Tech & Sourcing @ Morgan Lewis


In the first part of this two-part series, we briefly discussed three contract models and how they correlate complexity with shifting technology landscapes. The third model looked at where outsourcing and robotics intersect, and we stated that much of the success of this integrated model will rest with the fee schedule, how pricing is set up, and how the risk of transformation is shifted.

When contracting for complex relationships, it’s always a good idea to pay careful attention to how the fees work and how the fees will drive behaviors. Unfortunately, it’s not uncommon to have a fee structure and program objectives that either are unrelated, or, worse, drive behaviors that create severe headwinds for the program. This is one of the reasons why we encourage taking a team approach to these deals by integrating the legal, business, and technical teams very early in the process to form an integrated deal team.

The introduction of robotics into outsourcing provides a classic example of the interplay between fees, risk shifting, and ultimate deal success.

Suppose hypothetically that you are conducting a request for proposal (RFP) process for a business process outsourcing (BPO) transaction and a provider has promised a very healthy efficiency gain over the term of the agreement. When you dig into the solution you learn that robotic process automation (RPA) will be a significant driver of cost reduction, but successfully incorporating the RPA solution will require substantial business transformation on the part of the customer. Now consider how the pricing may play out.

A very common tool used to drive efficiencies in BPOs is to simply set base fees that decrease over time. The thinking is that the provider will have to become more efficient in order to take sufficient cost out of the environment so the provider can meet these targets and still retain deal profitability. This works fine when the processes being improved are internal to the provider, but what happens if the provider has to rely on transformation that is internal to the customer?

The obvious provider-friendly answer is to make the cost decreases contingent upon the customer’s ability to transform. Equally obvious is that this is a messy solution for the customer—one that may be difficult to measure and enforce, which may result in abuse. Certainly, this has the potential to increase the transaction costs of the deal (see our earlier post) because for every year that there is a targeted cost reduction based on contingent customer performance, there is the opportunity for finger pointing and other relationship-threatening discussions.

The obvious customer-friendly answer is to make the cost decreases independent of the customer’s behavior. This solution has the advantages of being easy to administer, lowering transaction costs, and allowing predictability over time.

This seems to be a great solution for the customer, and in a competitive procurement process the customer may just have the leverage to get the provider to agree to it. But whether this is truly a good solution for the customer is very fact specific and is where the real “art of the deal” comes into play.

Contracting away the necessity for the customer to transform is a great contracting solution, and may very well be a great solution for the program. But the provider still needs that transformation to happen in order for the customer to remain attractive. Since it’s usually not in the customer’s best interest to have a provider that is losing money, it becomes important for the deal team to assess both the customer’s and the provider’s ability to actually effect customer change without the contractual commitment.

Because the customer is now contractually entitled to get the benefit of the value targets without transformation, the question is this: Will the parties, working together, be able to show sufficient business value in excess of the targets to inspire the customer to make changes? If the answer is yes, then this is a great solution. If the answer is no, then this solution is not right for this customer/provider combination. It may be time to rethink the solution, or it may be time to rethink the choice of provider.