Banks weighing the merits of turning to a third-party processor to handle electronic banking have a lot to consider. How can they achieve the connection benefits and cost savings of outsourcing without sacrificing control of their own customer relationships? Can a bank be protected against exponential price increases when transaction volume rises or processing demands grow? Can it be assured that the service provider will remain willing and able to make changes to the system to accommodate unique needs?

These are precisely the kind of questions that electronic banking service providers don't answer in their standard, preprinted contracts. The following checklist will help you negotiate price, performance, and procedures to protect your customer relationships.

Price

*A fixed, all-inclusive fee will protect the institution against price increases and excessive pass-through costs.

Electronic banking vendors generally offer their services on a per- transaction basis. They may also add a separate charge for items known as "pass-through" costs: services supposedly not under the direct control of the vendor - such as telecommunications, postage, network fees, travel expenses, training, supplies, and the like.

This pricing structure favors the vendor and forces the financial institution to bear the risk of price increases. To limit this risk, you should negotiate a fixed, all-inclusive fee or not-to-exceed fee based on some predefined account or transaction level, for all services, products, and software offered under the agreement. Costs are predictable under such an arrangement.

*Pass-through charges should be carefully spelled out and made the service provider's responsibility.

Telecommunications is generally the biggest pass-through item and warrants special consideration. Negotiate this item as a part of the fixed, all-inclusive fee. Insist that any changes the vendor initiates (or mandates) for telecommunications lines, modems, and the like be their responsibility. Increases imposed by the telephone carrier, or investments required due to technological changes, can be negotiated or addressed under a consumer price index adjustment.

*Performance penalties will ensure that the conversion takes place as planned.

Negotiate a declining scale of charges for each month the conversion is delayed. For example, you can specify in your negotiations that a 25% discount will apply against the first three months' billings for each month the conversion is delayed, with another 25% discount for each additional month the conversion is delayed thereafter.

*Payment should be linked to a formal acceptance test of the system to reduce the risk of nonperformance by the service provider.

Some vendors' contracts arbitrarily request the first three months' estimated fees and the entire estimate for implementation/conversion assistance. Negotiate a graduated payment schedule based on completion of tasks in the conversion plan and acceptance test approval.

*Negotiate the shortest possible term without jeopardizing price concessions.

Most vendors will try to negotiate the longest term possible. You can benefit from this if they are fixing the fees. However, to mitigate the risk of being locked in with the provider, an attempt should be made, where appropriate, to negotiate termination terms.

*A most-favored-nation clause will ensure that the institution receives the service provider's best price now and in the future.

The most-favored-nation clause states that all the prices, terms, warranties, and benefits are comparable to or better than the equivalent terms being offered to any of the vendor's present customers. This clause also binds the vendor to amend the contract if more favorable terms are offered to another customer during the term of the contract. The most- favored-nation clause is particularly important under a service bureau relationship in a competitive market such as this one.

Performance

*Determine business requirements before an agreement is consummated.

Many service providers offer to perform a business requirements survey after the contract is signed. Negotiate to have this performed before the contract is signed and incorporate the findings into the agreement, or make the agreement subject to the acceptance of the survey results.

*Verify software functionality and commit the vendor to any feature claims.

The institution should get a full description of the software, its functionality and performance specifications incorporated into the contract. It should also include a description of work to be performed by the servicer including application processing, product types, report generation, bill payment, account reconcilement, etc.

*Establish service level requirements and incorporate them into the contract with nonperformance penalties.

Service level commitments need to be spelled out and incorporated into the contract. Performance penalties should be associated with all of the service level commitments. Begin by negotiating a percentage credit (for example, between 10 and 20%) of the monthly fees for failure to perform on each individual item.

*Clearly address the institution's training requirements and the vendor's commitments.

The institution should negotiate for at least two to three weeks of on- site training and off-site classroom training, for as many people as you deem necessary. The training commitment should be included in the fixed, all-inclusive fee.

*Carefully define acceptance test criteria in the contract and link them to the payment schedule.

The satisfactory completion of the acceptance test should drive the definition of "conversion" in the vendor's service contract. Link the acceptance testing and conversion milestones to the payment schedule. The time period for acceptance should include a "hands-on" period (usually a minimum of 30 days) during which the institution's employees can monitor and verify the test results and general operation of the new system.

*Review the institution's current problem log and outstanding service requests and negotiate their resolution with the new system.

Ask the service provider to review the institution's software problem log and review any outstanding service requests or problem notices currently pending with your current provider. Negotiate with the service provider to resolve these items or gain contractual assurances that their standard software will correct these problems.

*Vendor customer-support functions should match the institution's hours of operation.

Verify that customer-support functions will match the hours of operation of the institution, with after-hours support available via beeper from a designated and knowledgeable support representative. Negotiate to obtain an experienced, dedicated support representative who has a good working knowledge of the service provider's system and the institution's processing requirements. The institution can also try to negotiate response-time commitments to service inquiries.

*Consider invoking a lemon clause for all hardware and software performance

You may wish to press for a lemon clause requiring the vendor to replace, rather than repair, persistently malfunctioning hardware or software. This kind of clause would apply mostly to equipment installed for remote printing or data communications. The clause should provide a benchmark for triggering the replacement requirement - that is, if equipment or software is inoperable for more than 10 percent of the time for any two consecutive months, then the service provider will replace the equipment or fix and replace the software.

Procedures

*Prepare a conversion plan before signing contracts.

Conversion planning aligns expectations, spells out responsibilities, and commits the parties to generating the results and completing the tasks required for a successful conversion.

The conversion plan will afford the institution the security that the implementation assistance proposed by the service provider is sufficient and was not underestimated during negotiations. Preparation of the conversion plan also improves your bargaining position by further educating the institution about the requirements of conversion, the projected costs, and potential risks. The conversion plan will help you negotiate implementation charges as a part of the fixed, all-inclusive fee since the tasks, resources, and time frames will be articulated and agreed upon.

*Avoid a transfer of errors from your current system to the new system by performing a file scrub before conversion.

The old adage applies here: garbage in, garbage out. Negotiate to get this performed prior to conversion at the service provider's expense.

*Invite the service provider to participate in the management of information technology at the institution.

Specify that the service provider's dedicated support representative is to meet regularly with bank managers. Also invite the service provider to perform an annual review of the institution's operations to assess the level of understanding and how well the system is being used by the institution's staff.

*Ask to review the service provider's disaster recovery plan for the data center serving the institution

Make sure it is site-specific and was written for the data center serving your institution. During negotiations, the bank could also request the service provider's participation in its overall disaster recovery planning efforts.

*Insist on verifying the vendor's financial stability and processing integrity.

Confirm that an independent, third-party review will be performed annually, with two copies provided to the institution. Most vendor contracts specify that the institution will be charged for the third-party review. Negotiate to get this included in the fixed, all-inclusive fee. You should also specify that the service provider make you aware of its financial position annually, including the specific financial results of the data center serving your institution. The institution may want to negotiate a termination clause to be invoked if the financial performance of the service provider falls below some prescribed level.

Insist that the service provider's insurance and bonding coverage will remain at or above some minimum prescribed level.

*Verify the service provider's responsibility that the software will allow the institution to meet all regulatory processing requirements.

This item is not readily apparent in many vendor data processing contracts.

*Renewal of service bureau contract and software license.

Your institution should ask for a provision in the service bureau contract and software-licensing agreement for renewing the agreements on the same terms and conditions as the original license.

*Software updates to be installed by the service bureau.

Negotiate to have all new software releases and program updates included in the fixed, all-inclusive fee.

*Provision for software access if the service provider is threatened as a going concern.

Ask for a provision in the contract providing access to the software in the event that the service provider goes out of business. This provision should allow you to obtain the source code of the software without paying another licensing fee.

Richard K. Crone is a manager in the Financial Services Consulting Group of KPMG Peat Marwick, the international accounting and consulting firm. *** CHECKING THE LIST TWICE

Other procedural items that should be negotiated in the outsourcing contract:

*Make it the vendor's responsibility to calculate performance percentages for service level penalties.

*Get the vendor to assist the institution in the revision of policy and procedures manuals due to the conversion to their system.

*Clearly define the role of the project managers from the institution and the service provider. Negotiate to have the service provider assign two individuals (one primary, one as a backup) to coordinate the conversion. The lead individual should have full project management responsibility. In the contract, define the project manager's responsibilities to ensure they include progress monitoring and reporting and resource coordination.

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