The Bottom Line

When is the Right Time to Start Vendor Contract Negotiations

Posted by Russ Bourne on Mar 15, 2017 9:00:00 AM

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The typical financial institution has dozens of contracts in place with numerous vendors that support its operations (both customer-facing and internal). As a result, staying on top of the expiration dates for all of those agreements to maintain an effective renewal process can present a significant challenge. At a minimum, doing so is simply best practice, but in other cases, such due diligence may also be a regulatory requirement or a board mandate. 

So how long before a contract’s expiration should the negotiation process begin? The answer depends on many factors, including the service in question and the length of time moving to a different (new) vendor would require. One factor that should not come into play, however, is the level of satisfaction with your incumbent. The deck is stacked in favor of the vendor in many ways, so financial institutions (FIs) must seek out leverage points wherever they can. 

In many cases, considering a replacement of an incumbent vendor is a non-starter as it would require a protracted process encompassing both internal disruption and detailed customer communication. Swapping out a core system can easily require two years, not including the additional year that’s typically necessary to carry out an effective Request for Proposal (RFP) process. Any vendor worth their salt is going to have its own tickler list, and an FI should expect to hear from them (on average) roughly 18 months prior to a contract expiration date, if the institution hasn’t already initiated conversations. This timing is by design – if negotiations haven’t begun at least two years before the contract expires, an FI’s leverage is limited as the incumbent is quite aware of what an alternative will require.

Practice Your Poker Face

This isn’t to say that bankers should always orchestrate an RFP, spending everyone’s time in the process, if they are satisfied with their current supplier. There are other ways to foster an appropriately competitive environment. It’s always a good idea to begin with the incumbent – particularly if you are pleased with the existing relationship. Merely doing the necessary analysis of options often offers an ideal opportunity for a frank, constructive exchange regarding the relationship and pricing.

With so many contracts in play, it’s also advantageous to take a more holistic approach to a contract renewal strategy. Given the ongoing trend of industry consolidation, it’s quite possible an institution has multiple contracts with a single vendor – all with various expiration dates. Moving these deals to a coterminous state both helps to clarify the relationship and improve the bank’s leverage to obtain the best possible deal. Similarly, non-incumbents may already have contractual relationships for adjacent products – again improving an FI’s leverage.

Embrace the Educational Moment

While it can be time-consuming, vendor evaluation can also serve as a valuable education process as an opportunity to better understand a rapidly evolving market. This is where a contract management partner can be of great value in facilitating the process – whether it’s for a full RFP or a more tactical due diligence. A subject matter expert negotiating numerous contracts in a year will certainly know more about industry nuances than an in-house resource diving into the topic once every 3-5 years. With the connections in place to arrange meaningful conversations with properly positioned contacts, such partners can also save time compared to an internal project manager who has a full-time job of a different sort most of the time.

Because switching costs for financial services applications are typically very high, this creates a significant barrier that favors the incumbent. This underscores the importance for FIs to make the best decision – and strike the best possible deal – when vendor relationships are first initiated. Incumbents have various strategies to deter financial institutions from the starting early and doing a comparative review of their position.  For example, in a recent post we discussed the perils of “free money”– offers of a signing bonus from an incumbent to secure early renewal. Although such proposals are not inherently bad, they’re an implicit acknowledgement that a vendor values your relationship at a rate higher than its stated terms. Armed with that data point, it’s only logical for a financial institution to research the true value of its business.

Topics: Vendor contract negotiation