Case Study: Farmland Industries Inc.
October 16, 2009 by Bierce & Kenerson, P.C.
Farmland Industries Inc., a federation of 1,700 rural farm cooperatives that is the largest farm cooperative in the United States, filed for bankruptcy protection on May 31, 2002, after reportedly rejecting an offer by Smithfield Foods Inc. for acquisition of Farmland’s meat business. The meat business is operated as a joint venture with U.S. Premium Beef Ltd., which has the right of first refusal.
In the 1990’s, Farmland Industries re-directed its capital and took on considerable debt to become a larger processor of farm commodities. The subsequent declines in crop prices resulted in a loss of $90 million for the fiscal year reportedly ended August 31, 2001, with additional losses of $46 million for the half year ended February 28, 2002. Investors in Farmland’s subordinated bonds reportedly aggravated the liquidity crisis by redeeming the cooperative’s bonds in droves. This story offers an example to vendors of the impact of massive changes in a customer’s business environment, as well as the inflexibility a customer faces when it has committed to joint ventures.
This bankruptcy could be bad news for Ernst & Young LLP (or its successor Cap Gemini Ernst & Young). In April 1997, E&Y and Farmland formed OneSystem Group LLC (OSG) as an IT joint venture to provide IT outsourcing and business process outsourcing services to Farmland Industries and the Farmland Cooperative System, the largest farmer-owned cooperative in North America. The joint-venture relationship reportedly introduced results-based metrics and gain-sharing through the establishment of unique payment methods for services funded by realized business savings.
In a bankruptcy, executory contracts may be terminated. In a joint venture where one of the parties is bankrupt, the bankrupt joint venturer may terminate future obligations to provide funding and services, but it still owns the joint venture interest.
To Bundle or Not to Bundle Goods and Services: NASA’s Desktop Contract
October 9, 2009 by Bierce & Kenerson, P.C.
Some bundling of goods and services is intrinsic to all outsourcing. The advantages of bundling to the service provider have been touted by Lou Gerstner, who, while Chairman of IBM, observed that services are the “wrapper” in delivering goods and related services as a package This case study comments upon the practice of bundling.
NASA’s Bundled Desktops.
NASA’s Inspector General’s Office announced in late July 2003 that NASA has overpaid by an average of 24% for computer accessories and supplies purchased through a $1.3 billion 1998 desktop IT outsourcing deal with multiple vendors covering desktop, server and communications equipment and support services. The overspending reportedly occurred on the “Outsourcing Desktop Initiative for NASA” (“ODIN”). Under the program, participating service providers are required to maintain at each NASA site that they support an online catalog of supplemental computer supplies and accessories, such as keyboards, printer cartridges and PDAs. The catalog purchases were at prices above market levels because they were bundled with related services.The NASA Inspector General criticized the contract structure because of “unnecessary” product bundling with services (such as installation and maintenance support) and a failure to permit the customers to negotiate volume purchase discounts on products whose prices had fallen in the marketplace.
When is “Bundling” Necessary or Appropriate?
The NASA Inspector General’s report raises the issue of unbundling in long-term services contracts The report highlights how a long-term outsourcing transaction that bundles goods and services is susceptible to criticism for market-driven elements for pricing of underlying products, where the service provider has committed to deliver installation and maintenance as “necessary” corollaries to ensure compliance with dependent service levels.
Necessary to Minimize Price. Bundling may be unnecessary if it inhibits the outsourcing customer from gaining access to the marketplace for underlying technology products that can be obtained in the marketplace. However, market access may need to be balanced against other considerations, such as the degree of retained control over the infrastructures that deliver the outsourced services.
Necessary to Ensure Service Levels. If the service provider is solely responsible for service levels that depend on the quality or condition of underlying technology platforms, the service provider may reasonably insist upon the right to ensure that such platforms are properly maintained. Accordingly, the bundling of goods and services is usually tied to the SLA. If the customer wishes to perform services within the scope of the outsourcing, such as purchasing software or computers, and installing them by the use of in-house personnel, the service provider may reasonably request exculpation from a failure in the service levels. The essential business issue is whether the service provider must show that the customer’s failure caused the SLA breach.
The Balance.
In conclusion, bundling may be aggregated in some cases. A properly crafted agreement can provide both flexibility and control for the customer, without unnecessarily jeopardizing the service provider’s ability to deliver agreed service levels.