Negotiating Managed Network Contracts

Business Communications Review – 

Make sure responsibilities are clear and avoid “scope creep.”

Managed network services are a hot topic today. This article is intended to help users navigate the complexities of a managed network contract. The first rule is to be prepared before negotiat­ing. Gather detailed information about what it costs your company to operate and manage its networks. Know what activities (e.g.., staffing, hours of coverage) and what results (e.g., response times, uptime of 99.X percent) you get for this investment. A wise company will bring in those with hands-on experience-typically operations, technical and support teams early in the process, to detail these activities and results.

The Ins And Outs Of Scope

Managed network contracts run the gamut in terms of what is within the “scope of services.” At one end, they may include only the vendor’s equipment and management of vendor-provided transport. At the other, they can include on-site staff to maintain and manage the customer’s entire network, solicit and evaluate proposals for new services, engineer changes and optimize network usage and performance.

What is “in scope” (and the price you pay) depends on:

1.) Your needs.

2.) The vendor’s inherent skills and/or willingness to subcontract to meet your needs.

3.) The assumptions on which the vendor based its pricing.

4.) The “fine print” of your contract.

Because managed network services are “cus­tomized,” a vendor’s standard statement of “in scope” services is unlikely to meet your needs. The statement often imposes more obligations on you than on the vendor-odd, since you are the one paying. For example, the statement of work may go into great detail about your site prepara­tion obligations or your obligations regarding con­

sections to existing network management tools, yet say- little about what the vendor will do once it arrives at the site or how it will integrate its man­agement functions with your systems.

Vendor responsibilities can be defined by ref­erence to activity (the vendor will do a, b, c, d, and e) or results (the vendor will do what it takes to achieve 99.99 percent uptime). The latter are more satisfying to customers, but harder to negotiate.

Recognize that the defined scope of services is basically a snapshot-things are sure to change over time. To deal with this, the contract should require the vendor to provide services and prod­ucts that are substantially equivalent to those specifically detailed in the Scope of Work (which is usually an attachment to the contract), as well as any other services or activities that are not specifically detailed but are inherent in or sub­stantially related to those services.

Scope creep-cost increases that occur as the customer discovers that services it needs and thought were included in its monthly fee are not-is the bane of managed network deals, and fighting about it has been the death of many com­prehensive agreements. You want the contract to establish “rules of engagement” and a process to resolve whether an activity is in scope, without going to war. The rules should ensure that pend­ing resolution, the vendor is required to perform the work in question when that is necessary to meet the pressing business need. Without such a provision, you may be forced to pay whatever the vendor sees fit to charge.

The vendor will seek to impose additional charges for any activity that is not specifically detailed as “in scope” (such activity is generally referred to as “Out of Scope” services), as well as for activities that turn out to be performed more frequently than the vendor assumed when pricing the deal (often referred to as “Incremental Ser­vices”). The contract should clearly distinguish between In-Scope Services (covered by the price), Incremental Services (for which additional charges will apply for additional units), and Out­of-Scope Services, for which the price is subject to negotiation.

Don’t Let Your Commitment Throw Up A Red Flag

Ideally, a managed network contract would scale up and down seamlessly as your needs changed. Unfortunately, that’s not the way it usually works. Most vendors will try to get you to commit to a certain volume of services, based on revenue, sites and/or percentage of spend, and will impose a sig­nificant penalty (termed a shortfall charge) if you fail to do so. The question is how to minimize the chances of owing money for failing to meet a commitment.

First, make sure to keep an ample “cushion” between your expected use of services and your commitment. The vendor will push for 90 percent. Don’t buy it. You need the cushion to avoid short-fall charges if circumstances, your business or technology changes. You may also want to negoti­ate the right to close some sites without eat­ing into your cushion. Unanticipated short-falls are the biggest problem, after scope creep, in managed net-work contracts.

Second, preserve flexibility in how the commitment will be satisfied. Anything the customer buys from the vendor should count ‑ although, not surprisingly, vendor forms don’t read this way.

Third, fight the (inevitable) vendor push for exclusivity. The ability to use third parties to per-form some or all “in-scope” work will increase your leverage as your use grows beyond the com­mitment, and will give you needed flexibility to peel off services that the vendor performs in a way that doesn’t meet your standards.

Finally, make sure your contract reduces the commitment or releases you from exclusivity (if you agreed to it) in the event that:

1) there is a business downturn;

2) you sell a business unit or migrate to a new technology;

3) there are chronic service problems;

4) a force majeure condition affects the services or your ability to use them.

Avoid MACD Attacks

Moves, adds, changes and deletes (MACDs) occur with varying frequency depending on your com­pany’s propensity to “chum” people, premises and services. Lots of things fall into the MACD cate­gory, and the activities necessary to perform each differ significantly.

The “soft MACD” versus “hard MACD” dis­tinction is fairly well understood-the latter involves a site visit and physical manipulation of cable, the former is performed at a keyboard from

a distance. But even within these categories there are differences-some subtle; others larger. The contract must properly address these distinctions, as MACDs are generally billed per: occurrence based on type (at least when their frequency exceeds the contract allowance).

For example, vendors often distinguish at a high level between soft and hard MACDs based on whether the activity can be performed remote­ly. If it can’t, the activity falls into the hard MACD category. Within the hard MACD category, the vendor may propose different types of hard MACDs-such as those that require specialized engineering skills as opposed to those that simply take significant staff hours-but the list is unlike­ly to detail all of the types of hard MACDs your employees routinely perform.

Negotiate with the vendor to get a complete list, with specific exam­ples. Then check the vendor’s price propos­als based upon your knowledge of the time and expertise needed to complete the activi­ty, and push for a price that reflects the aver-age expertise and hours needed for a task-not the worst-case scenario.

Hardware/Software Concerns

Hardware and software are among the most diffi­cult-and most important-issues in a managed network contract. The parties’ rights and responsi­bilities with respect to equipment (including both hardware and software) must be well defined. Who will provide the equipment? Will the vendor manage third-party equipment? Will it cost more if the vendor can’t manage the hardware with its existing systems? Is the equipment lease cost bun­dled into the monthly fee or separately stated? If you are purchasing the equipment, are there appropriate warranties covering defective equip­ment and software during a reasonable warranty period?

If the vendor will lease the equipment, expect them to seek ways to minimize the risk associated with their up-front investment, such as by impos­ing required “in-service” periods-i.e., the time that you are committed to pay for the equipment or bundled service-or requiring you to buy out its lease even if you have terminated the underly­ing agreement for default.

Resist any obligation to pay the full monthly recurring charge for the provision of service to a terminated site for the remainder of the in-service period. Instead, consider an appropriate “stranded asset charge.” If the vendor does not sell the equip­ment, ask the vendor to store the equipment for future use in your network. And you should never pay such charges if you terminate a site or de-install equipment for the cause.

If the vendor will manage your existing or third-party equipment, understand how. Vendors often want to limit their hardware monitoring and management responsibilities to stuff they can monitor remotely using their existing monitoring software. If your hardware doesn’t fall into this category, vendors will seek to impose significant upgrade or retooling costs. Don’t be caught off guard. These types of costs are often disguised when the vendor gently refers to the customer tak­ing the responsibility for additional third-party costs caused by this requirement.

Include provisions that require the vendor to upgrade or replace software and hardware within the Scope of Services. Contracts often distinguish between routine and “forklift” upgrades and require the vendor to keep software at, say, an n-minus-1 release level over the contract term at no additional cost. You

may also want the vendor to provide upgrades to remain in compliance with your company’s technology standards and to fix software bugs that threaten the network without specifically affecting network per­formance (e.g., securi­ty breaches). Software upgrades can lead to hardware upgrades if the software is not support­ed on the existing hardware. The’ key issue is never: Can you get the hardware and/or software upgrades, but: Who pays? And that is subject to negotiation.

Vendor software licenses are particularly odi­ous and frustrate your use of the software. They often grant only a personal, non-transferable, right to use the software “for internal purposes only” and permit you to make one copy of the software, but prohibit you from modifying or sublicensing it. You can’t assign the licenses to successors or affiliates or sublicense it to an outsourcer; you have to buy more. You can’t make a reasonable number of copies as part of your routine backup processes, or disaster recovery or staging environ­ments. You are exposed to breach of contract and intellectual property infringement liability if you customize, enhance or create unique interfaces to the licensed software.

All these considerations severely interfere with your ability to maintain or hire another vendor to maintain, the software and related equipment. The scope of your licenses should expressly allow you (and your designated users) to use, copy, access and (if necessary) modify the software as part of the managed infrastructure in support of your requirements during and, if you purchase the equipment, after the expiration of your contract with the managed service provider.

Intellectual Property Matters

Determining who should own what intellectual property is also a key issue in managed network contracts. Each party retains intellectual property rights to its “pre-existing work”-stuff that it owned or created before the deal-but may have to grant the other a limited license so the vendor can provide and you can receive the benefit of managed services. This is usually accomplished with a pair of clauses-one acknowledging that a party retains ownership of its pre-existing work and another prescribing how the other party can use that pre-existing work.

Ownership rights in “developed works”-stuff (e.g., custom interfaces, written materials, busi­ness methods or databases) created during the term-is challenging, and the permutations are numerous. Three princi­ples help frame the negotiations:

• You should own all developed works, in­cluding all data, derived . from your pre-existing works. Likewise; the vendor should be free to commercially exploit developed works it derives from its pre-exist­ing works.
• You should have very broad rights (either as the owner or perpetual licensee) to use, copy and modify developed works created by the vendor for you on a custom basis.
• Your rights in a developed work should survive expiration or termination of the deal if the developed work is part of a system you will continue to use.

Information Security Guidelines And Audits

Information security is also of great concern in managed network deals, especially where the ven­dor controls your technical security measures. At the highest level, the vendor should abide by your information security guidelines, not its own.

The vendor should also cooperate with and assist you in your vulnerability assessments and security audits and should share information about the effectiveness of its security policies. Your abil­ity to comply with Sarbanes-Oxley and data pri­vacy laws depends heavily upon these things (see BCR, October 2004, pp. 39-43).

Smoothing The Implementation

Moving to a managed network can be demanding and sometimes difficult. Vendors try to delay specifics about implementation until after the contract is signed. Don’t go along with it. Where time permits, include a detailed project plan and schedules for the transfer of network and operational functions and employees to the vendor in the contract. If time is short, include an outline of key activities and dates, with an obligation for the parties to complete the detailed project plan shortly.

Either way, make sure the vendor has incen­tives to meet the key deadlines by including reme­dies for its failure to do so. Finally, make sure you are kept abreast of how the implementation is pro­gressing. Require the vendor to provide progress reports and meet with you on a weekly basis as part of its in-scope work.

Managed Network Rates

Managed network rates are complex and, like the scope of work, run the gamut. There are a few general areas of concern. First, look out for the Con­sumer Price Index (CPI) rate escalators, and get rid of them. They mean you take all of the infla­tionary risks instead of the vendor building that risk into its business case and they take no account of ongoing productivity gains, which are substantial.

Second, get pricing that is sufficiently granular to let you scale up and down and change services at a predefined cost. Finally, seek an equitable reduction to your rates if certain events (such as de-installation of a site for cause or a business downturn) occur.

Keeping Rates Competitive: The best ways to keep a vendor on its toes with respect to rates is to let your sales rep know you will move services currently provided by the vendor to a competitor or to put the business out for bid as the term draws to a close. Of course, your sales rep must believe you. Bolster your position by:

1.) keeping the contract term reasonably short;

2.) keeping a large “cushion” on your commit­ment; and

3.) avoiding exclusivity.

Rate reviews are also an important tool. From the vendor’s perspective, rate review in a managed network contract is problematic because the pric­ing involves a significant labor component, and the cost of labor generally goes up, not down (that’s where the CPI escalators come from) and you will want a rate review that effectively permits only downward price movement.

A vendor will, however, typically offer what we call a “we’ll talk” clause. Some customers treat such a clause as a vendor concession that their CFO will love. But on careful reading, these clauses offer nothing more than a conversation-the vendor agrees to talk with you about prices, but not to change them unless it feels like doing so. Instead of a “we’ll talk,” seek a rate review mechanism with “teeth.” The best rate review pro-visions trigger reductions in the commitment if the parties are unable to agree on appropriate rate modifications, thereby giving the vendor a greater incentive to keep prices competitive. This type of rate review provision, however, is very difficult to get in managed network contracts.

Vendor Cooperation With, And Management Of, Third Parties

Although certain of your networking equipment may be “out-of-scope,” the vendor will need to cooperate with you or a third party help desk-to troubleshoot problems. At a minimum, you will want a clause in the contract and/or the Statement of Work that requires such cooperation.

The contract may also appoint the vendor as your agent for the purpose of managing third parties such as equipment maintenance providers. If it does, require the vendor to monitor, direct and supervise the performance of these third parties, to seek available service level agreement (SLA) credits and to enforce assurances of performance.

The vendor-especially if it also provides transport services-will likely resist taking responsibility for managing third-party transport providers. You needn’t bother asking most trans­port-focused vendors to manage one of their com­petitors as your primary carrier-the vendor will not agree to assume this responsibility, and if it did, the problems of such arrangements outweigh any conceivable benefits. For one thing, the ven­dor may not have the tools to monitor and trou­bleshoot the services provided by third parties. For obvious reasons, competing transport vendors also don’t like each other, which means that having one manage another quickly turns into a finger-point­ing festival, severely degrading the value of the network management you are purchasing.

That said, you may need the vendor to manage a limited number of third-party transport providers in situations where the vendor does not provide the service to a particular site, or where the vendor provides the service, but not at com­petitive prices. This issue can be negotiated, but understand that the vendor will want to limit the scope of its services. Be prepared to make com­promises to get what you need.

Term

Vendors typically seek longer terms for managed network contracts, usually 5+ years, than you are used to with telecom deals (which typically run no more than 3 years). The vendor’s reason is the need to recover upfront capital expenditures.

Don’t fall for it. Even in the best deals, a ven­dor will get some combination of termination charges and/or stranded asset charges and/or shortfall charges if a deal ends early. These should adequately protect the vendor’s investment, espe­cially if combined with a high commitment and/or exclusivity. Also, keep in mind the term of your underlying telecom contract(s) the vendor will manage. Try for a term that is coterminous with your telecom contract(s), or four years, whichever is shorter.

Termination Rights And Transitions

While no one buys a managed network expecting it to fail, you need to be protected should that occur. Most vendors won’t offer specific rights to terminate the contract without termination liabili­ty. Their form contract will apply a termination charge if you terminate the contract for any rea­son, including the vendor’s material breach, before the end of the term.

If you are lucky, the vendor may offer you the right to terminate without liability if it materially breaches the contract, but will give itself a 90+ day period in which to cure the breach. The proposed termination charges will be sky-high (along the lines of 100 percent of the vendor’s expected charges over the remaining term plus unidentified equipment costs and third-party costs). They should instead be based on the vendor’s un-amor­tized investment plus a small profit.

Finally, if you terminate the managed service contract or the separate unmanaged telecom transport contract, you don’t want to be stuck using the same carrier to provide half of your needs-the unmanaged tele­com transport without the managed services or vice versa. Try to include clauses in each contract that permit you to terminate one contract without liabil­ity if you terminate the other for a cause.

SLAs

Your contract should include meaningful metrics-aka service levels-tailored to your operating environment and needs. Carefully review the vendor’s proposed exclu­sions from calculations of its compliance with the service levels. Good service levels become bad when swallowed by broad exclusions. For exam­ple, if unscheduled maintenance is excluded, there is effectively no service level.

The contract should also require the vendor to provide regular reports on actual performance against the service levels, and service credits when performance falls below key service levels. Ser­vice credits in a managed network contract are likely to fall far short of compensating you for the costs incurred when you experience service level failures, and trying to fix this is, frankly, a waste of breath. It’s much more effective to keep a fat cushion in terms of commitment, and move (or credibly threaten to move) services that are not performing.

That said, if performance is a priority, you should get better than what the vendor initially offers. For example, the vendor’s initial offer will likely make its obligation to grant service credits contingent upon your reporting an outage and requesting a credit within a very short period after the trouble occurs. In a managed network deal, management is key and part of that should include the vendor’s responsibility for proactively posting service credits to your account.

Finally, the service levels should include par­tial termination rights and associated commitment reductions in the event of chronic problems-and the definition of chronic problems will be critical.

Transition Support

At the end of the term, the contract should require the vendor to provide assistance in the transfer of management services back in-house or to a suc­cessor manager. The “transition” period may run six to nine months depending upon the time you need to complete the transfer.

During the “transition” period, the contract pricing, terms, and conditions (other than any rnin­imum commitments) should continue. Without this, if you get near the end of the contract the ven­dor will try to force you to renew by threatening you with large price increases that will take effect the day your contract ends. MCI is famous for doing this, but it is not alone.

Conclusion:

Negotiation Advice First, when consider­ing moving to a managed network, cus­tomers typically un­derestimate the time required to prepare and release an RFP, evaluate proposals and negotiate the contract. Too many customers think that it can reasonably take six months to prepare an RFP; three months to get back and evaluate bids, and then three weeks to negotiate a 100-200-page agreement and attachments.

That’s silly and plays into the hands of the vendor, who will urge you to sign early if you are negotiating from its forms (which will be the case in all but the largest deals). Be realistic about time frames. While there is nothing wrong with setting reasonable deadlines, make sure the vendor understands that you are in control of the process, so that deadlines don’t work against you.

Second, try to settle on the key business terms before exchanging contract drafts – ideally, before you have winnowed down to one bidder-but bring lawyers in early to review the business terms and help you spot critical details. Issues will arise that you did not foresee, but having a reasonably comprehensive agreement on the business terms before drafting begins will save you time and expense in the long run.

Finally, present a united front. If management and your negotiating team each sends different signals to the vendor, your bargaining leverage will be undermined.