When was the last time you reviewed your outsourcing agreements? Taking a fresh look at those contracts can help you cut costs in tough economic times.
Julian S. Millstein is a senior counselor in the global sourcing and technology transactions groups in the Morrison & Foerster law firm's New York office.
The global recession is forcing every company to consider new ways of cutting costs. This can be a challenge for supply chain managers who are saddled with long-term outsourcing relationships entered into in better times, and which may no longer be as favorable as they once were.
It's possible to cut some of the costs associated with these relationships, but it is not easy. In this article, we discuss four areas that offer opportunities to revise and improve your long-term outsourcing contracts.
1. Make the most of flexibility
A well-drafted outsourcing contract includes provisions that allow the contract to adapt to the customer's changing requirements. Many agreements contain fixed charges that are based to some extent on transaction or headcount assumptions in the initial year of the agreement. Often these amounts can be adjusted when conditions change. For example, a contract may allow adjustments to fixed charges if the volume of activity falls below an agreed baseline, or if the service provider achieves additional cost savings.
Even if a contract does not specifically envisage and make pricing allowances for changing circumstances, you often can make other changes that will save you money. For example, your agreement may have been negotiated at a time when stringent service levels were a priority. Service excellence, however, comes at a price, and reducing service levels can significantly lower the cost of delivery. Do you really need that 99.999 percent availability of a product or service? Studies indicate that each additional "9" in the availability measure can add 30 percent to costs. What business benefits are you getting for that additional 30 percent?
Or consider whether you could trim back or streamline services. Do you really require all of the service components in the original contract? Do all of the vendor's activities provide a business benefit? If not, ask your vendor to drop or scale back those services and amend the contract accordingly.
The procedure you establish for making changes in the contract should require the vendor to reduce its charges in line with the reduced scope of service. An important caveat: In many contracts, if a certain portion of the services are removed, that removal will be treated as a partial "termination for convenience," and a termination fee might be payable. Even in these circumstances, there may be some scope for negotiation. If the services you want to eliminate are disproportionately costly for the vendor to provide, the vendor may be willing to discontinue that piece of the business and waive the penalty.
Flexibility in a contract may allow you to reduce costs by delaying or canceling some or all scheduled process transformations (for example, automating manual processes) or technology upgrades. If the outsourcing agreement includes some form of process transformation, consider whether all or part of that project could be delayed or canceled. If you give short notice of the delay or cancellation, however, you may be required to compensate the vendor, but the cost savings from eliminating the project could well outweigh that penalty. And take a close look at any provision concerning information technology (IT). Does the agreement provide for unnecessarily aggressive technology upgrades? If so, now might be the time to re-evaluate your strategy for refreshing technology. But be careful not to indiscriminately cut IT spending: Targeted technology investments could help to boost sales and even save more money than you could through cost cutting.
2. Enforce your contractual rights
Too often, companies spend a long time negotiating a comprehensive outsourcing agreement, only to file away the executed contract in a drawer and manage the day-to-day relationship on an informal basis. Tough economic times, however, demand a return to more formal and controlled management. To get the full benefit of the terms in your existing agreement, review its service-level and pricing mechanisms, and then enforce the rights you already have.
Failing to enforce existing contract provisions inevitably leads to missed opportunities. For example, companies frequently fail to demand credits for "minor" service failures, preferring to give the provider some leeway for the sake of "the relationship." However valuable this trade-off may be in better times, even small service credits can add up. Exercising your right to claim them can produce appreciable cost savings.
Another example involves the right to benchmark service charges. Prices you agreed on years ago may be out of step with the market. A benchmarking right that will automatically reduce service charges in line with market pricing offers an easy way to realize cost savings. Even the threat of benchmarking can be enough to bring a vendor to the table to negotiate a reduction in fees.
Consider also whether to utilize the auditing rights in your agreement. By doing so, you can verify whether the vendor is invoicing the correct amounts. Audits can also determine whether you are being invoiced for the volume and type of services you actually use. Are you paying for a software license that has elapsed? Is the vendor in breach of any of its obligations?
Finally, make use of the dispute-resolution provisions in your outsourcing agreements. Check to make sure that they meet your needs. If your service provider is based offshore, will you have any enforceability issues? Ideally, you want to review and address these matters before you ever have to invoke dispute mechanisms. On a related note, parties to outsourcing agreements often fall into informal dispute-resolution processes rather than follow the steps laid out in their contractual agreements. Avoid potential problems by insisting that your vendor use the correct process, and if it fails to follow up on legitimate disputes, use the appropriate escalation and resolution mechanisms.
3. Find opportunities for renegotiation
It's wise to periodically review outsourcing agreements to assure that they are supporting your current business requirements. But when economic circumstances affect the business case for a particular deal, a review is not just a good idea, it's essential. That's why now is the time to consider whether any element of your outsourcing agreement should be renegotiated to reflect fundamentally different economic conditions.
One area where you may want to renegotiate is offshoring. If you decided to restrict a service provider from offshoring certain service elements when you first struck the agreement, there probably were valid reasons for doing so. Now, however, cost sensitivity may outweigh any potential downside of offshoring, and you may wish to change the terms to allow it. If your deal already includes offshore operations, then it's time to consider whether the allocation of currency risk is still valid. If you are paying for offshore services in the local currency, are you prepared to accept the currency risk? Or should your company hedge the currency risk on its own, without involving the vendor?
Provisions for dealing with corporate mergers, divestments, and other changes of control are prime candidates for renegotiation. Review the extent to which your existing relationships could accommodate a merger with a competitor—or the extent to which those relationships could be terminated and transitioned to an acquiring (or acquired) entity's vendor. Accordingly, you will need to review your agreement's assignment, termination, and pricing provisions to determine what your rights are when there is a change of control. If the contract does not already allow it, consider including the right for related companies to be added or removed as "services recipients." Outsourcing contracts often will treat the removal of a services recipient as a partial termination for convenience, but you can avoid the liability to pay a termination fee if the divested entity enters into a replacement contract with the same vendor.
If the provider's cost of borrowing is less than yours, consider mid-term renegotiation of pricing. Many outsourcing relationships spread recovery of the provider's up-front costs over the full term of the agreement, and therefore they allow the customer to defer payment for such items as transition, asset-acquisition, and initial start-up costs. There is no reason why you could not consider a similar principle mid-term. For example, the vendor might finance mid-term price reductions in return for higher prices later on.
4. Use your leverage
It is all very well to come up with a list of potential improvements to your outsourcing contract, but it's quite another thing to get the service provider's attention so that you can implement those improvements. To bring your service provider to the table, you must consider areas that you can leverage as well as changes that may offer value to your provider. Here's an example of the latter. Suppose you are satisfied with your provider's services but wish to receive price concessions. To make those concessions worthwhile for the provider, you could offer to extend the contract.
An example of using leverage would be exercising your right to terminate for convenience. Vendors prefer to retain existing, profitable clients rather than see them go to the competition. If you threaten a convenience termination, the vendor may therefore be open to discussing compromises. This is more likely if the net value of the agreement exceeds any compensation you would be obligated to pay to the vendor for the termination.
Here's another possibility. If the vendor is in breach of any of its contractual terms, then you can use the threat of termination on those grounds. Taking steps to (or even threatening to) enforce contractual terms and claim damages may give you some leverage. Of course, the more material the breach, the more successful such a tactic will be. If the breach is so material as to allow termination of the contract, it could threaten the vendor's reputation, and the vendor will want to avoid any negative publicity.
You could offer the provider additional business in return for a lower unit price. Sometimes reducing the scope in exchange for a price reduction serves both parties' economic interests. For example, you might offer to drop a poorly performed service that produces very little or negative margins for the provider.
Finally, if you are satisfied with the provider's services, consider offering to act as a reference in return for some additional benefits. If you are a large, prestigious customer, your recommendation could help your vendor get new clients. That might not sound like a lot of leverage, but in a tight market it could lead the provider to offer substantial benefits in return for your public endorsement.
Managing outsourcing agreements in difficult economic times requires thoughtful review in light of your organization's current goals. By conducting this type of review, you are likely to find many opportunities to gain additional cost savings or other advantages. So pick up your contract and look it over with care. There's no better time to do so than the present.
Residents and businesses along the Florida panhandle today are keeping a close eye on Tropical Storm Helene, which is forecasted to strengthen into a major hurricane by the time it strikes the northeast Gulf Coast on Thursday.
Hurricane and storm surge watches are already in effect for that area, which could see heavy rain and flash flooding across portions of Florida, the Southeast U.S., Southern Appalachians, and the Tennessee Valley, according to predictions from the National Hurricane Center.
The storm would come a month after Hurricane Debby delivered drenching rainfall for days over Florida in August and after Hurricane Beryl hit Houston in July, knocking out power across the region.
As Helene continues to gather strength from the warm waters of the Gulf of Mexico, experts are warning that the storm’s impacts could include the Port of New Orleans, agricultural operations throughout the Southeast, and additional citrus and fruit farming business in Florida, according to a report from Everstream Analytics’ chief meteorologist Jon Davis.
From a supply chain perspective, additional disruptions could include rail and road transportation stoppages, closures of interstate highways I-10 and I-75, widespread power outages, and shutdowns of offshore energy operations in the eastern portion of the Gulf of Mexico, Davis said.
As the third potential hurricane to hit the area within as many months, the arrival of Helene shows that extreme weather events aren’t just anomalies, but rather they’re the new normal for shipping companies and port authorities, according to Frank Kenney, Director of Industry Strategy at the technology consulting firm Cleo.
To cope with that constant battering, businesses need to adopt a new mindset, he said. “The only way to keep supply chains running smoothly is to build resilience into every aspect of operations. This starts with diversifying logistics strategies. If a shipper is dependent on a single route or port, they’re setting themself up for trouble. Instead, it’s crucial to have multiple backup routes and options ready to deploy when the unexpected happens,” Kenney said.
Following that strategy, inland ports such as Savannah and Macon, Georgia, will likely gain importance in coming years since their locations offer proximity to ocean ports while also providing access to major highways and some protection from coastal flooding. “In short, the storm isn’t going away, but by embracing diversification, leveraging technology, and ensuring supply chain visibility, U.S. ports and shipping companies can stay ahead of the curve. The companies that prepare for these challenges now will be the ones that continue to thrive, no matter how extreme weather events rock the boat," Kenney said.
Container imports at U.S. ports are seeing another busy month as retailers and manufacturers hustle to get their orders into the country ahead of a potential labor strike that could stop operations at East Coast and Gulf Coast ports as soon as October 1.
Less than two weeks from now, the existing contract between the International Longshoremen’s Association (ILA) and the United States Maritime Alliance covering East and Gulf Coast ports is set to expire. With negotiations hung up on issues like wages and automation, the ILA has threatened to put its 85,000 members on strike if a new contract is not reached by then, prompting business groups like the National Retail Federation (NRF) to call for both sides to reach an agreement.
But until such an agreement is reached, importers are playing it safe and accelerating their plans. “Import levels are being impacted by concerns about the potential East and Gulf Coast port strike,” Hackett Associates Founder Ben Hackett said in a release. “This has caused some cargo owners to bring forward shipments, bumping up June-through-September imports. In addition, some importers are weighing the decision to bring forward some goods, particularly from China, that could be impacted by rising tariffs following the election.”
The stakes are high, since a potential strike would come at a sensitive time when businesses are already facing other global supply chain disruptions, according to FourKites’ Mike DeAngelis, senior director of international solutions. “We're facing a perfect storm — with the Red Sea disruptions preventing normal access to the Suez Canal and the Panama Canal’s still-reduced capacity, an ILA strike would effectively choke off major arteries of global trade,” DeAngelis said in a statement.
Although West Coast and Canadian ports would see a surge in traffic if the strike occurs, they cannot absorb all the volume from the East and Gulf Coast ports. And the influx of freight there could cause weeks, if not months-long backlogs, even after the strikes end, reshaping shipping patterns well into 2025, DeAngelis said.
With an eye on those consequences, importers are also looking at more creative contingency plans, such as turning to air freight, west coast ports, or intermodal combinations of rail and truck modes, according to less than truckload (LTL) carrier Averitt Express.
“While some importers and exporters have already rerouted shipments to West Coast ports or delayed shipping altogether, there are still significant volumes of cargo en route to the East and Gulf Coast ports that cannot be rerouted. Unfortunately, once cargo is on a vessel, it becomes virtually impossible to change its destination, leaving shippers with limited options for those shipments,” Averitt said in a release.
However, one silver lining for coping with a potential strike is that prevailing global supply chain turbulence has already prompted many U.S. companies to stock up for bad weather, said Christian Roeloffs, co-founder and CEO of Container xChange.
"While the threat of strikes looms large, it’s important to note that U.S. inventories are currently strong due to the pulling forward of orders earlier this year to avoid existing disruptions. This stockpile will act as an essential buffer, mitigating the risk of container rates spiking dramatically due to the strikes,” Roeloffs said.
In addition, forecasts for a fairly modest winter peak shopping season could take the edge off the impact of a strike. “With no significant signs of peak season demand strengthening, these strikes might not have as intense an impact as historically seen. However, the overall impact will largely depend on the duration of the strikes, with prolonged disruptions having the potential to intensify the implications for supply chains, leading to more pronounced bottlenecks and greater challenges in container availability, " he said.
A coalition of freight transport and cargo handling organizations is calling on countries to honor their existing resolutions to report the results of national container inspection programs, and for the International Maritime Organization (IMO) to publish those results.
Those two steps would help improve safety in the carriage of goods by sea, according to the Cargo Integrity Group (CIG), which is a is a partnership of industry associations seeking to raise awareness and greater uptake of the IMO/ILO/UNECE Code of Practice for Packing of Cargo Transport Units (2014) – often referred to as CTU Code.
According to the Cargo Integrity Group, member governments of the IMO adopted resolutions more than 20 years ago agreeing to conduct routine inspections of freight containers and the cargoes packed in them. But less than 5% of 167 national administrations covered by the agreement are regularly submitting the results of their inspections to IMO in publicly available form.
The low numbers of reports means that insufficient data is available for IMO or industry to draw reliable conclusions, fundamentally undermining their efforts to improve the safety and sustainability of shipments by sea, CIG said.
Meanwhile, the dangers posed by poorly packed, mis-handled, or mis-declared containerized shipments has been demonstrated again recently in a series of fires and explosions aboard container ships. Whilst the precise circumstances of those incidents remain under investigation, the Cargo Integrity Group says it is concerned that measures already in place to help identify possible weaknesses are not being fully implemented and that opportunities for improving compliance standards are being missed.
By the numbers, overall retail sales in August were up 0.1% seasonally adjusted month over month and up 2.1% unadjusted year over year. That compared with increases of 1.1% month over month and 2.9% year over year in July.
August’s core retail sales as defined by NRF — based on the Census data but excluding automobile dealers, gasoline stations and restaurants — were up 0.3% seasonally adjusted month over month and up 3.3% unadjusted year over year. Core retail sales were up 3.4% year over year for the first eight months of the year, in line with NRF’s forecast for 2024 retail sales to grow between 2.5% and 3.5% over 2023.
“These numbers show the continued resiliency of the American consumer,” NRF Chief Economist Jack Kleinhenz said in a release. “While sales growth decelerated from last month’s pace, there is little hint of consumer spending unraveling. Households have the underpinnings to spend as recent wage gains have outpaced inflation even though payroll growth saw a slowdown in July and August. Easing inflation is providing added spending capacity to cost-weary shoppers and the interest rate cuts expected to come from the Fed should help create a more positive environment for consumers in the future.”
The U.S., U.K., and Australia will strengthen supply chain resiliency by sharing data and taking joint actions under the terms of a pact signed last week, the three nations said.
The agreement creates a “Supply Chain Resilience Cooperation Group” designed to build resilience in priority supply chains and to enhance the members’ mutual ability to identify and address risks, threats, and disruptions, according to the U.K.’s Department for Business and Trade.
One of the top priorities for the new group is developing an early warning pilot focused on the telecommunications supply chain, which is essential for the three countries’ global, digitized economies, they said. By identifying and monitoring disruption risks to the telecommunications supply chain, this pilot will enhance all three countries’ knowledge of relevant vulnerabilities, criticality, and residual risks. It will also develop procedures for sharing this information and responding cooperatively to disruptions.
According to the U.S. Department of Homeland Security (DHS), the group chose that sector because telecommunications infrastructure is vital to the distribution of public safety information, emergency services, and the day to day lives of many citizens. For example, undersea fiberoptic cables carry over 95% of transoceanic data traffic without which smartphones, financial networks, and communications systems would cease to function reliably.
“The resilience of our critical supply chains is a homeland security and economic security imperative,” Secretary of Homeland Security Alejandro N. Mayorkas said in a release. “Collaboration with international partners allows us to anticipate and mitigate disruptions before they occur. Our new U.S.-U.K.-Australia Supply Chain Resilience Cooperation Group will help ensure that our communities continue to have the essential goods and services they need, when they need them.”