Negotiating professional services

When licensing software beyond the shrink-wrapped applications, there are typically five negotiation areas: license fees, annual support fees, professional services, travel and living, and training.

June 21, 2011
by Phil Downe


Ten years have passed since my first article for Purchasingb2b in 2001. Not much has changed since then.

When licensing software beyond the shrink-wrapped applications, there are typically five negotiation areas: license fees, annual support fees, professional services, travel and living, and training. Let’s focus on professional services (PS) over an implementation period where the buyer needs the vendor’s help (or a certified third party) to configure the software. Beyond the “activate/de-activate” functionality, there’s also a need to build interfaces with the existing in-house systems.

The specifics of how the buyer wants the new application to work is detailed in the request for proposal (RFP) as a statement of work (SOW). The vendor’s response usually comes as a systems implementation plan in MS Project, detailing the timeline and tasks from kick-off to post go-live tuning support.

You want a fixed price, but there’s no possibility of that without fixed specification. Before you start writing a RFP you must get your subject matter experts (SME) working on the SOW. Ten years ago you’d be lucky to find anyone with a well-defined process document for the existing system, let alone a detailed version for how the new system would work. Even today I see internal process documentation lagging behind the active system.

Your vendor bids a fixed price—based on their interpretation of the SOW—then adds a healthy contingency, or they bid a time and materials (T&M) alternative with an estimate with a much smaller contingency, if any, based on their interpretation of the SOW.

The vendors are still in a competitive bid process so they need to keep their offer as low as reasonably possible while still complying with the technical requirements. If it doesn’t say, “Yes, and included in the PS estimate”, you’re probably not getting it unless it was clearly defined in the SOW.

With a fixed bid there should be a detailed list of everything not included to ensure the scope is clear. Have the vendor submit the exclusions list with the RFP response, with the proviso that any functionality not excluded is automatically included in the PS quote. For T&M, that’s a leap of faith unless you have a solid SOW, and in that case why not go fixed price? Who wants to carry all the risk of a budget overrun with T&M?

To be fair to the vendor, in lieu of a very detailed specification, they can’t know your system’s every data flow. Those idiosyncrasies usually don’t appear until the discovery phase after the deal is signed and the boots are on the ground. Then your SMEs might be hard-pressed to know enough about all the functionality in the new system to write the SOW to exploit its potential.

My preference is to see a RFP response with a T&M offer hopefully based on a solid SOW. I’d want to see the daily rates for each category of resource the vendor is proposing from their ranks. I’d also like to see where those resources are engaged within each task of each phase for the entire systems implementation plan. Vendors may not like providing that level of detail. But they have it, because how could they price the effort without it?

How much contingency have they built into the estimate? They wouldn’t have much credibility if there were none, which would raise the question of a low-ball bid. If it were 20 to 25 percent on a T&M, I’d say that’s reasonable. Now you have some rationale to negotiate the PS costs to 75 to 80 percent of what was proposed and reserve the contingency for changes that were not anticipated in the SOW.

Next, I’d address rates. At $1,800 a day for a full-time equivalent (FTE) vendor resource, five days a week, less three weeks vacation and a dozen statutory holidays and the vendor is billing out 233 times $1,800—$419,400 for that FTE. That’s probably north of a 200-percent markup, leaving room for a project-rate discount. If you needed one FTE for a week it would be different, but two or three FTEs over a six-month period and I’d expect a volume discount.

Another benefit of mapping the resources with associated rates to the implementation plan is it provides the rationale for meaningful milestone payments. Make sure you have reasonable holdbacks. It’s not about putting in the time. It’s about results, which usually means a user acceptance test (UAT). The completion of a UAT triggers a payment. Fail the UAT and the payment gets held back until the work meets the specifications. Depending on whether the agreement is fixed price or T&M presents different levels of risk to the vendor, but the onus remains on the buyer to ensure the agreement covers lost time, increased costs and non-performance penalties from vendor mistakes or misinterpretation of the SOW.

Once both sides are confident of the specifications and that they are unlikely to change, the parties might come to a final agreement on a fixed price. Check with purchasing or legal first—in fact before you send out the RFP—to ensure you are within your procurement policy. b2b


Phil Downe ([email protected]) is an independent IT contract negotiator, founder of Relations Management Goup Inc. and a member of the Purchasingb2b editorial advisory board.