Admittedly, we have spent a disproportionate time helping clients with the big deals ($60M/year or more) but now, perhaps based on the economy and the trend where clients have many smaller outsourcing contracts, we have been spending more time reviewing the small deal. With many of them coming to term or with clients now needing more for less, we have been analyzing the viability of these deals and the practicality of exiting these deals. The next steps being considered are the usual: i.e., either bring the service in house or find another higher performing provider.
Here is the problem:
There is a very high cost to change.
The one-time costs to exit a small deal are often similar, not only in kind, but also in amount, to the one-time costs to exit a big deal. They can include:
· Termination Fees
· Knowledge Transfer fees from incumbent to new provider (in-house or third party) – these are usually charged on a time and material basis
· Software license fees if the mix changes
· Consent fees to change
· Service overlap fees (since you are inevitably paying your old provider and new provider for some overlap)
· Transition Fees
o Start-up for new provider
o Coordination to manage the complexity of the three party change – old provider, new provider, and you
o Project charges to separate from shared assets in an incumbent data center
· Application remediation to move to a new platform
· Training on the new processes or tools
· Contracting costs (legal or advisor) for the new deal and the termination agreement you will need with the incumbent
· Hiring and start-up costs for new staff
· Data Center or hardware costs for in-house delivery
· Etc……..you get the picture
These one-time costs are never under seven figures. Let’s look at a quick back-of-the-envelope example:
Assume for this example that you have an infrastructure outsourcing deal coming to an end where the fees are roughly $9M/year and the vendor supplies most of the hardware, software, data center, etc.
Now you want to move to another provider.
Your one-time costs will conservatively exceed $6 Million.
The trend to do shorter deals exacerbates this problem.
In a five year analysis, without any contingency for delays (which we would strongly recommend adding based on experience), you have to make up the one-time costs over the term of the new deal. You would have to get a price reduction of at least 6/45 or 13%. When you add the time value of the savings (which usually aren’t realized until later years and only if you make other transformational changes) and an expectation of some return commensurate with the risk, you are looking at least a 25% price reduction just to break even. Would you create all the distractions involved in switching providers for a business case that just breaks even?? Neither would we.
Now, factor in the small deal element. Right or wrong, there is a lot of overhead for outsourcers and they are all making a lot of money these days. This magnitude of price reduction can’t be achieved without significant transformation such as standardization, virtualization, off-shoring, reduced service, etc., etc., etc. In other words, all these changes bear their own additional implementation costs and risks that need to be included in your business case, thus further raising the bar for the price reduction.
This vicious circle (change needed begets the cost of change) is resulting in clients in small deals not able to make a change from their current provider, at least not one that is justified by a business case.
This dirty little secret is often not considered when entering into the small deal. Sadly, the less enlightened providers understand this high barrier to exit and use it as an excuse to deliver poor service.
What should you do if you are in one of these small deals and want to get out?
What should you do if you are thinking of entering a small deal and want to avoid this problem?
Stay tuned for our next solution-oriented post………or call us in the meantime if you can’t wait!
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