The centralisation of procurement, tighter spending controls, and more strategic views on supplier management have led large enterprises to reduce the number of their IT-vendor relationships by an average of 20%. Building the right relationship with the right supplier is more important than ever for today’s CIO.

Any relationship begins and ends with the strength of personal relationships that are forged, but he says that the culture of a relationship really needs to transcend individual behaviours to permeate across every interaction point from CIO level down. In this context, the services contract provides a view of the level of shared understanding of the different but related needs of each of the parties.

The framework the contract provides is key to aligning the goals of the relationship and should be seen as a means of protection against bad behaviours. It also provide some terms of reference that help build continuity of service for key individuals, be they an account director, a CIO or an IT executive. It takes on special relevance in the case of contracts that are outsourced over a long period.

Cynics argue that suppliers promote longevity into the sourcing agreements simply as a means of protecting a revenue stream.

A vendor will argue that the closer, over time, they get to understanding the real needs of their customer, the more likely it is the vendor becomes strategic to that customer and a partner that is able to innovate and drive added value.

Equally, customers who are prepared to get close to specific vendors can play a role in the commercial futures of their supplier. By indicating their preferences, wants and concerns they can help direct the product development and product acquisition plans.

CIOs often talk about wanting to implement ‘risk and reward’ mechanisms in their IT services or outsourcing relationships, and depending on the level of trust this may be in the form of risks which include a “penalty” payment for underperforming and the rewards include a cash bonus for over performing. But the more successful risk and reward mechanisms tend to focus on output metrics rather than input metrics.

So, instead of focusing on traditional input service levels such as system uptime, it may be more appropriate to measure the number of orders or processes handled by the system in a particular measurement period. Output metrics tend not to be within the end-to-end control of the service provider – for example the number of customer orders processed by a system will depend on customer demand, as well as the effectiveness and efficiency of the system. Output metrics, therefore, require a more collaborative approach between the parties.

In reality, the only risk that a service provider is often willing to take in these circumstances is the “risk” of not being paid a bonus. If a customer is able to persuade a service provider to accept a penalty for failure to meet business outcomes, it must, if possible, look carefully at the service provider’s risk pricing to ensure that any potential benefit to be derived from the penalty regime is not outweighed by the service provider’s conservative risk premium.

Transformational risk and reward mechanisms take the collaborative approach to the next level. They measure the success of major transformational projects and align incentives with enterprise-level outcomes such as market share or return on capital. The transformation might include the development of a new IT platform to support a new line of business or product.

Over time, technology and outsourcing solutions will develop, allowing outsourced activities to be undertaken more efficiently. The service provider should therefore be under an obligation to inform the customer of such improvements, together with details of opportunities to increase the customer’s revenue or reduce its cost base. This can be done at a regularly scheduled improvements meeting or on an ad-hoc basis.

In order to provide an incentive to the service provider to propose actual and realistic improvements, the customer could require a certain number of improvement proposals per year or require the service provider to build a certain number of improvement man-days into the services charges. It could also consider including a form of gain-sharing mechanism to address how reductions in costs or increases in revenues can be apportioned between the parties. If both parties derive some benefit from improvements, the service provider may be more likely to suggest them.

One prevailing view is that a shared values, shared risk and shared benefits approach is the best means to underpin a proposed partnership. At its most extreme is the joint venture relationship, where all profits and all losses are shared between partners in equal measure.

However, there is a clear consensus view that the strength of a relationship becomes very clear once a partnership has lived through some pain. A customer that experiences a well-recovered problem is very likely to become a more loyal customer.

Nick Kirkland, Managing Director of CIO Connect