Contract Flexibility: Improving Terms to Support Your Digital Transformation

In these fast-moving times, when technology is driving such rapid change, organizations must be adaptable – and they must be somewhere on the road to digital transformation. The fine print of managed services contracts can determine a great deal about the speed, cost and the ultimate success of such a transformation.

Contract provisions that increase flexibility in managed services relationships are not new. Enterprises have long sought benefits such as volume-variable pricing, flexible service-level management methodologies and structured contract governance to enable them to adapt to changes in demand, priorities and service requirements. These traditional provisions work well to address evolutionary changes to service requirements, demand and performance needs.

But digital transformation requires rethinking your service and sourcing strategy. Digital technologies are profoundly impacting the way business is done, which drives material change to existing services and contracts. With insufficient contract flexibility, an organization may find implementing these changes to be more difficult and expensive.

When considering how you can better prepare your contracts to support your digital transformation, keep in the mind the following:

• Termination terms. Termination for convenience is a key lever to transform contracts. Seek to negotiate more favorable terms including shorter notice requirements, enhanced rights for partial termination and reduced exposure to early termination fees.
• Minimum revenue commitments. Look for opportunities to reduce or eliminate minimum revenue commitments and ensure that any such commitments are relieved in cases of termination for convenience or expansion into digital services outside the managed services agreement.
• Stranded overhead. As consumption of a managed service decreases, associated credits are typically at the variable cost. In this situation, an enterprise buyer can be left with ongoing fixed costs that are burdensome and possibly unnecessary. Look for ways to minimize or eliminate stranded overheads in cases in which selected services are removed or significantly reduced.
• Contract term. Consider a shorter contract term when contracting or re-contracting services. Look to reduce the minimum required term for extensions and build in minimum levels of future price performance for extensions. Be sure to use technology to manage shorter contract terms and extensions as being proactive is imperative for driving lower costs.
• Termination assistance. Negotiating termination assistance services can be challenging at the time of termination. Consider negotiating a longer required duration, improved rights to modify the duration and a standard contract template documenting termination assistance services.
• Multi-supplier service integration. The industry has seen a significant move toward multi-supplier models over the last several years and this will accelerate in the future. Evaluate the extent to which your contracts support a multi-supplier service integration strategy.
• API-based architectures. Application programming interfaces (APIs) are becoming more critical, especially in the cloud-enabled, loosely coupled environments in today’s digital organizations. Ensure contracts address applicable service, security, pricing, performance and governance requirements for APIs.

To get started improving your contract terms, consider using the following approach:

1. Make sure you thoroughly understand your current contracts. Focus on the rights and obligations you already have under those agreements and document any gaps these contracts may have when compared to current market terms and digital preparedness.
2. Assess your digital transformation strategy to identify expected changes and document how each of those change scenarios impacts your contracts.
3. Model the financial, operational and customer impact of each change scenario based on your existing contracts.
4. Identify and prioritize high-value changes that would improve flexibility to address anticipated changes in demand.
5. Incorporate these changes into your negotiation strategy for each contract and seek to negotiate improved terms at opportune times.

With some advanced planning, you will be able to find opportunities to negotiate improvements to your existing contracts and improve your organization’s ability to execute its digital strategy. It won’t be easy, but remember that digital transformation is a journey, and improved contract flexibility will improve enterprise agility and position your organization to achieve its strategic objectives faster and more cost effectively.

About the author

Mr. Tracy is a Principal Consultant at ISG, with over 10 years of consulting experience serving clients across a variety of industries.  Steve thrives in helping clients manage complexity, and he applies his broad experience, strong communication skills, and deep analytical expertise to help clients achieve their business goals.  Steve has helped clients identify and deliver over $500 million in savings through effective preparation and sound execution of insourcing, outsourcing, and internal optimization initiatives.