Landing large services contract negotiations
Services contracts are complex by design, requiring multiple internal and external stakeholders to align on service definition, measurement, performance thresholds, commercial constructs, governance models and other crucial aspects to ensure a successful and beneficial arrangement for both parties involved. The process of designing a strong contract provides a necessary forum for the parties involved to have a uniform understanding of expectations and assumptions to drive joint success. Regardless of the category, a good standardized template for a services contract ensures that clients/organizations are well protected from various risks inherent in sourcing services from external partners. Below is a high level guidance on various topics crucial in negotiating large service contracts, offering insights and recommendations to achieve favorable terms and mitigate potential risks. While the right contractual position is subject to legal and risk management team consultation of your organization, the below is an attempt to bring together perspectives on key elements for consideration in your negotiations:
Scope and structure of your contract:
As a foundational element of the construct, define what type of services would be covered under the contract. Many large service providers offer a wide range of services across digital marketing, Information technology, sustainability, business process outsourcing, tax advisory, consulting and other professional services. In an ideal scenario, all services from an outsourcing provider and its respective affiliates and subsidiaries should be under a single framework contract with right provisions to mitigate contractual risk, however, realistically, it is extremely difficult to get alignment across all categories on a uniform contractual position. We recommend driving services with similar risk profile under one framework contract.
Service delivery and Pricing model:
Are most of the engagements with the service provider on a time & material basis, on an outcome or output based model or on delivering a fixed scope of work at a fixed price? Establish transparent pricing methodologies and mechanisms for handling scope changes or additional requirements to avoid disputes.Pricing structures vary from fixed costs for defined scopes to time and materials or outcome-based models that adjust based on project complexity or outcomes achieved. Around 40-50% of software project services contracts follow a fixed-cost pricing model, whereas 30-40% opt for time and materials, and the remaining use outcome-based models. Define your negotiating position based on the future pricing model for services from the supplier and push for including necessary clauses in the contract to drive transparency whatever be the chosen model for a given engagement.
Service Locations
Where is the service delivered from by the service provider? Are there any specific constraints around restricted access due to confidentiality of the service outsourced? What flexibility would the service provider offering the service have in guiding its employees to deliver services for your organization. Specify service delivery locations, remote work arrangements, and data handling protocols for off-site work.Ensure compliance with local regulations, data protection laws, and security measures for remote service delivery as a part of the contract. Service contracts most often specify primary service locations and may include/outline provisions and conditions for remote work, adhering to data security and local regulatory requirements. Approximately 60-70% of service contracts define primary service locations, with remote work provisions included in 40%-50% of contracts incorporating provisions for remote work.
Collaborating with other Suppliers:
Large multinational firms often engage with multiple, though limited set of, strategic suppliers and usually have different components of the service spread across different strategic suppliers. It is crucial to address the conditions around how the service provider will collaborate with other suppliers. Address collaboration with other suppliers, ensuring compatibility and coordination for integrated services. Large service contracts should outline collaboration guidelines with other suppliers, defining roles, responsibilities, and communication channels to facilitate smooth collaboration among suppliers for integrated services.Approximately 50-60% of contracts involve cooperation with other suppliers, with collaboration guidelines detailed in the contract for 80-90% of these cases.
Sub-Contracting:
Large service providers engaging in multi-million or multi-billion, multi-year contracts often require specific pockets of expertise coming in from Niche suppliers. Niche suppliers are the ones who have deep capabilities in a specific industry/domain/category. Service provider attrition is anywhere between 15% to 30% based on the nature of the service and the demand for specific skillset, especially when the service is delivered from developing economies. Large service providers usually have back to back contracts with staffing firms to sub-contract work in situations which require an immediate backfill or where deep expertise is sought for any specific complex engagement. Define conditions for subcontracting services and maintaining quality standards. Obtain approval rights for subcontractors and outline accountability measures to ensure quality and confidentiality.
Personnel & Resource Attrition
As referred to under sub-contracting, resource attrition in people based businesses is natural and large service providers proactively plan mitigation measures through planning overheads in terms of buffer/non-billable resources, sub-contracting relationships with staffing firms or in exceptional circumstances place demands on deployed teams to stretch work hours and thereby compensate reduced team strength by overtime from existing team members. As a client, engaging a large service provider, you should ensure continuity of key personnel deployed on the engagement to have consistent quality and delivery. Address the retention of key personnel and procedures in case of staff turnover. Include clauses ensuring continuity of service quality and adherence to agreed milestones, despite personnel changes and outline procedures for introducing replacements.
Milestones & Implications of slipping key milestones:
What are the key intermediate milestones, where you want to check progress of a service provider? What provisions would you want to include for any slippages? What is the extent of the cure period you would provision in the contract for the service provider to get back on track with the overall service delivery schedule? Set clear milestones with realistic timelines and define repercussions for late deliveries. Include clauses for penalty payments or extended service commitments in case of milestone delays to ensure accountability in your frame agreements to ensure that at an individual engagement level, key provisions work as guidance on governing the contract. Many service contracts specify penalties for late delivery, often equating to a percentage reduction in payment for each day of delay. Penalties for late delivery typically range between 1-5% of the contract value(or milestone payment) per day, with around 70-80% of contracts incorporating such penalties.
Warranty Period
Very common in project work related to software development, warranty period ensures that any issues in delivered and accepted work products are rectified after acceptance and payment for an agreed amount of time. From a service provider perspective, warranty period is baked into overall pricing for the engagement. As a client, you should negotiate a warranty period with a service provider which will cover most of the real world scenarios/usecases. Define warranty periods for services and products provided, specifying terms for defects and maintenance. Ensure a reasonable warranty period and articulate conditions for warranty claims and remedies. Warranty periods typically range from 6 to 24 months(depending on the scale of the service delivered), with 80-90% of contracts specifying warranty terms
Service Level Agreements and Performance Management
Many of the business process outsourcing engagements, IT service management engagements and more broadly any “as-a-service” work requires agreement on service levels with a service provider. These may include response time, resolution time, quality of delivery measured in terms of a net promoter score or a customer satisfaction score, % claims addressed etc. While you should engage the customers or custodians of the service in defining requirements around service levels, ensure that the definition, measurement, reporting and measures to deal with missed or deteriorating performance are clearly articulated in the contract. Establish Service Level Agreements (SLAs) detailing performance metrics, response times, and service quality benchmarks. Clearly define SLA metrics, penalties for non-compliance, and mechanisms for service improvement. Many contracts contain an at-risk amount, which is usually a percentage of the total contract value with the service provider. Depending on your negotiating position and leverage with the supplier, define under what conditions would you withhold the at-risk amount. Assign a weightage to the critical service levels from a “service credit allocation pool”(usually 100% to 200% depending on number of SLAs across your engagements with the supplier) and define penalty for the service provider for missed SLAs or continued default on the committed critical service levels. While the idea is not to take a stick approach, a penalty model often provides guardrails around diligent performance management of a service provider.
Termination for Convenience
There are a number of situations where you might want to terminate the contract with your service provider. Some of the scenarios may include, but not limited to, a drastic change in the need for the work product, lack of due budget allocation to continue with the service, a significant management change pulling the plug on the service, a massive organizational restructuring, a change in operating model wherein potentially the service is planned to be insourced or at an extreme a change in macroeconomic or geo-political conditions requiring you to re-evaluate where, why and who of service delivery.
Whatever be the situation, it is prudent to have a strong termination for convenience clause in your contract, allowing termination without cause under specific conditions. Ensure clarity on termination notice periods, associated costs, and transitional procedures to minimize disruption. About 25-35% of contracts allow termination for convenience, with notice periods ranging from 30 to 180 days, and termination costs averaging 10-20% of remaining contract value.
Payment Terms
Establish clear payment terms, specifying invoicing frequency, milestone-based payments, and acceptable payment methods. Negotiate fair terms such as partial payments upon completion of milestones, regular invoicing upon completion of specified tasks and provisions for late payment penalties to ensure timely payments. Roughly 60-70% of service contracts involve an initial deposit. Payment terms vary but often include an initial deposit ranging from 20-40% of the total contract value, with subsequent milestone-based payments or periodic invoicing upon service completion. Milestone payments are typically aligned with project deliverables, with 25-30% paid upon completion of significant project stages.
Benchmarking
You invest a lot of effort and months of time in a hard negotiation with your service provider on prices and finally take a sigh of relief only to discover in a peer networking forum that the price you negotiated is more than 15% of what your peers are paying for the exact same nature of work. Well, to mitigate situations such as these, it is critical to have a sound benchmarking clause in your framework agreement. Incorporate benchmarking mechanisms to assess service quality, pricing, and performance against industry standards. Establish benchmarking criteria and intervals, allowing for fair assessment and adjustments to maintain competitiveness. Contracts often include provisions for periodic benchmarking against industry standards. Roughly 40-50% of service contracts have clauses allowing benchmarking, with assessments conducted every 12-24 months in about 60-70% of cases. A benchmarking clause enables you to readjust the pricing of the service provider, if the pricing is over an agreed threshold. The price benchmark reference will be provided by a mutually agreed independent provider, whose cost is usually shared with the service provider.
Step-In-Rights
This clause enables you to ensure service continuity by permitting internal resources or another service provider in case of failure of service provider to deliver on the commitments. Crucial to negotiate support from the service provider through the transition phase, in terms of knowledge transfer, continuity of critical services, whilst ensuring that you continue to pay the service provider for any additional reinforcements required until steady state is achieved in the new setup. Clearly outline conditions triggering step-in rights and the client’s responsibilities to avoid service disruption.
Transition and Exit Costs
Define responsibilities and costs associated with transitioning services to a new provider or bringing them in-house. Negotiate reasonable exit costs and establish a clear transition plan to avoid service interruptions.Contracts define responsibilities and costs associated with transitioning services, outlining a transition plan to mitigate service interruptions. Around 70-80% of contracts define exit costs, with average costs ranging from 5-15% of the contract value, depending on the complexity of the transition.
Insurance
This clause plays a pivotal role in allocating and mitigating risks between parties involved. An insurance clause outlines the insurance requirements, responsibilities, and obligations of both parties involved in a service contract. It serves as a risk management tool, ensuring adequate coverage for potential liabilities, losses, or damages that may arise during the contract’s term.
i) Insurance Coverage Requirements: Specify the types of insurance coverage required (e.g., general liability, professional liability, workers’ compensation, cyber liability). Define coverage limits, deductibles, and any specific endorsements or additional insured requirements.
ii) Policy Requirements: Detail requirements for insurance policies, including the naming of parties as additional insured, waiver of subrogation, and policy duration. Specify that policies must be maintained with reputable insurers and must meet industry standards.
iii) Notice and Proof of Insurance: Outline the obligation for parties to provide certificates of insurance demonstrating compliance with the insurance requirements.Specify the timeframe for providing updated certificates and notice in case of policy changes or cancellations.
iv) Indemnification and Liability: Clarify how insurance ties into indemnification provisions within the contract. Define the relationship between insurance coverage and each party’s liability in case of claims or losses.
v) Claims Handling and Cooperation: Define procedures for handling insurance claims, including reporting requirements, claim notification, and cooperation in investigations.
Some of the key guidelines in negotiating this important clause are as follows:
- Clause should be tailored to Contractual Risks: Ensure that insurance requirements align with the specific risks associated with the services being provided. Tailor coverage limits and types to adequately address potential liabilities inherent in the contract.
- Compliance with Industry Standards and Regulations: Stay updated with industry standards and legal/regulatory requirements concerning insurance coverage. Ensure that insurance requirements comply with any relevant laws or industry-specific regulations.
- Review and Negotiation: Carefully review insurance clauses in contracts, seeking legal advice if necessary, and negotiate terms that provide adequate protection without overburdening either party.
- Certificates of Insurance: Require periodic submission of certificates of insurance during the contract term to ensure ongoing compliance. Verify that the certificates reflect the required coverage and endorsements.
- Continuous Coverage: Specify that insurance coverage must be maintained throughout the contract term and any extended liability period after contract termination.
- Mutual Protection: Aim for a balanced insurance clause that protects the interests of both parties. Avoid excessively burdensome insurance requirements that may hinder the service provider’s ability to comply or increase costs unreasonably.
An effective insurance clause in service contracts is essential to mitigate potential risks and liabilities, providing a framework for adequate protection for all parties involved. It’s imperative to draft clear, comprehensive, and balanced insurance clauses that address specific risks while ensuring compliance with industry standards and legal requirements. Collaborative negotiation and understanding of insurance terms are crucial for creating mutually beneficial contracts that offer appropriate protection without undue burden. Consulting legal professionals specializing in contract law and insurance can further strengthen the efficacy of insurance clauses in service contracts.In summary, specify insurance requirements for liability, errors, omissions, and other potential risks. Review insurance coverage to mitigate financial risks and ensure compliance with industry standards.
Cost of Living Adjustment(COLA) & FX Adjustments
In service contracts involving international transactions, Currency of Living Adjustment (COLA) and Foreign Exchange (FX) adjustment clauses serve as critical mechanisms to manage the impact of currency fluctuations. The inclusion of these clauses aims to ensure fairness and stability in contractual arrangements. COLA provisions address cost-of-living changes by adjusting prices or payments based on fluctuations in local economic conditions. Similarly, FX adjustment clauses mitigate the risk arising from currency rate fluctuations, safeguarding parties against potential financial losses or gains due to currency volatility. To mitigate FX movement risks effectively, best practices involve specifying threshold levels of FX variation that trigger adjustments. For instance, the contract may stipulate a threshold of, say, 5-10% deviation in exchange rates over a specified period as the trigger for adjustments. Defining clear and reasonable thresholds helps manage risks without disproportionately burdening either party. Additionally, parties can consider employing financial instruments like hedging strategies or using currency exchange mechanisms to mitigate FX risks, providing stability and predictability in pricing and payments throughout the contract duration. The careful drafting of COLA and FX adjustment clauses, along with specified thresholds and risk mitigation strategies, ensures a balanced approach to managing currency-related uncertainties in service contracts.
COLA adjustments are usually reviewed annually or semi-annually with Consumer Price Index (CPI), Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), or other local/regional cost-of-living indices used as index for adjustment. Adjustments often follow a formulaic approach, correlating the change in the chosen index to the percentage adjustment in pricing or payments. Considering that minor changes should potentially be absorbed by either parties as a cost of doing business, the clause usually defines a threshold for triggering adjustments. A minimum threshold for COLA adjustments, such as a certain percentage change in the cost-of-living index (e.g., 3-5%), before triggering adjustments is most often negotiated based on assessment of either parties on prevailing macro situations in respective countries where the volume of business is expected to be the highest.
Volume Rebate:
A very standard clause in most large service contracts. Most organizations want to reduce their respective supplier base to drive benefits out of consolidation and this clause could provide a strong motivation to project the benefits. Negotiate a sound table of discounts based on your internal projection around business consolidation with the service provider. In most large contracts an incremental $10M in business on a $100M existing volume should fetch a minimum of 2% of additional rebate.
Pricing Transparency:
The objective of this clause is to agree in black and white on pricing transparency on any given engagement. Pricing, which the service provider attests is competitive in the market(esp. for new/novel services where benchmarks are hard to get). Many contracts agree on a catalog pricing or a formula based pricing approach based on roles deployed for a given engagement or based on nature of the deliverables. Whatever suits the service you plan to engage the provider negotiate a transparent, standardized and competitive structure in line with the prevailing benchmarks.
Limitation on Liability
A Limitation on Liability clause in service contracts is a critical provision that defines the extent of financial responsibility and risk each party assumes in case of breach, errors, or unforeseen circumstances during the contract’s execution. This clause sets the maximum amount one party can be held liable to the other, safeguarding against potentially excessive damages or losses. The clause delineates the scope and limitations of liability, often capping the total liability amount to a specific sum or tying it to the contract’s total value. Furthermore, it commonly outlines exclusions from liability, such as indirect or consequential damages, loss of profits, or punitive damages. While this limitation seeks to protect both parties from disproportionate liabilities, drafting it requires careful consideration to ensure fairness and balance. Factors like the nature of services, industry standards, and bargaining power influence the negotiation and inclusion of this clause. Nevertheless, parties should approach these clauses cautiously, seeking legal advice to align limitations on liability with the contract’s objectives and risk appetite, mitigating potential disputes or legal ramifications down the line. In some of the good contracts, it is not uncommon to see the cap on liability to three times the total contract value or capped by a dollar amount
Indemnification
Indemnification clauses in large services contracts play a pivotal role in allocating risks and liabilities between contracting parties. These clauses aim to protect one party (the indemnified party) from financial losses, damages, claims, or legal actions arising from the actions, omissions, or negligence of the other party (the indemnifying party) or a third party. Best practices in drafting indemnification clauses involve clear and precise language outlining the scope of indemnification, specifying the types of claims covered, and establishing procedures for handling indemnification claims. These clauses commonly include provisions requiring prompt notification of claims, cooperation in investigations or legal proceedings, and the right to control the defense of claims. Furthermore, they often delineate the limits of indemnification, excluding liabilities beyond a specified scope or imposing a cap on indemnification amounts. Given the complexity and potential ramifications of indemnification clauses, parties should engage legal experts to ensure clarity, fairness, and alignment with industry standards, thereby mitigating risks and ensuring a balanced allocation of liabilities in large services contracts
Governing Law
The Governing Law clause in large services contracts holds significant importance as it determines the legal framework and jurisdiction that will govern the interpretation, validity, and enforcement of the contract. Best practices in drafting this clause involve careful consideration of various factors to ensure clarity, fairness, and enforceability. Parties typically select a specific jurisdiction whose laws will govern the contract, often choosing a neutral and recognized legal system conducive to both parties’ interests. It is advisable to align the chosen governing law with the location of the contracting parties or the place where the services will be primarily performed. Additionally, the clause should expressly state that any disputes arising from the contract will be subject to the chosen governing law and the designated courts or arbitration forums for resolution. To enhance enforceability and reduce uncertainties, parties should seek legal counsel specializing in international contract law and consider potential implications of the selected jurisdiction on the contract’s interpretation and enforcement within large services contracts.
Data Privacy
In the evolving landscape of data privacy regulations worldwide, the inclusion of robust Data Privacy clauses in large services contracts is imperative to ensure compliance, protect sensitive information, and mitigate potential risks. With varying data protection laws like the General Data Protection Regulation (GDPR) in the EU, the California Consumer Privacy Act (CCPA) in the US, and similar regulations emerging globally, these clauses need to align with the most stringent standards across jurisdictions. Best practices involve specifying the types of data collected, processed, and shared during service provision, outlining security measures, and defining the roles and responsibilities of each party in safeguarding data. These clauses also address data transfer mechanisms for cross-border data flows, procedures for handling data breaches, and requirements for obtaining consent for data processing. Moreover, they often mandate regular audits, risk assessments, and the appointment of data protection officers to ensure compliance. As data privacy regulations continue to evolve, it’s crucial for parties to regularly review and update these clauses in accordance with the latest developments in data protection laws and seek legal counsel specializing in data privacy across different countries to create comprehensive and compliant clauses within large services contracts.
Confidentiality
Confidentiality clauses within large services contracts are paramount in safeguarding sensitive information shared between parties, especially in light of evolving global regulations governing data protection and confidentiality. With stringent data privacy laws like the GDPR in the EU, CCPA in the US, and similar legislations worldwide, confidentiality clauses must align with these stringent standards. Best practices involve clearly defining the scope of confidential information, outlining obligations to maintain confidentiality, and specifying permissible uses and disclosures. These clauses often address the handling of confidential data, encryption measures, and procedures for data retention and destruction. Moreover, they may include provisions for compliance with industry-specific regulations and international data transfer mechanisms. Continual monitoring of regulatory updates and the integration of these changes into confidentiality clauses are crucial. Parties should regularly assess and update these clauses to align with the latest regulatory developments, ensuring robust protection of confidential information and compliance with diverse global regulations within large services contracts. Seeking legal expertise well-versed in international confidentiality laws aids in crafting comprehensive and compliant confidentiality clauses.
Intellectual Property
Intellectual Property (IP) clauses within large services contracts are critical in defining ownership and licensing rights, usage permissions, and responsibilities concerning creations, innovations, or assets produced during the contract’s execution. These clauses typically address the allocation of IP rights, outlining whether the service provider retains ownership, grants licenses, or transfers rights to the client for any IP developed or utilized during the service delivery. Best practices for IP clauses include explicitly defining the scope of IP covered, specifying ownership rights, and determining licensing terms for any pre-existing or newly developed IP. These clauses often detail obligations regarding confidentiality, indemnification against IP infringement claims, and procedures for resolving disputes related to IP ownership or infringement. To ensure clarity and fairness, parties should engage legal professionals well-versed in IP law to tailor these clauses to the specific nature of the services, preserving both parties’ rights, preventing potential conflicts, and safeguarding valuable intellectual assets within large services contracts.
Assignment
The Assignment clause within contractual agreements plays a pivotal role in delineating the conditions and limitations under which either party can transfer its rights, obligations, or interests to a third party. This clause typically outlines the circumstances allowing assignment, the necessity for obtaining prior consent from the non-assigning party, and the criteria for approval. Best practices involve explicitly defining the instances where assignment is permissible and the process for seeking consent, ensuring that the rights and responsibilities under the contract cannot be transferred without explicit approval. Additionally, parties may include provisions specifying that any unapproved assignment attempts will be deemed void or constitute a breach of contract. Careful consideration is crucial in drafting this clause to maintain control over the contractual relationship, prevent undesirable transfers, and safeguard against potential breaches stemming from unauthorized assignments.
Compliance
The Compliance clause in large services contracts serves as a cornerstone for ensuring adherence to various legal, regulatory, and industry-specific requirements across different jurisdictions. Given the continuously evolving regulatory landscape globally, such as the General Data Protection Regulation (GDPR) in the EU, California Consumer Privacy Act (CCPA) in the US, and other sector-specific regulations, this clause demands meticulous attention to detail. Best practices involve outlining clear obligations and responsibilities of both parties to comply with applicable laws and regulations. These clauses commonly specify reporting mechanisms, auditing rights, and the obligation to promptly update the contract in response to regulatory changes. Furthermore, they may address indemnification against non-compliance, mechanisms for resolving disputes related to compliance, and the appointment of compliance officers or data protection officers where necessary. Continuous monitoring of regulatory updates and periodic reviews of the Compliance clause are imperative to ensure that large services contracts remain in compliance with the latest legal and regulatory developments across different countries. Ensure that the clause specifies conduct of regular audits, outlines reporting mechanisms, and establishes compliance procedures to avoid breaches and penalties.
Negotiating large services contracts demands meticulous attention to detail and thorough consideration of numerous facets. Implementing the guidance and recommendations provided in this report can significantly enhance the negotiation process, fostering a mutually beneficial and sustainable relationship between the contracting parties while mitigating potential risks and ensuring legal and operational compliance.
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Industry
Global capability centers(GCC)
Location
US Global market
Technologies
Artificial Intelligence
Robotic Process Automation
Data Analytics
Case Study
