Gaining value in a commodity contract and deal negotiation

A government client sought to purchase telecomms services on behalf of itself and 50+ partner agencies, across 120 countries. When does a commodity contract become something more?

Objective: To help the client clarify its evaluation process, prioritise its requirements, and negotiate a sustainable deal which would succeed for both parties over the long term.

Kiah approach: Look outside the box and find the value for both vendor and purchaser, and build clarity, communication and accountability into the contract.

This was a seemingly simple contract for telecommunication services – albeit providing services for some 50 government agencies across 120 countries. But essentially, it was still buying a telephone line, was it not? That’s a simple commodity product repeated in multiple locations. Surely there was little value to be gained other than the best price, and best price would surely result from the competitive tender process.

As is the way with most commodities – ‘oils ain’t oils’. It the job of the tendering companies to find ways to differentiate and that makes comparison difficult. Different third party suppliers, differing project plans, differing quality of service and different pricing all serve to make comparison difficult. Eventually the evaluation team did recommend a preferred provider and we were invited to assist with negotiation.

The end result was clearly a good deal. Worth nearly $300m over the contract term, at the time of signing, it delivered more than 300% more services for less than the current cost to government, with a significant more value in the contract than was envisaged in the RFT.  Charges are better than competitively tendered pricing and consistent with world-wide market pricing.

Here are just three lessons we learned from this deal.

The contract isn’t for lawyers

It may be a legal document but its job should be to help the arrangement work, not be a hindrance. This was a complicated multi-party arrangement, with two of the parties being government.  It started with a tri-partite Deed that linked two separate service contracts with two separate contracting agencies.  The management arrangements were also unclear with a whole of government agreement in the offing but separate agencies wanting contract as well as service autonomy. There may have been a drive for plain English contracting but it hadn’t found its way here.

The purchaser went to market with this structure – any bidder would cost the complexity, the potential for discord between the purchasing organisations and the cost of just managing the complexity. The bigger the deal, the higher the governance reaches and the less commercial decision makers will understand or accommodate the pleas of the business development managers that ‘it’s ok, we can manage it’.

In the end we still had two contracts, but no tripartite agreements. There were clear obligations, reporting, and authority – and only one unequivocal contract authority for each contract. Internal issues are internal and have no place driving a contract arrangement.  The main contract was logical, easy to read and made it clear how the arrangement would operate.

It would be quicker, and probably have garnered better responses from vendors, if the contract was sensible before releasing the RFT.

Beware the contract term

This went to market with an initial four-year term, with two 3-years options extending the potential contract life out to 10 years. This is fairly standard model, seemingly protecting the buyer by withholding long term commitment depending on performance. One argues that it provides flexibility.

It’s usually an ‘own goal’. It takes at least two years to come to a conclusion that the buyer wishes to let the contract come to a conclusion. A year for transition and settling, maybe a warning and a second year of non-performance. More likely it takes three years in all but circumstances of exceptional non-performance.

By then it is too late to reasonably develop and release an RTF and execute a new contract in a multi-agency arrangement. Ultimately an extension must be exercised to ensure continuity of services, and in a difficult relationship the supplier may will insist on the 3-year extension. This contract would have effectively seen a seven-year commitment by the purchaser, despite the contract wording.

The vendor will calculate pricing on the initial and committed term. Any start-up costs will be amortised over the initial four-year term, and pricing strategies and discounts will also be based on the shorter term. This reduces access to discounted pricing and the most favourable of terms. Effectively the purchaser has limited the opportunity for best value without a compensatory gain.

The shorter contract term, while a seemingly attractive protection against poor performance and a changing environment, didn’t practically exist and served to limit the value available.

Ultimately we concluded with a 10-year contract but the contractor’s tenure linked to technical performance and the quality of the relationship, along with provisions for rebasing pricing, services, and performance as technology and buyer needs change.

The price clearly improved, though it is unclear if it was the best possible price if the RFT had sought a more sophisticated relationship and leveraged competitive pressure to its fullest extent.

Managing service performance

Service performance is traditionally managed through KPIs and agreed service levels. This contract was no exception and were clearly drafted by technical and legal staff a part of the RFT. They weren’t unusual, nor were they particularly useful.

Every site had around 5 technical service levels. With 150+ service locations that was more than 750+ points of measurement and reporting very month – possible, but onerous. The rebate model, somewhat typical, sought a 10 per cent service fee rebate for every 1 per cent below the agreed service level. At 10% below the level the contractor would receive no service fee. Superficially it sounds logical but three things happen:

The contractor will make a loss. Not only will they not be paid to cover the costs of their work, they will have to pay any subcontractors in the ‘chain of service’ who were not at fault. Contractors may put profit at risk but rarely will they risk base costs.

At 10% below a service level the maximum impact thresh-hold is exceeded. This may occur in a few days early in the reporting period due, say, to a catastrophic failure. There is little incentive for the contractor to apply additional effort to resolve the issue within the remainder of the reporting period once the thresh-hold is reached.

The actual impact on the vendor is small when it is done service by service – it could be as small as 150th of the monthly fee. There is little drive for senior executive interest over such small amounts, which will be considered a cost of doing business and an allowance probably built into price.

Service and performance levels and credit regimes are difficult. They need to be well planned and contractor responses considered. These are not technical issues they are business issues.

We adjusted the service and performance approach to measure overall performance not isolated service levels. The model recognised that some failures would occur, but the acceptable thresh-hold across the network was low and the consequence high. Truthfully the technologists were uncomfortable but as a business approach it drove vendor senior management attention at quite a low thresh-hold of non-performance.

Consequences were tiered, escalating to a reduction in contract term for repetitive non-performance. This is a series commercial consequence well beyond a few dollars associated with a service level rebate that any company would wish to avoid.

Service and performance frameworks should encourage escalating senior management attention and provide an incentive to get the services to work properly. They are not a penalty and cost recovery regime.

Was it a good deal?

Clearly it was a good deal but was it the best possible deal?  That is truly the unanswerable question and in some ways irrelevant. The better question is: ‘Is it a deal with which the client was satisfied?’

It has:

  • high quality and increased levels of service for better than tendered pricing and less than current costs
  • a clear contract with clarity of obligations and authority
  • a sound, escalating, service performance management framework that encourages quality delivery and management attention to non-performance.

It also has additional benefits not envisaged in the RFT including a strategic relationship framework and delivery model that reduced internal costs by several million dollars. In our view it might have been even better (and quicker) if the RFT had approached the market with a more sophisticated business overlay rather than a simple technology procurement.

Nevertheless, it is a good deal. The vendor can make money, with maximum tenure, if they deliver. The customer gains more than they anticipated for less than they envisaged with a sound contract that provides confidence that quality services will be delivered.

Applying relationship principles to a commodity contract