Fund innovation with new techniques to harden your existing contracts

Harden your contracts to redistribute risk as your organization grows.

Are you responsible for hiring? Do you hire contractors and consultants? Are you trying to determine how to eke out the best discounts and deals as you bring in new contractors while still maintaining a team of high-quality staff? You’re not alone.

Hi, I’m Peter Nichol, Data Science CIO.

Today we’re going to talk about some techniques for contracting more effectively with your partners and your strategic vendors.

You’ve likely heard about server hardening. This is a set of disciplines and techniques that improves the security of an “off the shelf” product, system or device. Here we’re also talking about hardening, but applying it to contracts. Contract hardening is the process of tightening existing contracts to distribute risk more evenly across all parties in the contract versus an uneven distribution of risk.

I’ll walk through several examples of how to specifically modify contracts to provide a more significant advantage to the organization as you start to grow and expand. I’ll also share some contract-hardening techniques that I’ve recently applied to organizational contracts. You might find them useful as your organization expands.

Rebates or discounts

The rebate is a discount based on net spend. This concept is founded on the principle that as the net volume—or value of executed contracts—increases, the client should receive a discount.

This might initially be a small amount; for example, 1% or 5% of the total contract value. The actual percentage will depend on the vendor’s markup and margins. However, essentially, if you, as a client, spend $1 million versus $5 million versus $10 million, you should get back some percentage of that net spend. Over time, it will add up. At first, 2% might only be $100,000, but it will increase with net spend to $400,000 quickly. When multiplying the rebate percentage times a dozen or more vendors, the rebates add up to millions of dollars avoided.

In addition, this rebate clause allows you to have dollars to reinvest in critical business operations; i.e., innovation or pursuing other enabling technologies that were previously unfunded.

Boomerang clause

The boomerang clause prevents contractors from rejoining the organization at a higher bill rate. Often contractors will be engaged for short durations—six or nine months. On occasion, these contractors will leave the organization for new opportunities. When a new opportunity at your organization looks better than their existing engagement, they’ll be rehired six or nine months later at a higher rate. For example, a contractor might have initially joined the team at $150/hour and was later rehired at $180/hour, or they joined at $100/hour and were rehired at $125/hour. In both cases, the company is paying more for the same resource with the same skills and capabilities.

The intent behind the boomerang clause isn’t to prevent rehiring good staff. The objective is to ensure that just because a new consulting or staffing company represents the consultant, we, as the client, aren’t overpaying for services rendered.

This clause prevents consultants from being rehired within six months at a higher rate. It doesn’t matter who’s representing the consultant or contractor; the rate can’t be increased if it’s within those six months. As a client, we don’t care what the margin or markup on the consultant was or will be with the new vendor. This clause prevents the client from increasing budget forecasting for similar resourcing; e.g., to prevent overbilling a contract.

90-day turnover

The 90-day turnover clause ensures that recruiting companies always place the best candidates at the client site. The idea behind this clause is to incentivize strategic partners to provide the best talent possible.

It’s not uncommon for vendors to feel pressure to place candidates and maintain billing tables. As a result, these vendors suggest and eventually place contractors at client sites that aren’t a great fit. Vendors, of course, want those contractors to bill forever. However, because of executive pressure and how contracts are written, they’re indirectly encouraged to place contractors into organizations where they know the fit isn’t ideal. This results in high turnover in those hard-to-place positions.

Who suffers when contracts don’t last more than six to 12 weeks? We, as the client, do.

There’s usually no negative impact or financial penalties for a recruiting or staffing company placing resources that turn over or leave the company. However, as clients, we’re required to pay for new training and the business impact resulting from gaps in resource coverage.

This clause shifts the burden onto the recruiting company to ensure they place resources they believe are the best fit for the organization. This contract states that if a contractor turns over (leaves for any reason) within the first 90 days, the recruiting company must pay for the transition costs. This transition could be two weeks or four weeks. The client is paid in credit for transition-services penalties. This is commonly a credit for total contractor billing (less expenses) through the first 90 days of service. This clause incentivizes recruiting companies and vendors to provide candidates that meet the qualifications and will be a good fit with the organization—not just a temporary fit.

Right-to-hire

The right-to-hire clause removes unnecessary fees when converting contractors to employees. Typically, contracts have clauses specifying that the client will pay either a one-time payment or a percentage of the annual salary for any contractors hired. That one-time fee might be equal to one year’s salary.

Alternatively, the fee can be a percentage—25% to 40% of base salary is standard industry practice. Generally, this is a reasonable vendor ask. However, when companies are experiencing a period of high growth, these fees become excessive.

With this clause unmodified, every time the client converts a contractor to an employee, the client pays a 25% fee. This fee is typically between $25,000 and $75,000 depending on the base salary of the incoming contractor. The occasional conversion fee is high but digestible. However, once you’re converting 10 to 15 resources a year, these fees become ridiculous. Imagine converting 15 resources and paying $600k in fees.

This clause places a cliff on the right to hire. The amended clause states that any resource engaged for longer than six months will have no conversion fee. If the contract is converted between one month and six months, there’s a declining percentage specified by a rate table. For example, if a resource is converted within one month of engagement, the client pays a 15% conversion fee; however, if the resource is converted after five months of engagement, that fee is 5%. Then, of course, after six months, there’s no conversion fee.

Recovery of assets

The recovery-of-assets clause shifts the responsibility for recovery risk from the client to the vendor. The contractor, at the end of the engagement, will have a laptop and additional peripheral devices such as mice or keyboards that must be returned to the client. As a client, it’s challenging to be responsible for chasing down these individuals to recover our assets. So, who’s in the best position to recover those assets? Of course, the vendor is in the best position because they hold the contractor’s last paycheck.

This clause shifts the burden of responsibility to recover borrowed assets from the client to the vendor. If, by some chance, assets aren’t recovered within 15 or 30 days, there’s a penalty assessed to the vendor.

Contract hardening

To capitalize on the growing purchasing power of expanding organizations, leaders must harden their staff-augmentation contracts and strengthen their contracting language. I’ve identified additional examples—which I’ve implemented across organizations—to decrease liability, reduce risk, and lower the total cost of services.

  1. Client rebates: This provides a rebate of 1% to 5% based on annual services billed less tax and travel.
  2. Boomerang rehire programs: This clause prevents resources from leaving the company and being rehired at elevated rates within six months.
  3. 90-day turnover: This clause transfers vendor financial risk for hired resources that leave before 90 days. In this case, the vendor would pay for the markup over the direct rate to the resource and the cost of transition or a new resource.
  4. Rolling off: This clause provides the company with the right to remove resources without cause. This ensures we have the best and brightest at all times.
  5. Right to hire (temp to perm): Previously, companies paid 25% of the base salary to convert a given resource. This starts the conversation at 15% and moves quickly to a cliff at six months, at which time conversion is free. Additionally, I normally cap the max conversion fee at $30k from a previously unlimited value based on salary.
  6. Insurance requirements expanded: Often master service agreements don’t specify insurance terms. However, terms should be specifically articulated to include dollars of coverage for  general liability, professional liability, umbrella policy, worker’s compensation, and a crime policy shifting risk from the company to the agency.
  7. Recovery of assets: This clause transfers risk to the recruiting agency to recover company assets (laptops, mice, keyboards, etc.) because they’re in a better position given that they hold the final paycheck for the resource.
  8. New rate card: This clause shifts rates from blend or average to a rate card to specifically call out service standards and expectations based on rate tiers. For example, if resources are from Eastern Europe, they’ll have different rates than resources sourced from South America.
  9. Contract structure: This is a general cleaning and removal of duplicate references to the final contract not-to-exceed amounts. Duplications of the contract value create the additional risk of signing an error-ridden contract.
  10. Reporting: This is a clause to add mandatory reporting of resource progress to ensure accountability and delivery of services as expected; i.e., reporting out on SLA, BLA, or quantified objectives.
  11. Public announcements of contract: This clause protects the company’s right to privacy by not publicly announcing the granting of staffing contracts while requiring written permission to use the company brand.
  12. Simplified schedules: This combines the billing schedules for multiple resources; i.e., project manager and business analyst. This unified schedule allows greater flexibility to simplify contract invoice processing.
  13. Fixed hours: Normally, contracts include annual hours estimates; e.g., 2,080 hours and the possibility of allowing for overtime. Alternatively, this clause starts with working hours in the year and then removes holidays and two weeks of forced vacation for contractors to recover and recharge during the year. The result is a much more reasonable number of hours estimated to be billed for the current year.

Take time before you recontract to consider how risk is distributed within your contracts.

  • Are you taking on too much risk?
  • Do vendors have the right incentives to perform?
  • Is there an impact if those performance measures aren’t achieved?
  • Do both parties benefit when growth occurs, and are both vulnerable to a negative impact when contractions occur?
  • Is there reasonable coverage in the event actors work the system?

Consider revisiting existing contracts before blindly resigning to existing terms. By putting in place these contract adjustments, you’ll start to optimize your contracts and change the risk to be weighted in your favor.

Then, as your organization grows, make sure your contracts reflect that additional buying power.

If you found this article helpful, that’s great! Also, check out my books, Think Lead Disrupt and Leading with Value. They were published in early 2021 and are available on Amazon and at http://www.datsciencecio.com/shop for author-signed copies!

Hi, I’m Peter Nichol, Data Science CIO. Have a great day!

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Peter is a technology executive with 19 years of experience, dedicated to driving innovation, digital transformation, leadership, and data in business. He helps organizations connect strategy to execution to maximize company performance. He has been recognized for Digital Innovation by CIO 100, MIT Sloan, Computerworld, and the Project Management Institute. As Managing Director at OROCA Innovations, Peter leads the CXO advisory services practice, driving digital strategies. Peter was honored as an MIT Sloan CIO Leadership Award Finalist in 2015 and is a regular contributor to CIO.com on innovation. Peter has led businesses through complex changes, including the adoption of data-first approaches for portfolio management, lean six sigma for operational excellence, departmental transformations, process improvements, maximizing team performance, designing new IT operating models, digitizing platforms, leading large-scale mission-critical technology deployments, product management, agile methodologies, and building high-performance teams. As Chief Information Officer, Peter was responsible for Connecticut’s Health Insurance Exchange’s (HIX) industry-leading digital platform transforming consumerism and retail oriented services for the health insurance industry. Peter championed the Connecticut marketplace digital implementation with a transformational cloud-based SaaS platform and mobile application recognized as a 2014 PMI Project of the Year Award finalist, CIO 100, and awards for best digital services, API, and platform. He also received a lifetime achievement award for leadership and digital transformation, honored as a 2016 Computerworld Premier 100 IT Leader. Peter is the author of Learning Intelligence: Expand Thinking. Absorb Alternative. Unlock Possibilities (2017), which Marshall Goldsmith, author of the New York Times No. 1 bestseller Triggers, calls "a must-read for any leader wanting to compete in the innovation-powered landscape of today." Peter also authored The Power of Blockchain for Healthcare: How Blockchain Will Ignite The Future of Healthcare (2017), the first book to explore the vast opportunities for blockchain to transform the patient experience. Peter has a B.S. in C.I.S from Bentley University and an MBA from Quinnipiac University, where he graduated Summa Cum Laude. He earned his PMP® in 2001 and is a certified Six Sigma Master Black Belt, Masters in Business Relationship Management (MBRM) and Certified Scrum Master. As a Commercial Rated Aviation Pilot and Master Scuba Diver, Peter understands first hand, how to anticipate change and lead boldly.