Benelux has a mature outsourcing market, but with the credit crunch putting increasing pressure on costs there are new opportunities for IT outsourcing, say Kristof De Vulder and Arend Lagemaat

With a bit of a delay, there is no doubt that businesses in Benelux are currently suffering dramatically from the economic crisis. As in the UK, the governments of Belgium, the Netherlands and Luxembourg have intervened to bail out certain banking institutions in order to raise liquidity on the markets, but the impact of the financial crisis has been felt far beyond the financial sector.

In reaction to these events, companies have shifted focus from realising growth to realising cost savings. Continued pressure on costs has an impact on IT – the issue of how and where IT budgets are spent has never been under closer scrutiny. Both in relation to existing contracts and new projects, there is an overwhelming focus on short-term cost-cutting. Inevitably, this focus has legal implications on IT sourcing and
IT procurement contracts.

IT sourcing in Benelux

IT outsourcing has secured its position as a favoured business tool for companies in Benelux. Within Belgium, for example, a recent study of Equaterra comprising companies representing 80% of the total contract value for IT sourcing shows that IT sourcing is still growing. The same study showed that more than 50% of the business is considering more outsourcing in relation to applications, desktops and business processes, thereby attributing increased importance to cost savings and flexibility. Belgian companies are frontrunners with regard to outsourcing. A study by Ernst & Young in 2008 showed that 81% of Belgian businesses with a turnover of E100m (£89m) or more outsource one or more functions.

With respect to the Netherlands, research in 2008 by MarketCap shows that almost a third of all organisations with 50 or more employees outsource the management of IT infrastructure partially or entirely. Furthermore, this study shows that the outsourcing of whole IT departments or parts thereof, takes place at 29% of all organisations in the Netherlands. In particular, organisations with 300 or more employees make use of such outsourcing. An earlier study by Giarte on the use of business process outsourcing in the Netherlands among large Dutch companies showed that the use of business process outsourcing increased quickly between 2006 and 2007, rising from 16% in 2006 to 22% in 2007.

Clearly, Benelux is a mature market not only in terms of onshore IT sourcing, but also offshoring and nearshoring. As a result, many businesses will have already considered cost reduction measures in their sourcing contracts. Today's acute cost pressures have led to additional provisions being included in IT sourcing contracts.

Impact on existing IT sourcing projects

The current market situation has affected the way both new and existing IT sourcing contracts are concluded. Businesses looking to achieve cost savings are reviewing their existing (long-term) contracts in order to evaluate existing relations and determine the extent to which costs can be limited going forward. In such cases they have often been faced with the limitations of their existing contracts.

Benchmarking can be used to help re-negotiate existing contracts and ultimately reduce costs. For the client, the primary purpose of the benchmarking clause in outsourcing contracts is to verify that the price is still in line with the marketplace. With the economic crisis and declining revenues of technology suppliers, announcing the intention to begin a benchmark review will suffice to bring parties around the table to re-negotiate on pricing. Although benchmarking is commonly found in IT sourcing contracts in Benelux, many of these clauses are not well drafted or do not deal with the process and consequences of benchmarking on a high level basis only. Everyone that has been involved in a benchmarking exercise knows that the devil is in the detail as far as these clauses are concerned. If a benchmarking clause is not sufficiently robust it may not incentivise a supplier to negotiate on pricing or have the desired outcome once it has been exercised.

Clients may have contracts which do not include price revision or hardship clauses which allow one of the parties to force the other party to reconsider pricing or anticipate changes, such as dramatic changes in business volumes, an increased risk of financial distress, significant reduction of IT users, or other negative consequences following the economic crisis.

Another way to control costs is to threaten termination. For some this may not be a credible option if there are no early termination rights, unclear cancellation clauses or very significant cancellation fees to be paid in the event of termination. For some businesses in Benelux this has lead to a situation where they are locked in on long-term contracts with minimum volume commitments.

Impact on new IT sourcing projects in times of crisis

The best solution is to anticipate these issues before they occur when contracts are being drafted. The current climate has certainly led to an increased awareness of provisions that will make IT sourcing contracts 'crisis-proof'. One of the ways to anticipate future challenges in long-term IT sourcing contracts is to use unitary/transaction-based pricing regimes, whereby costs can be reduced in the event of lesser demand.

But the need to anticipate these challenges is not limited to the commercial terms and conditions. The legal terms and conditions of IT sourcing contracts have also been impacted by the economic crisis.

Clauses covering benchmarking provisions, hardship and early termination are frequently included in contracts and they enable customers to deal with emerging circumstances, provided these have been appropriately drafted. But there are many other clauses which may not have been considered for IT sourcing contracts 12 months ago, such as financial distress clauses, step-in clauses or compliance wording.

Financial distress

The lack of credit in the markets has led to a focus on provisions regarding insolvency and financial wellbeing during contract negotiations. Demand for clauses that protect the parties against financial risks often comes from the customer, but recently also from the supplier, often in the form of financial guarantees. These financial distress clauses oblige a party to report, on an ongoing basis, on its financial health. The other party may also be entitled to perform audits in order to verify these reports. Typically, such provisions will try to look beyond the officially published documents to ensure that financial problems come to light as they develop. Clauses that allow a party to suspend performance or even terminate when the financial situation of the other party raises concern, or in the event of relatively short periods of non- or late payment, are also becoming popular.

Step-in

Another provision receiving additional attention is the step-in clause. This allows the customer to temporarily take control of the outsourced services by replacing the service provider with another supplier or by performing the services itself if the service is substantially hindered, degraded or delayed as a consequence of any default or non-performance by the supplier or its subcontractors. More often than before, step-in is also seen as one of the remedies a customer could apply in the event of a supplier experiencing financial difficulties. In order to ensure continuity, the customer could decide to take away higher risk activities from the supplier.

Regulations and compliance

A variety of new regulations are expected as a result of the financial meltdown. At the recent G20 summit leaders stressed the need to improve the financial sector and systems. We can expect these changes to impact reporting and audit obligations, which may also be applied to other sectors. Consequently, drafters and negotiators of technology and business process outsourcing agreements often include clauses in their outsourcing contracts which allow changes to be made when necessary in order to comply with any legal or regulatory obligations ensuing from changes to the law. The clauses are not easy to negotiate as the parties need to define upfront who is responsible for monitoring the changes in laws, who will bear the costs and so on.

Short-term pain for long-term gain

The credit crunch undoubtedly provides new opportunities for IT outsourcing but it also has an immediate impact on existing and future outsourcing contracts. The value of a good outsourcing contract will prove itself in contract renegotiations. New contracts should be drafted, taking into account the lessons learnt by the current crisis, and aim to provide parties with enough flexibility to deal with situations of distress. Parties should, however, avoid making IT sourcing contracts less structured or strategically relevant in order to achieve short-term savings. This may result in higher financial and strategic cost in the long term. With strategic contracts in particular it is better to endure short-term pain for long-term gain.

Kristof De Vulder is a partner at DLA Piper in Brussels and Arend Lagemaat is a partner at DLA Piper in Amsterdam.