Building a Better Contract

Richard Malone couldn't believe his eyes when he read the fine print on a software contract he was negotiating.

A small European vendor expected his company, St. Louis-based Edward Jones, to pay $500 each time it called the vendor's helpdesk paging system after business hours. Should a technician be found, the vendor would also tack on an hourly rate for the technician's time between 8 p.m. and 8 a.m.

"They're trying to incent you not to call," says Malone, principal and CIO at the financial services firm, which juggles some 200 vendor and supplier contracts annually. His team eventually negotiated away the $500 fee, and the two parties agreed on a reasonable flat rate for service.

Such unpleasant surprises are common in the fine-print world of service contracts, where each new paragraph provides an opportunity to inflate costs, deviate from desired results or even cause legal troubles down the road.

But it doesn't have to be that way. When it comes to contracting for information technology, "it's a buyer's market out there," says Julie Giera, a vice president at Cambridge, Mass.-based Forrester Research. "The educated buyer has the upper hand," with the key word being educated, she adds. More than half of all IT contracts that are signed don't take advantage of key negotiating points, according to a 2004 study by Forrester. Even small businesses "have more negotiating power than they think," she says. "Often, these small companies feel like they are stuck. But they should recognize that even the very large vendors are trying to break into the small-business market."

Which parts of a contract are open to negotiation? Just about all of them. "The typical salesmen always come in with their standard contracts, which specify delivery times, prices, payment obligations and other terms. These provisions sometimes relieve or insulate the seller from liability for late deliveries, product defects or service claims" says Robby Birnbaum, an attorney with the law firm of Greenspoon Marder Hirschfeld Rafkin Ross Berger & Abrams Anton in Fort Lauderdale, Fla. "The truth is that it's all totally negotiable." Birnbaum and his firm help many small- and medium-sized businesses negotiate IT contracts.

Right-Sizing the Price

Price is one of the obvious points to negotiate. Giera says small buyers need to do their homework to find out what other companies have paid. There are benchmarking sites on the Web, such as The Benchmarking Network (www.benchmarkingnetwork.com), where members can share such information.

Next, consider the length of the contract. "Vendors will always trade a lower price for a longer term," notes Giera. And if buying hardware—the price of which typically drops over time—ask for "forward pricing," she adds. That means that over a three-year contract, for example, the price will drop by 5 percent next year and 10 percent the following year.

As a general rule, hardware gets cheaper but labor costs can rise dramatically. So sometimes there is a price escalation clause in a long-term contract. Beware of annual price increases and how they're calculated.

"We try to negotiate those out of the contract," says Malone of Edward Jones. "You're signing an agreement for 'X' number of years. When it comes up for renewal, then you go back to the table; that's the time to make adjustments. But these automatic escalators—I get real nervous with those."

Signed, Sealed . . . and Delivered?

It's important to include specific details about delivery in the contract, says Birnbaum, such as who is responsible for delivery and what happens if the product is damaged in transit. Birnbaum often sees legal problems surrounding delivery because an expensive piece of hardware is delivered damaged and the responsibility has not been spelled out in the contract. "As for IT services, unclear contracts relating to systems compatibility, maintenance and ongoing service issues often underlie the disputes we see," says Birnbaum.

"Look at liability," says Loreen Tabbut, vice president of information services at Calpine Corp., an energy company in Folsom, Calif. "A lot of times, the vendor doesn't want to have any liability. We make sure the liability clause is equitable between the vendor and the client should something go wrong," she explains.

And make sure the contract has an indemnification clause, which holds the customer harmless against any legal actions placed on the vendor. This is especially important in software agreements where open sourcing is involved. "No one owns Linux," says Giera. "Open source is not mature, and small businesses have to ask for this and be careful."

At Arrow Electronics Inc., software contracts always include broad coverage of intellectual property indemnification. "Contracts typically look to limit [indemnification] to U.S. copyright and patents. We won't allow that because copyrights are extra-territorial," explains John Fafian, manager of strategic sourcing at the Melville, N.Y.-based company. The Berne Convention, an international treaty that standardizes basic copyright protection among 100 countries, gives authors in other countries the same protection as it does in the author's own country. "Someone with a copyright in the U.K. can enforce it here," Fafian says.

Overall, the best way to avoid contract pitfalls is to include all the right people in the process—not just the sourcing person, Fafian concludes. "Include the IP person, business, risk and insurance, and a legal person. You have all the pieces covered."