Sunday, July 17, 2016

Managing Strategic Risk in Core Vendor Relationships

There’s been a lot of attention around core system selection, contract negotiation, and related matters recently.  I want to remind you that I have extensive experience in these areas, and generally have open projects involving new system selection, contract negotiation, and re-negotiation of existing contracts.  I have two things that will be of great value to you: extensive experience over the last 30 years, and a proven methodology designed to get you the very best outcome.
This time, I want to discuss contract negotiation (and renewal negotiations).  Next time, we will discuss system selection.
Just like contingency planning, vendor management is more than a regulatory requirement.  It is a prudent business practice. The failure of banks to properly manage their relationships with vendors caused banking regulators to impose vendor management guidelines. Poor vendor management costs money, plain and simple, and creates issues of exposure and liability that may be hidden until some sequence of events occurs that brings such liability to the forefront. 
Essentially, you should organize all of your vendor relationships in such a way that you know who you are doing business with, what the terms of the relationship are (time frames, service levels, bank obligations, vendor obligations) who the proper contacts are (normal involvement, escalated involvement) and have in place a methodology for tracking existing contracts, and getting new contracts into the same organized system so that they are also properly tracked. In many cases, a simple spreadsheet will do, but you will find numerous vendors who offer both desktop and web-based solutions for managing vendor relationships. Again, this is just common sense. Make sure that someone has central responsibility for vendor management. 
I want to spend some time on the specific exposure and liability involved with your large Information Technology contracts. Primarily, core processing, item processing, EFT services, and perhaps Internet banking. Especially when you outsource these services, you will find these contracts to be extremely specific, and virtually loaded with pitfalls to navigate during the course of their lifespan. Over the years, these contracts have grown in size and complexity, and I can assure you that the additional language is primarily to protect the vendor's interests, NOT yours. Below are several clauses that are most critical, as examples of how serious these matters can be. 
1) Natural Termination or "deconversion" fees. You will find that your IT contracts contain language detailing the vendor's responsibility when you choose to move to another vendor at the end of the contract. Most read something like this: "we will provide reasonable deconversion assistance at our then current rates" - or as I like to call it, a blank check. In practice, I am seeing fees that are the equivalent of an extra 6 to 12 months of processing fees. 

All that, for providing one or two sets of “tapes” or files to your new vendor for the conversion process. Note that the word reasonable, in the sentence above, is not modifying the word cost. When renewing these contracts, or signing new ones, insist on a reasonable fixed fee for the deconversion charges. Move on if a vendor won't agree to fix these costs. 
2) Early Termination fees. Let me be clear - I don't ever advise a client to arbitrarily break a contract and attempt to walk away without penalty. You wouldn't allow customers to do that with loan covenants or corporate resolutions. That being said, there is nothing wrong with attempting to negotiate a better deal when you renew or negotiate a new contract. Most of the time, early termination clauses provide for you to pay 80% of the current monthly fees, for the remaining life of the contract. First, this is too high a penalty. The vendor's margins are just not that good. Second, you will find that the vendors often include in the calculation of this 80%, pass through charges (such as telecom, or other third party fees like card production, postage, etc.) that you will still have even when you move to a different provider. I try to negotiate a true cost of the monthly fees from the processor, and then implement a sliding scale as the contract ages. I've seen a number of M&A deals fall through because the selling bank's early termination fees were simply too high. 
3) Auto-Renewal Clauses. Many contracts contain such a clause, basically saying that if you don't serve notice in advance (usually 90 days to 180 days) the contract will automatically renew, at the same terms, conditions, and pricing. First, try to take the clause out. If the vendor won't agree, simply serve notice, via a letter, at the time you sign the new contract that you will not auto-renew. This does not mean you will not renew the contract, it just means you want the opportunity to negotiate terms, conditions, and pricing prior to renewal. 
4) Refunds of Incentive Payments - especially when you move to a new vendor in the core and EFT areas, it is not uncommon for vendors to give you either hard dollars up front, or a significant credit that you can use against the purchase of goods and services. Understandably, if you break the contract early, they will want some or all of their money back. Again, I suggest a sliding scale, so that your liability decreases over time. Probably 100% the first year, then 20% reduction per year for each year after. 
I believe I've made my point that there is significant exposure in contracts for Information Technology services. It's important that you address your situation relative to existing contracts, and that you educate yourself so that future contracts are negotiated not just on price, but also on terms and conditions in order that the contracts are more favorable to your bank. 
Because of the complexity of these contracts, you will likely need help. I have extensive experience in reviewing and negotiating Information Technology agreements, and would be pleased to help you should you need assistance. My methodology includes a checklist of items for review, along with a thorough reading of every contract, addendum, and extension, and provides significant value in helping you manage this important risk area, and negotiating better contracts going forward.
Upcoming Speaking Engagements
July 27 - Advanced School of Banking at Penn State University 
August 5 - Kansas Bankers Association CEO Forum, Colorado Springs
August 11 - Graduate School of Banking, University of Wisconsin
August 13 - Alabama Bankers Association, CEO Conference, Point Clear, Alabama

Trent Fleming advises executives on strategy, management, and technology issues.  Reach him at or on Twitter @techadvisor

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