Outsourcing Contracts – To Renew or Not to Renew

Written by Chaithra Hanasoge

It’s that time of the year when Indian tech giants gear up for outsourcing contracts worth billions of dollars, which are up for renewal in 2016-17. While conference rooms turn into warzones with firms fighting it out to win new plush deals or lure their existing clients to renew deals, it is interesting to note changes in the way outsourcers are strategizing their contracts.

Take for example the ongoing tussle between Vodafone and IBM to renew the US$1B deal that expires within three months. Vodafone is considering outsourcing portions of the contract to other service providers to reduce reliance on a single vendor, a notion that IBM is frantically trying to change by even offering better pricing at the cost of its margin.  This bears stark resemblance to the IBM-Bharti Airtel deal in 2014 when IBM lost its 10-year marquee contract worth US$300M a year, to only retain a much smaller share in the renegotiation. Bharti Airtel cited the need for additional partners to bring in more innovation in its IT architecture as the reason. From both of these cases, it is evident that companies are more carefully gauging their options.

As companies strive for greater agility in today’s ever changing business environment, they require newer technologies and innovation in their products and are willing to experiment with multiple service providers. We see this in the widespread transition to smaller, shorter contracts, evident in the record number of new and restructured deals in 2015 and the drop in annual contract value (ACV) and average contract tenure. With contract expirations and renegotiations becoming more frequent, stiffer competition to win new deals is prompting service providers to resort to tactics such as better price offers while bidding for outsourcing deals.

Another key focus area that is becoming increasingly important in contract renewals is regulatory compliance and risk management. Recent times have seen greater enforcement of regulatory requirements with imposition of fines or more serious actions on firms who run afoul of regulations. More so than the desire to avoid fines, leading global companies are reinforcing their risk management practices to avoid costly service disruptions, protect their brand and take advantage of new opportunities. A recent survey revealed that nearly 45% of United Kingdom’s firms have experienced downtime due to natural disasters, while about 91% of them incurred expenditure each time services went down, with the maximum quoted as £500,000 (~US$ 568050). One of the prominent examples for the impact of insufficient disaster-recovery practices was the devastating Chennai floods in November 2015, which disrupted normal operations of large firms for weeks and took a toll on their revenues. A contract renewal presents an opportunity to review and adjust contract clauses to reflect the latest regulatory requirements and risk management best practices.

In recent months, many firms have chosen to avoid contract renewals altogether in favor of insourcing and captive centers, including JP Morgan, AstraZeneca, Lowe’s and Deutsche Bank. Factors vary from dissatisfactory outcomes in outsourcing endeavors to the need to retain full ownership of the newer and more flexible technologies. Insourcing allows these companies to focus on talent and build innovation and technology into their core capabilities.

With so many options to choose from, how are companies answering the big question “to renew or not to renew?” There are many company-specific if’s, when’s and how’s to consider, and there’s no one-size-fits-all answer. To choose the right strategy, companies must carefully consider their priorities and corporate objectives. And a key component of success is to start early. Companies should begin evaluating their choices much ahead of the contract expiry date (we recommend 6-12 months ahead, depending on the complexity of the deal), to avoid the deadline day lock-in.

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