Strategies for Managing Inflation in IT Contracts

1. Identify Which Contracts Pose the Most Risk

Contracts with the highest risk profile typically have the following elements in common:

• No type of price protection clause for subsequent term renewals

• Solely pegged to an index with no other price increase protections

• Are based on annual renewal

• Professional Service contracts without rate cards

We typically see these types of agreement in the following service / category areas:

• Subscription-based services (Software as a Service, Platform as a Service, Infrastructure as a Service)

• Co-terminus software maintenance and support contracts for on-premise licenses

• Managed or outsourced services (helpdesk, application support) with annual cost of living adjustments (COLAs)

2. Prioritize Contracts with the Most Risk

Once you’ve identified those contracts that pose the most risk to the organization in terms of inflation vulnerability, it’s important to prioritize them. Priority typically is based on these characteristics:

• Renewal cycle (is the contract due for renewal this year?)

• Spend (prioritize highest to lowest)

• Spend (prioritize highest to lowest)

3. Negotiate

Once contracts have been identified and prioritized, we would recommend the following negotiation options:

• Negotiate longer terms.

  Annual contracts are risky now due to the severe yearly increases in inflation. Look to negotiate renewal terms greater than one year and leverage a longer contract term for discounts or more favorable price adjustment clauses at the end of the term.

• Itemize maintenance and support renewals.

  If you’ve co-terminated multiple software maintenance and support renewals, then look to negotiate at the line-item level. Older, more stable software titles should require less of an inflationary uplift than newer, less stable software titles. The net overall effect should be to lessen the inflationary increases by selectively applying higher and lower uplifts.

• Stagger the increases.

  As an alternative to a longer term or an itemized approach, stagger the price increase over time. As an example, stagger a 10% increase over two years, each year with a more palatable 5% increase in costs. Cap these increases at the nominal value and do not agree to tie pricing to an index.

• Negotiate improved price protection.

  For new contracts such as “as a Service” contracts, negotiate price protections for subsequent renewals. We would recommend 3% to 5% or annual change in Consumer Price Index For All Urban Consumers, whichever is the lesser. This mechanism provides protection from drastic inflationary upward price changes in future renewals.

• Leverage supplier month/quarter/year end.

  If possible, leverage end of month, end of quarter and end of year deadlines where suppliers tend to be more open and willing to make deals.

• Supplier transparency.

  Ask suppliers to show you proof of why they are asking for increases (besides CPI-U changes). For hardware, ask them to show written proof that they are taking on price increases from component manufacturers. For software, ask them for proof in terms of people or technology increases and adjustments. It’s more appropriate to apply adjustments to a supplier’s true input costs than to apply an adjustment to a total price.

• Get creative.

  Is there something you are willing to trade instead of the price increase? Perhaps reference calls or a speaking at the vendor’s next conference could be a way to barter opportunity. Think out of the box as to what you as the customer could give the supplier instead of incurring the price increases.

• Keep up to date with Economic Indicators.

  Reference the CPI, ECI (Employment Cost Index), and PPI (Producer Price Index) in all your negotiations.

4. Proactively communicate the potential impact of these increases

The potential is high to see alarming price increases in today’s market, so be sure to communicate to all leadership the forecasted increases for budgeting purposes. Executive management won’t want to be caught off guard, so it’s best to arm yourself with the data and present realistic scenarios. Additionally, you may need executives to step into some of the negotiations with strategic suppliers.

Rising inflationary pressures are forcing enterprises, IT procurement teams, and practitioners across other procurement categories to become more strategic in how price adjustments are approached and negotiated. By applying a thoughtful and innovative mindset to this environment, procurement teams can minimize the impact of inflation now and into the future.