Beware of Minimum Commitments for Outsourcing Contracts

Once upon a time, IT service providers demanded exclusivity from customers. As those early outsourcing deals wore on, clients grew weary of being locked in to a "one and only" provider. To keep their customers happy, outsourcing vendors began offering minimum volume and revenue commitment clauses, which gave customers some room to breathe while insuring a certain level of return for IT service suppliers.

Minimum commitments--which can take many forms, including revenue, service volume, or full-time employee levels--oblige an IT services buyer to consume no less than a certain level of business with the vendor, either annually or over the life of the contract. Such clauses are typically contained in a special section of the master service agreement or in the contract's pricing schedule. (See also: Outsourcing Contracts: Clause Control.)

For a time, IT executives were all too happy to sign on the dotted line, deeming minimum commitments a reasonable demand. Fast forward to today and--while IT service providers of all stripes continue to press for minimum commitments--savvy customers are pushing back.

The Drawbacks of Minimum Commitments

"There is no benefit to the customer from a minimum volume clause," says Atul Vashistha, chairman of offshore outsourcing consultancy neoIT.

Indeed, minimum requirements deter clients from seeking services from alternate providers even when the current vendor is not performing. They also make it difficult to respond to major events like business downturns, changes in strategy, and mergers and acquisitions.

"The inclusion of minimum commitments creates an underlying encumbrance that limits client flexibility," explains Marc Tanowitz, principal at outsourcing consultancy Pace Harmon.

Outsourcing providers have their reasons for asking clients to commit to a certain level of business--some more defensible than others. Minimum commitments can enable vendors to recoup upfront investments, better plan staffing decisions, and ensure a certain level of revenue or profit.

"The suppliers have legitimate concerns," says George Kimball, partner in the San Diego office of law firm Baker & McKenzie's global IT and telecommunications practice. "Pricing and margins may be based upon some assumed combination of skills, facilities and other resources that might be skewed by drastic reductions or 'cherry picking'."

For example, in large infrastructure deals where the providers are compelled to acquire significant client assets, minimum commitments are not uncommon, says Tanowitz. Outsourcing vendors are also more likely to negotiate for strong minimum commitments from a client if the contract is put together quickly with less time for due diligence, says Vashistha. Putting a floor on the minimum amount of business the deal will generate provides some risk mitigation for the provider, should the work prove more difficult or costly than it seemed.

But many of today's outsourcing deals require less significant up-front investment by the vendor, particularly application development and maintenance contracts or newer "infrastructure light" deals. Customers who place a bigger premium on flexibility see little to like in minimum commitments clauses.