Negotiating an outsourcing deal is often seen as a battle between the banker and the vendor, each wanting to enhance its own bottom line.
But beyond just haggling over price, negotiations establish a foundation for the bank-vendor relationship. And what is included or left out of the outsourcing agreement determines whether the foundation is concrete or quicksand.
With more complex and varied deal structures being added to the mix, getting a good outsourcing contract has become a lot more complicated.
Beyond the traditional pricing-formula-based contract, many companies are moving toward performance-based agreements and even ones in which "customer satisfaction becomes an important measure of success and how the provider is compensated," said Michael F. Corbett, president of Michael F. Corbett & Associates Ltd., a Poughkeepsie, N.Y., outsourcing consultant.
The journey to a successful contract begins long before the bank sits down to negotiate, many experts said. It's important for a bank to be clear about its objectives and the benefits it expects.
Banks should collect an array of objectives from many different areas of the business, said Joe Auer, president of International Computer Negotiations Inc. The Winter Park, Fla., firm has been working with banks and other companies on outsourcing and technology acquisitions for 23 years.
Some common mistakes should be avoided when beginning the task of hiring an outsourcer. Selecting a vendor before beginning negotiations is the greatest mistake that bankers make, Mr. Auer said. "You can't do that - that's called begging," he said.
Banks should negotiate with a short list of vendors - no more than three, Mr. Corbett said.
"I caution my customers against being too short-term, too savings- oriented both throughout the process and in terms of how they negotiate with a particular vendor," Mr. Corbett said.
Many experts say a red flag should wave when a vendor begins talking about partnering. "It's on everybody's lips these days," Mr. Auer said, "but vendors view this partnership as: You take the risk, and they take the money."
Flexibility is also something that bankers should keep in mind, according to Timothy J. Ryan, a principal at Verdi Ryan Associates, a Williamsville, N.Y., consulting firm.
"You want to make sure you're aware of how that agreement would be impacted by some types of change that might happen during the term of that agreement," Mr. Ryan said. For example, if a bank merges or decides to expand its branch network, how flexible is the vendor about renegotiating the extent of service or providing services in a different way?
It is important to consider the special requirements of each type of deal. If a vendor is going to handle data processing at its own site, the bank must make certain that the outsourcer not only has the right technology for the job but also maintains it.
When seeking to outsource a systems integration project, a bank ought to check that the vendor has access to the necessary software and hardware and that the stream of software and hardware inventory won't dwindle, said Ellen L. Goldman, a contract negotiator at Bank of Boston Corp.
Different criteria apply to different outsourcing deals, but several things seem to apply across the board. While checking references, look for examples of how the vendor has handled institutions similar to yours. It is also important to determine whether the vendor's employees have the expertise needed to perform the contracted tasks.
Once the bank has completed researching vendors and narrowed the scope of its search, it is time to start sending potential vendors requests for proposals.
The vendor's reply should explain how it would accomplish the bank's goals. The proposal can be the starting point for negotiations. "Sometimes a vendor includes information . . . for marketing purposes. You want to use the information they provide as the basis for a warranty," Ms. Goldman said.
When it comes to negotiating, Bank of Boston takes a team approach. At least three people evaluate each contract from the perspective of the bank's business, technology, and legal concerns.
Developing a team is part of a successful strategy, Mr. Auer said. Ideally, someone on the team would work outsourcing deals as their core function, he added.
At Bank of Boston, a key ingredient of its strategy is its technology supplier management group. "It has been really advantageous for the bank to have a group like us in-house," Ms. Goldman said. "We're really able to facilitate bringing deals together."
The group works on reducing risk to the bank as well as trying to get the best financial terms. Using an intermediary also shields bank operating employees from any of the deal's potential rough spots. Since her contact with the vendor is only during negotiations, Ms. Goldman is in a better position to stand firm. "I'm the one who gets to wear the black hat, so to speak," she said.
Overall, the bank takes a win-win approach to negotiations. "Vendors have needs, and we have needs . . . . When those needs are opposing, that's when you need to compromise," Ms. Goldman said.
Vendors appreciate banks that know what they want.
Bob Andwood, vice president of financial institutions at PHH Mortgage Services, said some of the best relationships arise when "the financial institution has clearly thought out what they want to accomplish and the kind of operation they want to see when this is all done."
This vision of the outsourcing arrangement helps PHH Mortgage Services "know how to structure the relationship and the support we're going to provide to meet these goals," Mr. Andwood said.
Ms. Goldman said bank outsourcing deals should have "rights and remedies" provisions outlining the options if the relationship doesn't work out.
"From a very practical standpoint," added Mr. Corbett, the New York consultant, "you have to put as much energy into defining how you will terminate the relationship as you do in defining how you will create the relationship."
Another element that many recommend including in a contract is performance goals, which tie the provider's compensation to its ability to perform to agreed standards.
In drafting the contract, banks need to make sure that all terms are clearly defined. "If it's not in a contract, it's not part of the deal," Ms. Goldman said. The bank could be left at the mercy of the vendor to provide whatever isn't specified in the contract, she added.
International Computer Negotiations gives its clients a checklist of 300 items for analyzing a draft outsourcing contract, said Mr. Auer, its president.
Besides omissions, banks must stay away from using vague language. "For instance, it's terrible to have a deal where you say the new system is going to work 'better' than the old system. Everybody thinks they understand what that means, but the fact is, it costs you $500,000 per word in court to define those," Mr. Auer said.
After you've agreed on terms and spelled out the provisions, it's time to put the contract up to a test. A good outsourcing contract "should be one that a disinterested third party of average intelligence can pick up and read without coaching and understand what the deal is," Mr. Auer said.
Even after the contract is signed, the bank's work is far from done. "The success comes not when the contract is signed but as the relationship is managed over time," said Mr. Corbett.