What to do with existing outsourcing contracts?

Risk aversion and focus on operational issues may result in a lot of organizations not paying a lot of attention to their existing outsourcing contracts (besides bargaining for a lower price here and there). This is of course an understandable reaction, but you might miss some opportunities and risks that come with the current situation. Risks may come in a slightly higher probability of suppliers going bankrupt (strategic risk) while more operational risks may be induced by the reaction of the suppliers management on the economic circumstances.

To reduce costs, the supplier may for example reduce its innovation budgets which could lead to (even) more pressure on expressed and contractually agreed intentions regarding ´strategic partnership´ and ´adding value´. Be thus mindful that the supplier lives up to these parts in the contract even though the supplier may assume that the economic situation allows for non-compliance to some parts of the contract.

To reduce the potential impact of a supplier going bankrupt, keep an eye on any signs of large clients leaving the supplier, news feeds that indicate difficulties to refinance debt or other triggers that might indicate that the supplier’s liquidity or solvency is reaching dangerous levels. For your key outsourcing contracts (e.g. single supply source), examine the clauses describing contract termination and who bears which costs of an exit. Can the contract be terminated without cost in the supplier goes into a ‘chapter 11’ process? At the same time, think of possible alternatives to continue the service, like in-sourcing or another supplier (e.g. draft some high level scenarios). This to prevent you have to start thinking only when the situation actually occurs.

For contracts that are ending in the near future the client organisation has two possibilities: continuing with the current supplier or a more risky approach by engaging into a new selection process. The downside of the risk of this last option is however counterbalanced by a potential higher return. If the first option is chosen, it is recommendable to at least conduct a benchmark to have a baseline the new offer from the existing supplier can be compared too.If the second option is chosen, it is advisable to take sufficient time to select a new vendor and draft the contract. This despite the pressure from senior managers to show quick financial results. First of all does a supplier sense if the client is under pressure to close and is less likely to propose the best deal. Secondly is the potential negative impact in the long term (e.g. too vague contract leading to disputes, unfavourable banding on pricing) such that it may far outweigh any financial benefit within the first year. But that interesting deals can be closed is illustrated by a recent article in The Economic Times showing that Indian suppliers alone have given $300 million in discounts on recently closed contracts.