Contracts: Going for the Long-term

164ASP944039376-443Most contracts are fairly short-term and the general consensus, according to Tim Cummins, president and CEO of IACCM, is that their average duration is about four years.

Tim, an expert and prolific writer on contracting issues, adds further that existing contracts are renewed or restructured at a rate of about 48 percent.

There is some variation depending on the type of business outsourcing contract (IT, manufacturing, finance, retail etc.) but the four-year duration estimate crops up often. Information Services Group (ISG) notes that existing outsourcing clients “are renegotiating, restructuring and renewing contracts more than ever before. The heavy activity is driven by changes in business strategy, changes to the scope of services sourced, issues with pricing, the introduction of new technology and work practices, and the consolidation of the number of service providers.”

ISG adds that  demands to manage risk, time and budget also are “forcing organizations to take their contracts to market. Restructuring has had an immediate impact on the average contract duration, which has shortened to about 4.2 years and has helped the average contract size to remain at a healthy $20 million level.”

“The average duration of outsourcing contracts has fallen in recent years, said Paul O’Hare of Kemp Little LLP in an article on benchmarking last year. “Whereas, in the past, a term of ten or more years was not unusual, in the current market, an initial term of between three and five years is much more common.”

In some industries like supply chain management / logistics outsourcing the average length of contract is even less while in the IT sector there is a trend to longer-term contracts, five years or more according to a January InformationWeek article.

The larger question is: what is the right contract term length? There is not a right answer, but in Vested agreements we are seeing a definite trend to longer term contracts. Why? Using a competitive bid process when there is a high likelihood of staying with incumbent is simply wasteful and an unnecessary duplication of effort. Think about it.  For companies that have deemed a supplier as “strategic” – why not make a long-term commitment to the supplier versus continually testing the market with a bidding process?

What is the reason so many companies have a “policy” that all work should be bid every three years, regardless of how successful the supplier relationship? Do you not trust your supplier? Or do you not have transparency that it is making a fair, but not overly high, profit margin and that the cost structure is inline with the market? If you answer is no to either one of these questions perhaps your strategic supplier should not be a strategic supplier.

If I am saying you are my “strategic” supplier, I want you to drive innovation, add value and make investments in my business; yet I am going to treat your company like it is a commodity and continually put your company through the ringer in what seems to be an endless loop of competitive bid processes every one to three years.

Todd Shire, Logistics Sourcing Strategy Manager at Intel explains the flaw in this logic when your aim is to work more strategically and collaboratively with service providers. “Our strategy had been to frequently rebid and transition our from supplier to supplier, always chasing the lowest transaction cost. We could feel comfortable that we were paying the lowest market price for a specific service, but we weren’t creating any value through relationship with our service provider. We were stepping over a dollar to pick up a dime.”

Is this practice really practical when what you are procuring is far more than a commodity and the cost and pain of switching suppliers is relatively high and you likely already know the key players in the industry that all have similar capabilities?

The answer to both questions is a resounding no!

I do understand the rationale of making sure your commercial agreements are in tune to the market, but ripping up an effective contract every two or three years on the off-chance a buyer will wring some savings, or that some ill-defined market advantage will accrue is shortsighted and definitely old-school.

The Vested sourcing business model offers a new mindset – and new methodology for working more strategically with “strategic” business partners.

Companies adopting the Vested sourcing business model – see our recent article in Outsource Magazine, “Outsourcing is Not Make Versus Buy: It is a Continuum,” for more details – are finding that establishing a long term win-win relationship can actually bring higher value than any short term price savings from bidding out the work.

Dell is one company that decided to “flip” its eight year relationship with GENCO ATC to a Vested relationship and is reaping the rewards, as explained in chapter 12 of the upcoming second edition of Vested Outsourcing, Five Rules That Will Transform Outsourcing and in this recent Bloomberg Radio podcast.

But where do you start? Vested has a comprehensive menu of books, resources, online courses and classroom courses at the University of Tennessee-Knoxville that take you on the path to long-term value creation with your long-term partner.

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