The Bottom Line

Vendor Contract Management: Beware the Perils of Free Money

Posted by Brad Downs on Mar 8, 2017 9:00:00 AM
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For all the banking executives that oversee vendor relationships, see if this scenario seems familiar: A long-time vendor visits your institution and, unsolicited, offers a contract extension along with attractive incentives; e.g., signing bonuses, rebates, pricing discounts, etc. To date, you’ve enjoyed a solid relationship with this partner with no plans to break the contract at expiration, so this provides an opportunity to look like a hero to your institution, bringing in an unexpected windfall to fund other priorities. What could be the downside? 

Incentives to sign a contract in financial services are certainly nothing new. Historically, they’ve been more commonly deployed by vendors looking to displace an incumbent – with the incentives positioned as a way to offset switching costs and to overcome a bit of inertia in the process. In recent years, however, we’ve seen an increasing number of incumbent vendors adopt this strategy to gain early renewals and/or contract extensions.

Know Your Price and Your Value

These types of incentives can be an effective component in a well-constructed contract management strategy. It’s often a good business practice to extend your relationships early as well, particularly when there is no appetite for a change in suppliers. The problem, however, is the knowledge gap between supplier and customer in understanding what the relationship is actually worth. By the nature of their business, vendors are subject matter experts with intimate knowledge of market dynamics. By contrast, a customer with a long-term supplier relationship – especially a positive one – has little reason to stay up-to-date with prevailing market conditions.

The most relevant, available data point is that your vendor has determined your business is worth at least as much as the upfront payment being offered. By not going to bid or bringing in a knowledgeable third party for vendor contract negotiating advice, we’ve seen companies accept incentives that were less than one-tenth of what could have been earned in competitive scenarios. Don’t leave that kind of money on the table – once a deal has been signed, there’s typically little opportunity to revise it.

It’s Rational, Not Devious

Furthermore, don’t assume that all other terms of the contract remain unchanged – or that they should. Be on the lookout for any modifications that may warrant attention by asking yourself: “Has anything changed about our arrangement that might have triggered this renewal?” Conversely, have gradual changes in your business profile (increased volumes, etc.) created opportunities for more favorable terms moving forward?

A decision on whether to accept upfront incentives as opposed to ongoing pricing benefits often comes down to a calculation involving time/value of money. It’s hard to perform such an assessment, however, without an understanding of the prevailing market rate. That’s one area where the counsel of a knowledgeable vendor contract partner becomes essential.

The renewal offers being extended by financial services vendors are entirely rational. Their objective is to extend existing relationships at the highest possible margin. There is nothing devious or underhanded about this tactic – after all, according to a common business truth, it’s less expensive to retain an existing customer than it is to win a new one.

Many clients may not realize the various types of incentives that are available or how much they should expect. In a business environment where everyone is looking to cut costs and/or free up funding for new initiatives, a healthy degree of due diligence on contract renewals is imperative.

Topics: Vendor Contract Management