“Change happens.” Sometimes it happens elegantly, with all parties agreeing. But change can be mismanaged, resulting in legal disputes on pricing, service level performance, duty to perform and impact on performance milestones Change mismanagement happens too.
Change as a Matter of Choreography. Contracts for business services resemble complex choreography for artistic dance, where each dancer minimizes effort and intertwines and exits from the scene according to a musical score. “Work flows,” “flow charts” and “algorithms” define the dance steps, the dancers and the music.
In business process management (BPM), “change management” choreographs the changes in the scope of work, pricing, scheduling, service levels and other essential commercial terms of the outsourced services. By contract, the parties can establish a predictable process for permitting such changes to ongoing contracts, without resulting in breach or termination.
Change Mismanagement. Sourcing and procurement procedures must define procedures for managing changes that will not break the contract. Experience shows that both the enterprise customer and the service provider are capable of mismanaging the change process. Such mismanagement results in litigation, waste (investment in the procurement process, startup costs and unwinding costs that may compensate the other party for unamortized profit).
Change Management Mistakes by the Enterprise Customer. Customers can make mistakes in planning that impact eventual operations:
- Inadequate financial analysis of the anticipated impact of the sourcing upon the operation, including neglect of costs of contract administration, price changes in the spot market over time.
- Inadequate “base case” that overestimates baseline demand, underestimates volatility in demand or fails to require internal procedures for governance of internal demand (such as charge-back pricing methodology for transparent allocation of costs of the services and contract administration).
Mistakes can occur in customer’s change management as well. For example, when the customer’s own clientele or consumers witness a severe decline in demand or transaction volume, the minimum monthly fees paid to the outsourcer might weigh heavily on costs. Of course, scalability in such volumes should have been anticipated, and the customer might have decided that the “price” of such minimum monthly fees was a safe bet in avoiding other capital investment that would otherwise have been necessary for continuing to offer the “services” in-house.
Severe volatility in such demand or transaction volumes can be very costly to the enterprise customer in a major outsourcing. For example, a supplier of mobile military equipment hired an IT service provider to ensure a high level of service that anticipated the government customer would be well-served. Then the military procurement strategists decided that the particular mobile equipment was not suitable for the next phase in the war. They wanted more mobility, less protection. So they canceled further purchases and continued only in “repair” mode for the existing fleet of such equipment. When the equipment supplier approached the IT service provider to reduce or redeploy the resources implied in the minimum monthly fees, the IT service provider refused, saying that such a change was too drastic and that the contractual termination fee was therefore due and payable upon presentation of an invoice. When the customer refused, the IT service provider sued. The matter was quickly settled with a substantial payment to the IT services provider and the customer’s loss of its upfront investment in the procurement process (lawyers, accountants, operations personnel and startup transition costs).
Change Management Mistakes by Service Providers. The biggest sin for a service provider is to invest additional time, effort and expense in providing services that are not paid for. Such change mismanagement can easily occur:
- Failure to notify the customer in advance of the need to change pricing due to customer requests for different services, different methods for service delivery or reduced or increased volumes of services.
- Failure to maintain records of changes in the services.
- Failure to obtain customer approval to changes in prices or pricing methodology.
- Failure to obtain customer approval for certain types of changes that have an impact on the smooth internal workflow of the customer’s in-house operations or the customer’s other service providers, and thus hamper the productivity of the enterprise customer.
For example, in 2005, Phoenix Signal and Electric entered into a contract with the New York State Thruway Authority to install cameras and signs along a toll highway. The contractor performed “extra work,” or “extras,” and claimed additional compensation. It claimed the extra work was justified because of the mutually unforeseen difficulty of performance, requiring an additional stage of work to provide sufficient cement foundations for the cameras and signs. Upon judicial review of the contractor’s claim for payment, the Court of Claims and the appellate court found that the additional stage was not an “extra” but was part of the base charges. Further, the courts rejected the contractor’s demands for payment of additional monies because the contractor had failed to meet two conditions precedent to payment: notice to the customer and adequate recordkeeping to enable the customer to audit the need and scope for the additional work. Phoenix Signal and Elect. Corp. v. N.Y.S. Thruway Auth., ___ N.Y.S. 3d ____, Dkt 512433 (Dec. 22, 2011, 3rd Dept App. Div.), NYLJ Jan. 3, 2012, dec.nylj.com/1202536924950. In short, depending on how the contract is written, the customer may refuse payment when the service provider mismanages the “change management” process.
Best Practices. All services agreements should define the parameters, processes and conditions for permitting changes. When the parties fail to plan, they plan to fail, and disputes will arise. A well-drafted Change Management procedure, implemented by regular reviews of performance against the contract terms, can avoid such mistakes.