Defining the outsourcing partnership

Be aware of any business issue that might motivate the finalist vendor to negotiate and use it to your advantage in the contract negotiations. Also, leverage all of the marketplace intelligence you have garnered during the request for proposal (RFP) process. Presumably you now have current information on prevalent service levels, costs, performance guarantees and at-risk fees.

Content of the contract

The development of a proper and detailed contract –also referred to as the service level agreement (SLA), statement of work, or, in the case of qualified plans, the trust agreement – is key to a positive working relationship and outsourcing partnership. Clearly established expectations and well-documented deliverables will result in a win-win for both parties.

Contract duration. Specify exact beginning and ending dates and negotiate multi-year rate guarantees to the extent possible. Outsourcing agreements typically run for three to five years (some as long as ten years). At a minimum, try to negotiate a rolling rate cap at the end of the guarantee period so that you have a budgetable number at all times. For example, if you have agreed to a three-year rate guarantee, you also want the financial assurance that the increase at the end of that period will be no more than CPI or a rate cap of current plus 3 per cent.

Outsourcing contracts have financial penalties for early termination as the vendor typically amortises implementation fees. If you terminate the arrangement before the amortisation costs are recouped, you are expected to make the vendor whole. There may be certain circumstances in which this penalty would not apply, such as failure to implement on time, gross negligence on the part of the vendor or a stipulation if the vendor ownership changes.

Most importantly, negotiate the details of the contract’s termination provisions early while you still have some negotiating power. Do not wait until you are considering terminating to determine who owns the data, how files will transfer to the new vendor, any termination expenses and whether you will retain your same service team during the transition to a new vendor. You might even want to consider imposing terminal performance standards to ensure appropriate behaviors in support of a smooth transition.

Parties to the contract. Always allow for additions or deletions to the parties of the contract to account for acquisitions or divestitures. A usual standard is that unit costs are only renegotiated if head count varies by more than 15 per cent up or down.

Require the vendor to name all subcontractors they’ll use and to give you the right of approval of any subcontractors introduced subsequently. While approval may not be negotiable, reasonable notice of the introduction of a subcontractor and stipulations on who will monitor their quality and measure their at-risk performance guarantees should be incorporated into the contract.

Services performed. Include all functions to be provided and outline all support services with as much detail as possible. Solicit input from every stakeholder within your organisation that touches the relationship and record their needs in detail, such as file layouts for IT, invoice content and timing for AP/treasury, transaction reporting formats for internal audit trails.

No matter the level of detail, there will still be issues that will arise that couldn’t have been anticipated. Therefore, the escalation process and governance around dispute resolution protocols needs to be an integral documented part of the service agreement.

Performance standards. Practically all vendors offer standard performance guarantees. One of the challenges of vendor management is constantly visioning the future needs of your organisation and creating new performance standards to support them. This requires new skills and competencies on the part of the vendor manager, and it takes time. Vendors need time to develop new metrics for measuring new performance objectives. However, this should not be daunting. Be creative and support the emerging needs of your company over time.

So, start with standard performance guarantees and tweak as much as possible. Use the ‘best of the best’ guarantees being offered in the market and try to negotiate them with your selected vendor. Negotiate specific performance around implementation, acquisition or divestiture administration and contract termination transition assistance to a new vendor.

Ensure your vendor’s employees are aware of the standards and engage them in sharing your culture, your expectations and even your reward system. Consider offering spot bonuses or incentives to the vendor’s customer service staff for exceeding performance standards.

Fees at risk are a critical element of reinforcing performance guarantees. Not that you want the money; you want the performance. However, you shouldn’t be expected to pay for performance that isn’t up to par. Often, vendors who place fees at risk also want to see an upside when standards are exceeded. While not unreasonable, be careful where the performance metrics are set. For example, if call centre speed of answer is set at 40 seconds and the call centre assigned to your account usually responds in 23 seconds, you would be paying a bonus unnecessarily.

Hold harmless statement. This contract clause can be a deal breaker and bring contract negotiations to a halt. Hold harmless language generally protects the vendor, holding them unaccountable for anything short of gross negligence – a term that usually ends up being defined by lawyers or judges. If your procurement or legal department has its own hold harmless clause that is immutable, you might want to consider disclosing it in your request for information (RFI)/RFP. Thus if the vendor has any problems incorporating your language, you’ll know before it becomes time-sensitive and problematic.

If terms like ‘gross negligence’ cannot be avoided, consider incorporating mediation or arbitration clauses in lieu of litigation.

Fees. Like termination provisions, don’t wait until fees are billed and in dispute before specifying how and how often you want your invoicing presented. Indicate the level of billing detail you want and any reconciliation process you need in order to satisfy treasury or internal audit. Your contract should specify how ad hoc services will be handled, the approval process or change order format and sign off and how billing disputes should be avoided, resolved or escalated.

Finally, you may negotiate the general and administrative percentage and the fees at risk for non-performance. Some vendors add a general and administrative percentage of up to 12 per cent (on the high side of the range) to the total professional fees/unit costs or markup outside vendor bills, such as printers or graphic designers, by as much as 25 per cent. These add-on charges should be disclosed in advance and may be negotiated. You can request that the printer, for example, bill you directly to avoid the mark-up.

Data security. Data security is a primary reason many organisations outsource their data transactions. Therefore, ensuring its continued safety is a primary reason for specifying your company’s data security standards in the contract. Get your IT professionals to underwrite these contract provisions. Confirm the data platform or platforms to be used and detail all security measures including encryption standards and file transfer protocols. Define who has access to your data and limit its access to contracted functions only. Specify confidentiality needs beyond anything that is legally mandated under privacy and other relevant legislation.

Communication review. Never assume that the vendor will automatically let you review communications sent directly to your employees before they go out. This is a stipulation that needs to be in the contract to ensure that the tone and content complement and support your organisational branding and marketing standards.

Handling emergency notifications isn’t an area that’s seen in a typical boilerplate contract, yet can be vital to employee relations and the success of the outsourcing partnership. Define the process for reporting emergencies, such as technology problems resulting in the call centre being inaccessible for a period of time. You don’t want to hear about these problems from your employees or local HR representatives. Specify the process of who should be notified, in what medium and within what time frame in order to avoid potentially embarrassing surprises and to remain proactive with your constituents.

Contingency plans. Like termination procedures, don’t wait until there’s a problem to devise a contingency plan. Anticipate natural disasters and the impact they can have on the vendor’s ability to transact or provide service to your employees. For example, if a winter storm requires closing the call centre for the safety of the vendor’s employees, what contingency plans need to be in place? Document contingency plans around the use of all backup locations and data backups, and all actions that need to be taken in the event the vendor experiences an emergency or loss.

Audits. Vendor audits are about quality assurance and prudent due diligence – and possibly meeting fiduciary obligations, especially in the qualified plan arena. Most vendors have no problem allowing them. However, some vendors want to charge for pulling random files, some want a minimum two-week notice before coming onsite and still others want to limit access to certain information.

To eliminate misunderstandings later, clarify the audit procedures in the contract. Name who will conduct the audits and how often. Generally you want access by a third-party auditor as well as your own internal auditors. Audits should be conducted at least every two to three years. Include an ‘audit on demand’ statement so that if processing errors or employee complaints begin to consistently occur, you can get to the root cause expeditiously. Specify the data to be made available from the vendor for audit, such as the type and number of files, how the random sampling is to be performed, what should be available upon arrival of the audit team, how an error is defined and how the audit results will be validated with the vendor before the results are returned to the employer.

Final contract review

HR has taken the lead in developing the contract, calling on subject matter expertise throughout the organisation as needed to ensure that all company standards are accurately reflected. Now, the final document needs review and signoff. The obvious first review goes to the legal department and other interested parties in HR, perhaps divisional leadership. While legal is performing the global contract review (give them a timeframe for completion), have IT, finance and purchasing, if you use a procurement function, review and approve their contract sections.

The rigour you invest in developing a comprehensive and detailed contract with clear escalation procedures for unexpected issues not covered in the contract will pay big dividends in a successful outsourcing partnership. The vendor, an extension of your HR organisation to your employees, is in a better position to succeed through clearly delineated expectations, communication contacts and protocols and step-by-step instructions on how to avoid service landmines.

Karen Roberts is senior vice president, Aon Consulting based in San Francisco’s office. Email: [email protected].