06.05.08
LOIs and Outsourcing Agreements
In a recent article published on Law.com, W. Carter Santos makes an argument against using Letters of Intent (LOI’s) to move projects forward when the negotiations of an outsourcing deal become protracted. His primary argument is that the customer looses substantial leverage by letting the vendor begin work prior to the signing of the deal.
While I agree with Mr. Santos at a macro level, I also think that the article fails to explore methods for retaining, or even increasing, customer leverage by using LOI’s. Furthermore, Mr. Santos offers suggestions, such as build in enough time and educate stakeholders, as solutions to a problem that is far more complex.
Why do outsourcing deals bog down? Several reasons, but primary to them is the complexity brought to the dealmaking process by the outside consultants and lawyers who feed on such complexity. Instead of focusing on the line of demarcation and necessary business terms, outsourcing negotiations get bogged down in counting every server and turning over every leaf? This is also one of the main reasons that outsourcing deals are obsolete when signed.
A more nuanced approach to outsourcing looks to the inputs and outputs - the lines of demarkation - and builds a structure that allows for the analysis of business issues as they arise. Does that lead to some ambiguities occasionally? Certainly, but at the same time, it creates a deal that can robustly handle the ebbs and flows of business.
But that is an aside. The real question is what to do when the deal bogs down. At that point, particularly if there are proposed staff reduction, the deal is probably well-known throughout the company (very few pledges of secrecy actually work). The “good people” are looking for new jobs. The HR department is beginning to study retention bonuses, etc. A delay at this point will jeopardize the company, as the replacement services are really needed.
In this instance, an LOI makes sense. There are usually enough steps in a transition that an LOI can actually help keep projects on their timeline. But there are pitfalls, too, with leverage and “hunger†being only two of them. Those risks fall to both parties, and both parties should undertake efforts to mitigate them.
So how does one balance the equities? There are several approaches. First, it is important to make sure that the supplier has some “skin” remaining in the game with regard to loss-of-contract risk. An LOI should never be fully compensatory - a significant portion of the costs should be part of the initial contract payment, but only if a contract is ultimately signed. This approach insures that the vendor stays “interested†throughout the dealmaking process.
Second, segment the work so that generally useful portions are front-loaded, and insure that the customer has the ability to use that work or subcontract it elsewhere. No doubt, vendors will complain that this leaves their IP at risk, but that can be addressed contractually. The important piece here is that the customer should try to get something of value from the relationship - even if the deal fails. This also creates benefits for a client who changes approaches or vendors mid-stream.
Third, keep the “person-out-of-the-room” involved. Someone who can pull the plug on the entire project if it is going awry. Until the final contract is signed, the deal maintains a large amount of uncertainty.
Fourth, limit the LOI’s scope, duration and dollar value severely. While this creates some additional administrative overhead, it also keeps the parties interested in moving the deal forward - and reminds everyone that the deal is not yet done. This approach is particularly useful as quarter- and year-end periods approach, as the threat of not being able to book the initial revenue tends to light a fire under many supplier deal teams.
Finally, consider a multi-vendor procurement. Let each of the vendors work with you for a while before making final award. They will see some revenue, the customer will gain lots of insights into the operations of their prospective outsourcers, and leverage will be maintained through the competitive bidding process.
While I agree with Mr. Santos that, in an ideal world, those doing outsourcing deals would not resort to LOIs, I have seen very few “real world” scenarios. I would even venture that LOI’s, done correctly, can create leverage for the customer that can be beneficial as deals get near closing. Instead of being a tool of the vendor - to be avoided at all costs by the customer - an LOI should be viewed as a tool that, when used appropriately, can offer many benefits.
