with the vendor’s hard-edged terms because they were accompanied by a price that was attractive.  On the other hand, the vendor with the take or leave it approach might be more cooperative (or quickly dispensed with) if the other vendors met the customer’s needs and expectations with more flexible, customer oriented terms.

If you are in a hurry to get the deal done, that is precisely when you have to go with a competitive process, unless you can afford to be told to take it or leave it.