Negotiating better tech contracts
A systematic, savvy approach protects bank interests
- Written by Michael Scott, Austin Associates
The rapid evolution of community bank core processing systems and auxiliary products—think mobile banking—is requiring extensive planning by management teams preparing to negotiate contracts with providers of the next generation of technology-based services.
Core systems profoundly impact all bank operations and customer service functions. Moreover, data processing and EFT costs, next to personnel, are often the highest-expense items for community banks.
Prior to entering into a negotiation process, it may be advantageous to understand the strategies, perspectives, and tactics that a vendor is likely to employ.
Getting inside the vendor’s head
Most vendors know better than bank personnel what the bank’s contract terms, conditions, and expiration dates are. They simply do this more than bankers do.
It is not unusual for some vendors to step up service levels, correct persistent problems, and provide “discounted terms” to preempt the client from entering into a contract negotiation process. In instances where service levels have been acceptable, and the bank and vendor have had minimal contact, vendors may try to “run out the clock” in the hope that a contract will automatically renew without pricing concessions.
Perhaps the greatest advantage for the vendor is a banker’s natural antipathy toward a system conversion. In some bankers’ minds, a conversion process is as uncomfortable as an unscheduled bank exam.
Compounding the decision, changing vendors may entail paying onerous early-termination fees or de-conversion charges, if applicable. (The latter is the cost to translate a bank’s files to formats that the new vendor’s technology can read.)
Regardless of a bank’s particular circumstances, there are two rules of thumb that are important to keep in mind.
Rule #1: Never accept a vendor’s initial offer, no matter how enticing the pricing may be—discounted or otherwise; and
Rule #2: Develop a negotiation plan 18-24 months before the expiration of the core system and other EFT contracts.
The advantages of these rules are twofold. First, rejection of a preliminary offer combined with notification of a negotiation process delivers a powerful message to vendors: The process will be organized, deliberative, and competitive.
Second, a substantial amount of lead time is essential to develop a comprehensive plan and process; the bank’s management team will need every bit of it to be sufficiently prepared. It also provides sufficient time for prospective conversions.
Preparing for negotiations
The first step in organizing the bank’s negotiation process is forming a committee to develop a plan that outlines essential steps, priorities, and timetables of the process. A properly structured negotiation process, in addition to consuming substantial time commitments of management, requires leadership that is attentive to detail and excels at follow-up and follow-through. Designation of a committee chair should ensure appropriate leadership of the entire process.
The selection should not necessarily be a default appointment of a data processing “expert.”
Equally important, the committee should consist of end users of the bank’s core and EFT systems—especially those executives representing lending, credit, deposit services, and marketing.
Among the initial issues to be addressed by the committee (and/or its chair) is a review of the Federal Financial Institution Examination Council Mandated Requirements describing regulations surrounding vendor management. (The requirements can be found at http://ithandbook.ffiec.gov/.) Vendor management regulations and guidelines impact the selection process prior to signing any contracts.
The committee members will need to compile a complete list of all core and core-related products and services for which a contract exists. When reviewing contracts, particular attention should be directed to termination dates and notification requirements. These should be squared against any addendum(s) to precisely determine expiration dates.
An objective of the negotiation process will be to ensure that all related contracts have coterminous expiration dates. Why? This provides the bank with the greatest amount of leverage in future negotiations.
A detailed spreadsheet with all contracts, expiration dates, costs, and other key information will help with organizing the Request for Proposal (RFP), which eventually will be distributed to potential vendors. Expenses for the core and core-related products and services should be normalized to a monthly base number to be used for comparative purposes with RFP responses.
The most vital component of the committee’s planning process is the compilation of core product offerings, usage levels, and performance data. This should be done with an eye on the bank’s long-term needs and expectations, which take into account the bank’s growth potential, business focus, customer demographics, and other strategic considerations. The committee must have exceptional insights into the bank’s strategic planning priorities.
Executive management, at a minimum, should serve in a review capacity in the information gathering process, prior to finalizing any key decisions.
While the bank may decide to limit negotiations to its existing vendors, the current state of the data processing industry provides opportunities to attain exceptionally favorable pricing and servicing terms through an open-bidding process. A residual benefit of evaluating multiple offers allows management to assess product innovations as well as service levels, in addition to pricing parameters.
For example, a competing vendor may identify a product or service approach that was overlooked by the current provider.
Getting the details in writing
The bank should issue an RFP whether the bank has predetermined to negotiate exclusively with its existing vendors or invited others into the process. (Note: An RFP also may be called a “Request for Quote,” or RFQ.) The RFP/RFQ crystallizes the bank’s needs and priorities, and presents deadlines for receiving information.
An important element of the RFP/RFQ process is designation of a single point of contact in the bank for all vendors. This standardizes the information flow and content, and mitigates “back channel” communications.
Upon submission of the completed responses to the RFP, each member of the committee should be required to review all responses and objectively rank his preferences. It is often beneficial to have each committee member present his assessments to the entire committee. Depending on the number of vendors evaluated, those that meet the bank’s initial expectations should be asked to provide an on-site presentation as well.
Hearing vendor presentations
In planning for vendor presentations, it is advisable for bankers to allocate a full day for each vendor.
The committee should prepare a detailed agenda for each vendor that delineates time limits for each item. In addition, committee members will want to prepare specific questions, in writing, to pose directly to presenters.
From a tactical perspective, the committee chair is responsible for managing the presentations, adhering to time frames and ensuring that presentations fill in “information gaps” arising from vendor responses to the RFP.
The presentations should not provide venues for sales pitches.
Negotiating through the process
Once the process has narrowed things down to two final vendors, then price and contract provisions should be negotiated prior to final vendor selection. Typically, the bank’s side of the negotiation will be handled by the point person, usually the committee chairman.
During final negotiations, don’t be afraid the walk away from a deal.
When put to it, the vendor will try to come up with a better price and better contract provisions rather than lose the sale. Remember, the bank has invested time in the negotiation. The vendor has invested time, travel, and more. The vendor wants to make the sale.
There are three items to be aware of when banks and vendors enter into contracts:
• Escalation clause—This is a contract provision that raises the price by an external index or a given percentage. Don’t take it at face value. Do the math, and see what this will entail now, and over the course of the contract.
• De-conversion clause—Again, this is the charge the existing vendor assesses to make the bank’s existing files communicate with the new vendor’s systems. Keep in mind, the work and billing will be done by someone that the bank will be saying goodbye to. (Yes, this is a little like a prenuptial agreement.)
• Length of contract—The vendor would like the bank to sign up for a long time. But can it be counted on to keep up with today’s rapid developments? Beware of contract terms beyond five years. A bank doesn’t want to be locked into obsolescence.
Coming down to “the one”
Once all presentations are completed and follow-up information—such as reference checks, service commitments, among others—have been gathered, the committee should select its vendor. Terms must be weighed against costs. The committee can’t make a selection solely on the basis of the price tag.
Prior to communicating its decision, the committee should ask the preferred vendor to deliver, in writing, all final pricing information, contract terms, conditions and language, service commitments, and other essential details. In addition, legal counsel should review all contracts prior to signing, and operations personnel should review all documents to ensure business issues are appropriately addressed.
Vendor selection and negotiation is a time-consuming endeavor that requires a broad cross-section of employee participation. A successful process is characterized by thorough planning, open discussion, attention to detail, and extensive follow-up.
Although pricing is always a paramount consideration in selecting the best vendor, client servicing, product flexibility, and vendor reliability are vital components in the bank/vendor relationship.
By Michael Scott, managing director, Austin Associates, LLC. Prior to becoming a consultant, Scott worked with various bank technology vendors. He can be reached at [email protected]
Tagged under Technology, Risk Management, Tech Management, Operational Risk,