Publications

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As we launch ourselves into 2012, many of us are asking what the New Year will hold for us in terms of changes to the legal landscape for sourcing and outsourcing transactions. Whilst we cannot claim to have the benefit of a crystal ball in this regard, we believe that there are some specific trends which we have seen developing in the last six to nine months, and which we expect to continue into 2012.

Sourcing trends 

• Customers are focussing on the rationalisation of their supply chain. Rationalisation brings the twin advantages of reducing cost (by using fewer suppliers with higher volumes) and being easier to manage (which is important now that there are fewer internal people available following internal headcount reductions). Rationalisation invariably involves, sometimes painful, discussions about contract termination or non-renewal, often with suppliers who have longstanding relationships with the customer. The process can also highlight potential 'gaps' in the original contracts relating to such exits. These gaps may favour the customer (for example, a lack of termination fees or redundancy costs remaining in the hands of the supplier), or the supplier (such as termination of licences which the customer had expected would continue or termination assistance issues)
• In tandem with rationalisation has been a noticeable shift back to larger, single supplier deals. These contrast with the multi sourcing programmes which were becoming very much 'flavour of the month' (many a multi-tower ITO project was finding itself broken down into its constituent parts upon renewal). In more turbulent times, the attraction of a single 'throat to choke', coupled with the pricing benefits that larger volumes with a single supplier can bring, is harder to resist
• The point of down selection to a single 'preferred supplier' has appeared much earlier. Equally, more customers have been conducting negotiations with potential suppliers on a 'sole source' basis. These approaches are motivated primarily by the attractions of speed and apparent reduction of procurement process cost. However there are inevitable consequential impacts upon the customer's bargaining leverage which may operate to the customer's detriment in the longer run
• Selective renegotiations (ie focussed on larger deals where prospects of getting meaningful price reductions are greatest) have continued. We see this stretching into 2012 but probably as less of a priority because most significant contracts will already have been addressed and renegotiated to the greatest extent possible
• There has been more use of benchmarking provisions. This is perhaps not surprising, however it is fair to say that benchmarking activity is still far short of the level that would be occurring if all benchmarking entitlements in significant sourcing contracts were exercised. We expect this to continue, with customers using the threat of benchmarking to engender meaningful price reductions by negotiation rather than going through the cost and hassle of the benchmark process itself if this can be avoided

Legal/ drafting developments

• Clients previously well known for negotiating hard and getting their way in contractual terms by reason of their bargaining power (ie larger financial services entities) are becoming more flexible - at least when negotiating provisions with a cost impact. For example, a bank which historically refused to compromise regarding its IT security policies became noticeably more amenable to potential 'exceptions' when significant cost reductions followed
• Suppliers have become much tougher on termination rights for non-payment short of actual insolvency and in shortening payment periods in general. Rights to levy interest upon late payment are beginning to be exercised on a more frequent basis
• Customers are similarly getting tougher in demanding clauses which give them 'early warning' relief and protection where the supplier seems to be sliding down to oblivion but isn't there yet (ie anticipatory termination rights which are linked to credit rating deterioration/ breaches of banking covenants). Given the precarious state of the economy in general, an increase in the actual usage of such clauses, which are now more prevalent in some of the larger deals seems likely
• Interestingly, we are seeing more cases of suppliers accepting liability in whole, or in part, for loss of revenue related elements of claims (having historically insisted upon such losses being excluded absolutely, whether they could be categorised as being direct or indirect). Even if not accepted as a potential head of loss 'in full', we have seen even tier one and tier two outsource suppliers agree to 'sub caps' applied to loss of revenue/ profit elements of a claim, and or offering up 'super service credits' distinct from the normal service level regime, which would be triggered whenever there is a breach which is likely to lead to revenue impacts. It will be interesting to see if 2012 leads on to challenges to another of the 'sacred cows' in terms of the limitation clauses, namely the absolute exclusions of indirect loss

General
Perhaps predictably, we are seeing a number of suppliers having difficulties having won deals in haste but repenting at leisure. This is particularly common for deals set up on a 'your current cost, less x%' type pricing model, rather than those priced by the supplier from the ground up. Difficulties tend to be due to an inability of such suppliers to align their ongoing cost base with fluctuations in the charges which they are then able to command from the customer. Whilst many of these deals will end up in renegotiations, some will (we expect) 'fail' altogether, leading to an increase in litigation and ultimately also in the amount of outsourcing specific case law.

Conclusion
To borrow/ paraphrase the Chinese phrase 'we live in interesting times', whilst the economy remains challenging, the sourcing and outsourcing markets remain dynamic and capable of making a meaningful difference to the prospects of customers and suppliers alike. The more experienced legal advisors who have the widest possible view of the market place should be ideally placed to help make this happen!