Expecting the Unexpected — Checklist for Pricing Protection
This is the second article in a four-part series that seeks to provide organizations with useful checklists to key components of outsourcing arrangements. We previously discussed ways that organizations can protect themselves at the end of an outsourcing through termination and repatriation terms and conditions. In this article, we explore ways organizations can contractually guard against unanticipated fee increases and additional costs.
Oftentimes, one of the key rationales for outsourcing is cost savings; however, those cost savings will be eroded if the customer ends up paying additional or unexpected charges during the outsourcing relationship. This can occur when the customer requires a service that was not previously contemplated or when there is a misunderstanding between the parties over the services to be provided or the fees payable for those services.
Below are measures that customers might take in the outsourcing agreement to reduce the chances for misunderstandings and avoid expensive surprises down the line.
- Clearly state the service description and specifications. A well-articulated set of service descriptions and specifications helps to ensure that the parties are in full agreement with the deal being struck. Have people who are reasonably knowledgeable in the subject matter, but not involved in the day-to-day operations, read the service description and specifications. Do they have questions or difficulty understanding those items? If so, then down the line, it’s likely that a dispute will arise over whether the existing fee arrangements include that service. Refine the services description and specifications until it’s clear what you’re paying for. To the extent applicable, it is also important to ensure that the service includes all hardware, software, systems, and people resources used by the service provider to provide the services, or required for your organization to receive the services.
- Create a transparent change order process and specify what will constitute a change. In addition to having a well-thought-out change-order process that meets your organization’s requirements, specify up front who is responsible for the cost of making certain changes. This will help manage the costs of scope creep. For example, does the agreement indicate who is responsible for the cost of:
- regulatory changes impacting the business of the service provider;
- changes that also benefit the service provider’s other customers; and
- changes relating to services that are inherently provided as part of the service provider’s day-to-day operations?
- Build in pricing for new services. In certain circumstances, it may be possible to negotiate pricing protection for new services with the service provider. For example, you may be receiving volume discounts for other services under the outsourcing agreement. If so, does the agreement indicate that those discounts will also be applied to new services?
- Ensure any termination fee is clear and calculable. Negotiating the right to walk away from a deal during the term for a fee can provide an organization with the flexibility to change directions, when dictated by the market or when the relationship with the service provider no longer works. To walk away, the organization must have a clear idea of the fee that would be payable. Is that fee specified and how is it calculated (e.g., an actual dollar amount, a percentage of remaining fees payable, or a combination of the foregoing)? It is clear that the organization does not have to pay any forgone profits or revenues of the service provider? Not being clear about the amount of the termination fee could mean that the organization will not be realizing the savings that it wanted to realize at the start of the deal, assuming that such fees have been built into the organizations business case for the deal.
The above checklist is by no means a comprehensive list of approaches to guard against fee increases. Other price-protection tools to consider include most favoured customer provisions, benchmarking rights, and currency or foreign exchange protection (particularly in offshore deals). Similar to a service provider’s concern of revenue recognition, customers should be equally concerned with ensuring that their original business case holds true for the term of the relationship.