In an environment of increasing competition, companies can reduce costs and develop a competitive advantage by outsourcing certain components of their operations to third-parties. However, when leveraging third-parties, it is critical that firms negotiate terms that mitigate risks and are aligned with the company’s overall organizational strategy. In our experience, some of the key clauses that companies across all industries must include in their contracts with third-party vendors are discussed in this paper.
Contracting Strategies That Drive Business Value
Companies in any industry may have access to vast amounts of confidential data. When companies on-board third parties to outsource certain operations, these partners typically gain access to this confidential data as well. Due to this, it is critical that companies establish the following guidelines around data ownership when negotiating contracts with third-party vendors:
Data Return After Engagement Completion
Third-party vendors must return all client data within a certain timeframe after an engagement is terminated or comes to completion. Our experience has shown that the timeframe could range from anywhere between 10 – 45 days, with 30 days being commonplace in most industries.
Clear Ownership if Fourth Parties Are Involved
In certain instances, third-party vendors may in turn leverage an external vendor to perform services for a client. These fourth parties also gain access to confidential data. Hence, it is critical that the third-party takes complete ownership in such situations, in terms of how the data is stored, accessed and analyzed by fourth parties. Additionally, in cases of non-compliance or cyber security breaches faced by the fourth party, the vendor must take complete ownership and have a clear risk-mitigation strategy.
Upon providing an advance notice, the client must be able to perform an audit of how the third-party stores and analyzes data. This should also include an ability to review key security certifications and ensure they are up-to-date. For example, if the third-party leverages the cloud to store data, this could include validating that SOC2 certification is valid.
In our experience, we have noticed that most vendors tend to include an annual price increase percentage that’s applied during each year of the contract. This could range from anywhere between 1-5%. However, to drive a best-in-class contract management strategy, year over year pricing must remain flat or tied to inflation at the worst for multi-year contracts.
Any company can expect to face a substantial amount of resistance from vendors to agree to this term. However, it is critical to request pricing under different contract term scenarios from vendors, right at the start of negotiations and contract renewal discussions Additionally, offering vendors a longer-term deal, applying competitive pressure and providing visibility into additional business opportunities is effective in convincing vendors to include this clause in their contracts
Most 3rd Party contracts include a year-over-year price increase
Renegotiating renewal pricing can provide a quick win opportunity for companies to drive savings, Assuming an annual spend of $1.5M, companies can expect to save -$464K by keeping renewal costs flat over a 5-year contract term
Performance Metrics and Clearly Defined Penalties In Case of Breaches
Companies are increasingly outsourcing their core business operations, such as claims processing to third-parties as an insurance company. These third parties directly impact the end-customer’s experience, and hence the renewal rate for a client’s insurance policy.
Given the impact that third parties can have on the top-line growth for any firm, it is critical that their performance is evaluated against specific metrics such as key performance indicators (KPIs) and service level agreements (SLAs). Further, there must be clearly defined penalties in-case of non-performance, based on the impact of the breach on the core operations of the company.
Termination for Convenience
In most cases, companies incur significant costs when terminating a third-party contract for convenience. Coupled with change management/transition costs, this could be a substantial burden.
We have a proven track-record of negotiating terms that enable companies in any industry provide as little as 30 days’ notice and terminate their contract for convenience at no additional cost. We are also successful in ensuring that such vendors provide transition assistance for a defined period after contract termination.
Findings from a recent study have highlighted that most financial services companies fail to negotiate a favorable termination for convenience clause
of companies have built in termination for convenience in the majority of their vendor contracts
Outsourcing certain business operations to third parties can provide a tremendous advantage to companies, if done correctly. By ensuring that all contracts with third-parties include contracting best practices discussed in this paper, firms can reduce risk, maximize value, and gain a sustained competitive advantage.