flexibility in outsourcing tobias schavon afshin yavari · värdet av flexibilitet i ett...

Midsweden university & Hogeschool van Amsterdam Institution of Information Technology and Media (ITM) Examiner: Leif Olsson, [email protected] Supervisor: Ronald Kleijn, [email protected] Authors email: [email protected], [email protected] Educational programme: Industrial engineering, 300 ECTS Extent: 11023 words including Appendix Date: 2012-10-09

Bachelor thesis in industrial engineering GR(C) IG023G

Flexibility in outsourcing A study of the value of flexibility in outsourcing

contracts using Real Options theory

Tobias Schavon Afshin Yavari

Flexibility in outsourcing

Tobias Schavon & Afshin Yavari

2012-10-09

Based on the Mid Sweden University template for technical reports, written by Magnus Eriksson, Kenneth Berg and Mårten Sjöström.

ii

Abstract Creating a successful partnership between a supplier and its client is a

challenging task and is the reason for stressing the importance of a well-

defined and effective contract. Outsourcing deals are generally long-

term and for that reason, clients are pressing for more flexible contracts.

This research will express the value of flexibility in an outsourcing

contract. It will also examine whether the flexibility can be improved by

using Real Options theory.

At present, flexibility is highly integrated and it is not always clear what

its value is. Using Real Options theory it is possible to determine the

value of flexibilities and whether they are worth acquiring. By using the

option theory, the client will also be able to minimize risks and make the

contract more flexible.

Keywords: Outsourcing, flexibility and Real Options theory.



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Sammanfattning

Att skapa ett framgångsrikt partnerskap mellan en leverantör och dess

kund, är i dagens samhälle en utmanande uppgift. Det är därför vikten

av ett väl definierat och flexibelt kontrakt inte kan betonas nog. Ett

partnerskap inom outsourcing är i allmänhet något man ser på lång sikt.

Det är därför kunder kräver mer flexibla avtal. Denna uppsats uttrycker

värdet av flexibilitet i ett outsourcing kontrakt. Den kommer också att

undersöka om flexibilitet kan förbättras med hjälp teorin för reala

optioner. Inom outsourcing idag, är flexibiliteten mycket integrerad och

det är inte alltid det framgår vad dess värde är. Med teorin för reala

optioner är det möjligt att bestämma värdet på flexibilitet och om det för

en kund är värt att införskaffa. Genom att använda optionsteori kan en

kund också minimera sina risker och det gör avtalen mer flexibla.

Nyckelord: Outsourcing, flexibilitet och Real Optionsteori.



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Forewords

This research has been conducted as the final part of our bachelor

degree in Industrial Economics at Mittuniversitetet in Sundsvall. The

research was conducted in Holland during our exchange period.

We would like to give thanks to everyone who has been part of this

research and who have assisted us in reaching our goal. We would like

to give special thanks to Eric Bruinsma at IBM in Amsterdam for taking

his time to make this research possible. We would also like to give our

gratitude and appreciation to our supervisor Ronald Kleijn for all his

support.

Amsterdam the 12 august 2012




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Table of Contents

Abstract ............................................................................................................. ii

Forewords ........................................................................................................ iv

Terminology ...................................................................................................... 7

Introduction ...................................................................................................... 8

1.1 Background .......................................................................................... 8

1.1.1 Atos 9

1.1.2 IBM 9

1.2 Purpose ................................................................................................. 9

1.3 Research question ............................................................................... 9

1.4 Delimitations ...................................................................................... 10

1.5 Outline ................................................................................................ 10

2 Theory .................................................................................................... 11

2.1 Flexibility ............................................................................................ 11

2.1.1 Robustness 11

2.1.2 New capability 11

2.1.3 Modifiability 12

2.1.4 Ease of exit 12

2.2 Discounted Cashflow ....................................................................... 12

2.3 Real Options ....................................................................................... 12

2.3.1 Binomial lattice 13

2.3.2 Option to Expand & Execute 16

2.3.3 Lognormal distribution 16

3 Method ................................................................................................... 18

3.1 Approach ............................................................................................ 18

3.2 Method theory ................................................................................... 18

3.2.1 Qualitative- & quantitative methods 18

3.2.2 Structured interviews 19

3.2.3 Validity & reliability 19

4 Results .................................................................................................... 20

4.1 Outsourcing contract ........................................................................ 20

4.2 Services ............................................................................................... 20

4.3 Cost of services .................................................................................. 20



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4.4 Robustness ......................................................................................... 21

4.5 New capability & Modifiability ...................................................... 22

4.5.1 Renegotiation 22

4.5.2 Benchmark 22

4.6 Ease of exit.......................................................................................... 23

4.7 Case example: TP Vision .................................................................. 24

4.7.1 Case example: New capability 26

5 Discussion ............................................................................................. 28

5.1 Robustness & TP Vision ................................................................... 28

5.1.1 Pay per use VS Options 29

5.1.2 Modifiable & New capability 30

5.1.3 Case example: New capability 30

5.1.4 Modifiable 31

5.1.5 Ease of exit 31

6 Conclusion ............................................................................................. 33

References ........................................................................................................ 35

Appendix A: Interview I ............................................................................... 37

With F. Winnubst, Atos .................................................................................. 37

Appendix B: Interview II .............................................................................. 41

With G. Delen, an outsourcing consultant .................................................. 41

Appendix C: Interview III ............................................................................ 44

With Eric Bruinsma, IBM ............................................................................... 44

Appendix D: TP Vision case ........................................................................ 47

Lattice I ............................................................................................................. 47

Appendix E: TP Vision case ......................................................................... 48

Lattice II ............................................................................................................ 48

Appendix F: New capability ........................................................................ 49

Lattice 49



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Terminology ABC: Activity Based Costing

BPO: Business Process Outsourcing

DCF: Discounted Cash Flow

IT: Information Technology

PV: Present Value

SLA: Service Level Agreement



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Introduction

1.1 Background

An outsourcing contract is simply stated as an agreement between two

parties, in which one company agrees to supply the other with certain

services over a period of time (Delen 2009). In the book IT outsourcing:

An introduction, Delen (2009) expresses the definition to be; ”The

transfer of services, where if applicable, the accompanying employees

and resources are transferred to a specialized service provider and

consequently 2. The rendering back of those processes by that provider

as services for the duration of the contract at an agreed-upon level of

quality and financial compensation structure” (Delen 2009, s.3).

In outsourcing two strategies can be identified. If the strategies are

properly used, then it becomes possible for management to take a

company to a different level which would not be available using any

other strategy (Quinn & Hilmer 1995). The first strategy is to focus on a

company’s core activities. The core activities can provide unique value

for the customer and offer a company certain leverage, compared to its

competitors (Quinn, Doorley & Paquette 1990). The second strategy is to

strategically outsource other activities. A company has no special

expertise in these activities and they are able to be better provided

elsewhere (Quinn 1992).

When combining these two strategies in a successful way, companies

can: Focus on maximizing internal resources. Focus on core activities.

Obtain full utilization from the external supplier, such as investments,

knowledge, innovations and special capabilities. With joint strategies in

markets that are changing rapidly and with technology constantly being

developed, this should reduce the risks and lower investments (Quinn

& Hilmer 1992).

Creating a successful partnership between a supplier and its client is a

challenging task (Maurer & Ackerman 2012). Fafchamps (1996) argues

that, economic exchange between a supplier and client cannot take place

unless contracts are flexible, because parties cannot be certain of ful-

filling their contractual obligations. The importance of an effective and

well-defined outsourcing contract therefore cannot be sufficiently



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stressed. Outsourcing deals are generally long-term relationships and

deals signed today may not be the deal required in the future. Clients

are thus pressing for more flexible contracts (Maurer & Ackerman 2012).

1.1.1 Atos

Atos is an international information technology service company with

over 70.000 employees in 48 countries. They operate as a joined-up

global resource and offer consulting & technology services, system

integration & managed services and hi-tech transactional services to

clients all over the world. The focus of Atos is on business technology in

order to assist companies in bettering their own organization (Atos

2012).

1.1.2 IBM

IBM is one of the world’s leading companies in information processing,

with more than 400,000 employees and thousands of technology- and

business partners worldwide. They are a globally integrated organiza-

tion working across borders to provide their customers with the com-

bined expertise from all of their worldwide locations (IBM 2012).

1.2 Purpose

This research will express the value of/and the flexibility in outsourcing

with the assistance of Real Options theory in order to determine

whether it is possible to improve the flexibility in an outsourcing

contract.

1.3 Research question

The research question for this thesis is as follows; how can an outsourcing

contract be more flexible and yet profitable for both parties?

To answer the above research question, it has been supplemented with

sub-questions which were more manageable and easier to comprehend.

Sub-research questions:

1. How is the flexibility handled by vendors today?

a. What flexibilities do vendors offer their clients?

b. How much does flexibility cost?

c. How is the cost calculated?

2. How can we measure flexibility?

a. How can we calculate the value?

b. Is flexibility worth having?



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3. Can Real Options be applied to improve a contract?

a. What benefits are there?

b. What possible flaws/constraints does the method have

when applying it to flexibility in outsourcing?

1.4 Delimitations

Limitations in this research include:

- This research will only look at the cost of flexibility, and not its

quality aspects.

- This research will be concentrated on BPO (Business Process Out-

sourcing) and IT (Information Technology) Outsourcing.

1.5 Outline

The following chapter contains all the theory necessary to comprehend

the calculations and analysis which have been produced. Chapter three

describes the method used during the research. Chapter four contains

all the results of the research which, together with the theory, will be

analyzed in chapter five. The last chapter contains the final conclusions

of the research. In the final part of the document all the references and

all the appendixes used in this research are to be found in addition to

the excel spreadsheets and interview questions & answers.



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2 Theory This section will deal with the necessary theory to understand and

comprehend the following chapters.

2.1 Flexibility

Upton (1994) expresses flexibility to be “the ability to change or react

with little penalty in time, effort, cost or performance”. It arises when

contractual performance is made, so in case of external events the client

is allowed to make changes to the original agreement. Bahrami and

Evans (2004) have stated three dimensions of flexibility. In addition Tan

and Sia (2006) have added a dimension called ‘ease of exit’ from Ybarra

and Wiersema (2003) and conceptualize it to be the four dimensions of

flexibility shown in Figure 2.1.

Figure 2.1 – Dimensions of flexibility

2.1.1 Robustness

Robustness means “the ability to endure variations and perturbations,

withstand pressure, or tolerate external changes. This relates to situa-

tions in which an organization has the built-in capacity to address

uncertainty for varying levels of demand, product mix, and resource

availability” (Barjis 2010, s. 43). This means a client is allowed to vary

the capacity usage of an existing service (Tia & Sia 2006).

2.1.2 New capability

New capability means the ability to innovate in response to changes

(Tan & Sia 2006). In other words this means that clients are allowed to



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add something new to the agreement at a later stage. According to Tan

& Sia (2006) new capability addresses radical changes in the business

environment that deviate substantially from the projections.

2.1.3 Modifiability

Modifiability means the ability to adjust attributes of existing services.

This means that the organization has the ability to make modifications

in relation to existing services in order to cope with less foreseeable

events as they occur (Tan & Sia 2006).

2.1.4 Ease of exit

Ease of exit is the ability to close an outsourcing relationship earlier than

anticipated, and transfer the services to another service provider or

backsource it to the client’s own organization (Venkatraman & Hender-

son 1998; Delen 2009). Both outcomes should have the fullest coopera-

tion of the current service provider (Delen 2009).

2.2 Discounted Cashflow

DCF (Discounted Cashflow) is a tool which can be used to determine the

value of an investment. The DCF method takes the present value of

future cashflow and then subtracts the required capital expenditure. If

the DCF is positive the investment will create future profits for the

company (Luehrman 1998).

To calculate the present value the DCF method uses the PV (Present

value) technique, which takes the time value of money into account

(Schmidt 2009). This means that future costs, revenues or profits will be

worth less than today’s costs, revenues or profits. The total PV over a

period of time is shown in equation (1). The x is the value of the ex-

pected cost, revenue or profit that year, the r is the risk-free rate and t is

the time period.

(1)

2.3 Real Options

DCF is a model which assumes a static, one-time decision-making

process. This could, however, provide a poor estimation, as all aspects

are not always known and it is very difficult to predict the future. Real

Options unlike the traditional approach DCF, assumes a dynamic

environment, where all aspects are not known and the management can

make future decisions to adapt to changes (Mun 2006).



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Real Options is a fairly new approach but it has its roots in Financial

Options, which has been around for several decades. This method

attempts to eliminate the risks associated with market trading by

determining the financial value of stocks and using stock option con-

tracts. Real Options however, uses the option theory to evaluate physi-

cal or real assets, as opposed to financial assets. Real Options can be

used to determine the value of free cash flow, commodity prices, market

demand and more (Mun 2006).

An option is simply an opportunity where someone has the right but

not the obligation to acquire or sell specific asset. All option can be

categorized either as a call option which means acquire, or put option

which means to sell (Mun 2006). This thesis will focus on call options,

“the right, but not the obligation to acquire something” (Luehrman 1998,

s.3).

2.3.1 Binomial lattice

There are many different means of calculating Real Options. This thesis

will focus on the binomial lattice approach. The binomial lattice ap-

proach, because of its high level of flexibility, is able to be used in

solving any types of options. It is also easy to understand and imple-

ment. In order to obtain a good approximation a binomial lattice solu-

tion requires a significant amount of steps and a great deal of computing

power. Because of the limited modeling flexibility and its preciseness, it

is better option to use closed-form equations, such as the Black-Scholes

formula, while solving financial options (Mun 2006).



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Figure 2.1 – Binomial tree

The binomial lattice method uses a decision tree containing two differ-

ent paths which it is possible for the value to take during each time

period. A solution can be obtained in two ways. The first involves the

use of risk-neutral probabilities, and the second, the use of market-

replicating portfolios. The method that this thesis concentrates on is the

risk-neutral probabilities approach (Mun 2006).

In any options model, there are at least two lattices. The first lattice is

that of the underlying asset, while the second is the option valuation

lattice. The basic inputs for calculating almost any type of Real Options

are S, X, σ, T, rf, b.

S is the present value of the underlying asset. X is the present value of

the implementation cost. Volatility (σ) is the natural logarithm of the

free cash flow returns in percentage terms. T is the time to expiration in

years. Risk-free (rf) rate is the return on a riskless asset. Dividend (b) is

the continuous outflows in percentage terms (Mun 2006).

When using the binomial lattice approach, several equations are re-

quired. Equation (2) is the up factor (u) for the first lattice. The up factor

is the exponential function of the cash flow returns volatility multiplied

by the square root of the time-steps. Time-steps means the time scale

between steps. If an option has, for instance, ten years to maturity and



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the lattice has been created using 10 steps, then every step has a step-

ping time of one year. To make the volatility equivalent to the time-

steps, its annualized value should be broken down by multiplying it

with the square root of time-steps (Mun 2006).

(2)

Equation (3) is the down factor (d) of the lattice, which is the reciprocal

of the up factor. The higher the volatility, the higher will be the up and

down factors (Mun 2006). The factors u and d use a lognormal distribu-

tion. The lognormal distribution is the distribution of a random variable

taking only real positive values. This is derived from the financial

options, where the value of a stock cannot be less than zero (Johnson,

Kotz & Balakrishnan 1994). The lognormal distribution has been chosen

because of the above stated characteristics. In addition it is based on the

fact that an assumption, in relation to statistical analysis it’s a standard-

ized form to go. More information about the lognormal distribution can

be viewed in chapter 2.3.3.

(3)

Equation (4) is the risk-neutral probability measure (p), which is proba-

bility that the underlying asset will increase in value in one time step. It

is the exponential function of the difference between the risk-free rate

and dividend multiplied by the stepping time. The down factor is then

substracted from this and then divided by the difference between the up

and down factors (J. Mun 2006).

(4)

It now becomes possible to create the lattice for the underlying assets.

This is achieved by multiplying the present value of the underlying

asset at time zero (So) with the up and down factors, using equations (2)

and (3) as shown in Figure 2.1. The intermediate branches recombine,

which means that if the volatility had been zero, equations (2) and (3)

would have been equal to one. Thus the lattice would have been a

straight line and it would have been sufficient to use a discounted cash

flow model since the value of the option would have been zero (Mun

2006).

To create the option valuation lattice, the backward induction process

should be used. In this stage, the values from the final nodes are multi-



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plied by their risk-neutral probability factors (p) and the reciprocal (1-p)

and then these are multiplied by each other. This value will also be

multiplied by the exponential of the risk-free rate to discount the value

to the following node (Mun 2006).

(5)

2.3.2 Option to Expand & Execute

The Expansion Option, values the opportunity to expand from one

existing state to a larger one. For this to occur an existing state must be

present and if this is not the case then an Execution Option should be

considered. This thesis will concentrate on American calls, which means

that the option can be executed at any given time up to maturity. This

means that while performing the backward induction, the nodes will

take either the maximum value of either the value zero or the option or

value from the previous nodes (5). This can be seen in equation (6). Ef is

the expansion factor which is the factor that is able to be expanded.

Using an European call would mean that option could only be exercised

on the option’s maturity date. Only the last node would then consider

the option and the remaining nodes would only contain equation (5) (J.

Mun 2006).

(6)

While dealing with an option to execute, equation (7) will be used

instead of equation (6).

(7)

2.3.3 Lognormal distribution

u and d are acquired from a lognormal distribution which is a continu-

ous probability distribution of a random variable, taking only real

positive values whose logarithm is normally distributed (Johnson, Kotz

& Balakrishnan 1994).

In statistical analysis, a normal distribution is required. On the other

hand it is well known that market returns are not normally distributed

(Peters 1994). “This information has been downplayed or rationalized

away over the years to maintain the crucial assumption of the tradition-

al capital market theory” (A. Weron & R. Weron 1999, s. 289). In finance

theory, information and investors are both treated as generic. All

investors are generalized to always look to maximize returns and to



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know how to value and handle current and new information. This

method fails because all types of information do, according to this

theory, have the same impact on every investor, which, in reality, is not

the case (A. Weron & R. Weron 1999).



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3 Method This chapter presents and justifies the methodology used during the

research. The reliability of the method has also been evaluated.

3.1 Approach

A qualitative study of the three main topics namely, outsourcing,

flexibility and the Real Options theory represents the theoretical founda-

tion in the research. This theoretical study then provided the framework

for the subsequent work. The next step was an empirical study which

was conducted by means of qualitative structured interviews. Inter-

views were carried out with two companies, namely IBM and Atos. An

additional interview was conducted with an outsourcing consultant.

The next step was to perform quantitative calculations using Real

Options.

Following on from this, it was time to produce a qualitative analysis,

according to the data required. This led to conclusions about today’s

situations, how Real Options theory can be used and what benefits it

could provide. An evaluation of the study’s validity and reliability has

also been implemented and can be viewed in chapter 3.2.3. The last step

was to complete the report and check for consistency and quality of the

work.

3.2 Method theory

This section presents and justifies the different methodological choices

in greater depth.

3.2.1 Qualitative- & quantitative methods

The purpose of a qualitative study is to gain a deeper understanding of

the study area (Lantz 2007). In this research a qualitative study was

made with regards to outsourcing, flexibility and mainly, Real Options,

to obtain the foundation for the work to be conducted. Of particular

importance of this study has been the book ‘Real Options Analysis’ by

Johnathan Mun.

A quantitative method can be used to find statistical and quantifiable

results (Holme & Solvang 1997). In this research the quantitative method

Real Options was used to calculate case examples and demonstrate how



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the methodology could be applied. Lastly, the interviews and analysis

were conducted in a qualitative way. The aim of the analysis was to

show how Real Options can be used and what benefits it could offer.

Thus, the qualitative analysis was considered to be an appropriate

approach.

3.2.2 Structured interviews

Structured interviews are intended to capture the respondent's percep-

tion of a given subject. The structured interviews allowed for a generali-

zation of the results. The interview questions and answers are available

in the Appendixes A, B and C. The interviews lasted, on average 40

minutes, and were recorded using a voice recorder on a mobile phone.

This allowed for a more complete compilation of the interviews.

3.2.3 Validity & reliability

The methods used are considered to have generated a result of high

validity. The validity is directly reinforced by calculations made and the

case study of the companies and for which the questions have been

answered and the purpose fulfilled. Since the research has been more

focused on contracts rather than on specific companies, the results can

be seen as a generalization. Reliability is directly dependent on the

consistency of the results. To increase the reliability, the analysis has

been based on a combination between the theory and results.



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4 Results This chapter contains all the results acquired during the research. The

first part is based on the results from the interviews described in the

appendix A-C which involved Winnubst, Delen and Bruinsma during

2012. The latter provided the calculation which has been used on the

specific case examples.

4.1 Outsourcing contract

The most common duration of an outsourcing contract according to

Bruinsma and Winnubst is five years. In the public sector Delen men-

tions that the most common time is about four years. All agree that the

minimum length is two-three years, and the maximum around 7-10

years. An outsourcing contract is according to Bruinsma often started by

the client sending a request for proposals to different suppliers and then

negotiating in order to discover the best deal.

4.2 Services

Services that companies such as IBM and Atos offer can according to

Winnubst be divided in different categories depending on the company.

Winnubst mentioned that Atos divides their services under three

different domains or towers as they call them: adaptive workplace

solution, application operations and manage infrastructure services.

Winnubst mentions that the majority of companies have the same

categories but that the terminology may differ.

4.3 Cost of services

Winnubst and Delen mention that the majority of outsourcing suppliers

charge their clients depending on both quality and quantity. For quality

Delen and Winnubst state, that companies usually divide this into

different ranks, for example; gold, silver and bronze. If a client wants to

have the golden quality then this will involve a higher cost than that for

silver or bronze.

For quantity Delen and Winnubst state that, companies usually use the

method pay per unit. This means that the client will pay for the exact

amount of the service used. For example, if a client rents storage space

then the client will pay per terabyte. Clients can also, according to

Bruinsma, Winnubst and Delen, pay per, for example, user, time period,

personnel, instance, seat, server image, invoice, call, function point and



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transaction. A few services still remain which are paid by a fixed

amount. If a client then wants more capacity than has been agreed upon,

then the client will, according to Bruinsma pay more but within the new

range. This indicates that there are three ways of paying for a service:

- Fixed cost + Fixed cost + … + Fixed cost.

- Fixed cost + Pay per unit.

- Pay per unit.

Winnubst states that the cost of a service is calculated by using the PQ

formula, in which P is equal to price and Q is equal to quantity. The

price is calculated by using the ABC (Activity Based Costing) method.

The ABC method does according to Winnubst and Delen break down

every service into activities and sets a price for each one.

4.4 Robustness

During the interviews it was confirmed that none of the companies will

deny their clients more capacity. As already covered by the sub chapter

‘cost of service’, the client will either pay within the new range or the

pay per use method will be applied. If the pay per use method is ap-

plied then the alteration of capacity is very easy. In order for the suppli-

er to then cover the fixed cost, Bruinsma mentions there will be a

minimum capacity which the client “has to use”. During the duration of

the contract the overall variance of the capacity use is usually about 20%

according to Delen and Bruinsma.

During the interview Bruinsma mentions an ongoing procedure which,

at the moment, for IBM, is an arrangement in which IBM provides

application management and hosting to TP vision. TP vision provides

Smart TV solutions which mean that, as a consumer, it is possible to

obtain access to the Internet through a television. How rapidly this new

trend will be adopted by consumers is, at present, not certain. This

makes the amount of capacity required by TP vision difficult to deter-

mine.

This service is provided by IBM for a fixed cost of €100,000 a month, for

one million unique users. The number of unique users is at the moment

approximately 700,000. The forecast is for an increase of an extra one

million users within a year, with a variance of 100,000 unique users a

month. Bruinsma says that IBM can reserve capacity, which TP vision

can choose to use at a later stage, but this will be provided for a particu-



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lar fee. For the next one million users, the monthly cost will be €85,000.

This robustness flexibility will be examined in chapter 4.7, to determine

what the option value would be for reserving the capacity.

4.5 New capability & Modifiability

Below are examples of flexibilities and tools which can exist in outsourc-

ing contracts. These tools can be used to modify or adjust an attribute of

an existing service and prove to be useful when negotiating a new

capability.

4.5.1 Renegotiation

A renegotiation clause enables some or all aspects of a contract to be

changed during its lifetime. Winnubst states that, even if there are

clauses that allow a client to renegotiate for a particular change, it is

somewhat irrelevant to make calculations. The reason being that renego-

tiation is an ongoing process and, as the world is changing, the client

will renegotiate the terms. If a supplier refuses to renegotiate, the client

will possibly not renew the contract when the duration period is over.

Winnubst also mentions, as a supplier, that there is no choice but to

renegotiate to maintain the relationship with the client intact.

Although renegotiating is an ongoing process Delen believes that it is

good to have clauses and regulations written down in the contract. This

is to prevent confusion, so that both the client and supplier know what

to expect and can meet on mutual grounds. At IBM, Bruinsma feels that

if the client, for example, does not have the budget, then the supplier

can take a look, but it does not indicate that there must be a change.

Bruinsma mentions that, in order to make the change possible, the client

will need to pay for the extra work that the supplier has to supply.

4.5.2 Benchmark

Winnubst, Delen and Bruinsma state that, external firms can be used to

conduct a benchmark on the suppliers’ services against their peers. The

supplier is required to score within a certain interval that is specified in

the SLA. If a score is above the interval, then credits will be awarded

and if a score is below the interval, then penalties are charged from the

supplier. A benchmark on a service is, according to Bruinsma, not very

common and there are very rare cases for which a client hires a third-

party in order to conduct one.

Winnubst, Delen & Bruinsma mention that, a client can also hire an

external firm to conduct a benchmark on the price. The firm will check



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whether the prices are competitive and if this is not the case then, prices

will be renegotiated. Bruinsma also points out that it is important that

the external firm is very precise during their benchmarking process.

This to ensure that the services, for which the price is being bench-

marked, do not differ from each other as, otherwise, the benchmark

would be irrelevant and not taken under consideration.

4.6 Ease of exit

As has been discovered during the interviews, there many different

clauses in relation to ease of exit, which can be used in an outsourcing

contract. According to Delen, all the clauses can be categorized into two

different groups:

- Termination for cause.

- Termination for convenience.

Winnubst mentions that the termination for cause could be for several

different reasons. Many outsourcing companies ask for the cause; poor

performance. This indicates whether the supplier performs poorly and

does not deliver as promised and thus enables the client to terminate the

contract. However, it takes careful planning and detailed sub clauses to

specify, what exactly poor performance is. Another cause, which is

common to have in an outsourcing contract, is, according to Winnubst,

the cause of ‘bankruptcy’, in case one of the companies becomes bank-

rupt. Also, the ease of exit clause ‘change of control’ often appears in an

outsourcing contract. This means that the outsourcing company can

terminate the contract if the outsourcing supplier is bought out by one

of their competitors, or the other way around, which is very unusual.

During the interviews both Bruinsma and Winnubst mentioned the

termination of convenience. This means that if the outsourcing company

starts to dislike their supplier or for some other reason wants to stop the

partnership, then this is achievable without having a relevant cause.

The usage of these termination clauses are difficult to determine. Kern

and Willcocks (2000) estimate that one in eight outsourcing deals ends

prematurely. According to Delen these clauses are used 14% of the times

(7% for cause and 7% for convenience). Bruinsma at IBM states that this

is extremely unusual and Winnubst at Atos states that it has only

happened once in fifty years. There is no up-front cost for having an

ease of exit clause in a contract, only a price when it is exercised. In all



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the interviews it was mentioned that the price for exercising the ease of

exit for convenience usually involves the remainder of the supplier’s

original investment, and also involves paying for the transference of

services from the provider to itself or another provider. Bruinsma and

Winnubst also add the following year’s transition costs and also five

percent of the lost year’s revenues.

4.7 Case example: TP Vision

It is now time to examine the case of IBM and TP Vision, using Real

Options with the option to expand. What is the option worth? What

would a reasonable price be? This will now be answered and further

discussed in the next chapter. Table 4.1 shows the data already provid-

ed. The income of €0.2 per user is an estimation that has been utilized,

since no real data has been provided.

Table 4.1 Statistics & Profit

Factors Figures

Option duration: 12 months

Unique users at the moment: 700.000

Estimated variation per month: ±100.000

1.000.000 Per/user +1.000.000 users +Per/user

Income €200000 €0.2 €200000 €0.2

Cost €100000 €0.1 €85000 €0.085

The first step in obtaining the option value was to determine the value

of the underlying asset. To obtain this value, the assumption firstly had

to be made that TP Vision earns twice as much as the cost per user. This

means an income of €0.2 per unique user. By using this it was possible

to calculate the monthly cash flows of all possible outcomes for the next

12 months. The cash flow at month zero is €40.000 and this was acquired

by multiplying the amount of users by the income per user, and then

subtracted from the monthly cost (700.000*0.2-1000.000*0.1). The next

month’s cash flow was calculated in the same way but with a variance

of 100.000 users per month. All the cash flow projections can be seen in



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Figure 4.1. Then an average of each month’s possible outcome was taken

and the present value from equation (1) was used in order to obtain the

value of the underlying asset, which was calculated to be €273,718.

Figure 4.1 - DCF

The second step was to determine the volatility of the option. It was

acquired by taking the difference in the highest growth possible with

the value of month zero ((100,000-40,000)/(100,000+40,000)), which gave

a percentage of 42%. The third step was to calculate the up and down

factors of the underlying asset lattice by using formulas (2) and (3). This

provided the up factor with a value of 1.129 and the down factor 0.886.

The fourth step was to obtain the risk-neutral probability factor, which

was given by equation (4) and has the value 0.487. The fifth step was to

decide the expansion factor which is 3. This value was obtained by

dividing the maximum cash flow after expansion by the maximum cash

flow without expansion. All these values can be seen in the table 4.2.

Table 4.2 Variables

Variables Values

Underlying asset (S): €273,718

Risk-free rate (rf): 5%

Volatility (σ): 42%

Expiration date of option (T): 1 year

Time step (δt): 1/12

Up-factor (u): 1.129

Down-factor (d): 0.886

Risk-neutral probability up (pu): 0.487

Risk-neutral probability down (pd): 0.513

Expansion factor: 3



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In order to acquire the exercise price another assumption had to be

made. Since the cost to expand would be €85.000 a month, this was

transformed and used as the exercise price. To obtain an accurate

exercise price for that particular month, the present value equation (1)

was used to discount the cost of each of the following months. If, for

example, exercising the option in month five, there will be seven months

left. This means that the exercise price would be €549,373.08. All the

exercise prices can be seen in table 4.3.

Table 4.3. Exercise prices

Month: Value

Exercise price 1: $753,376.39












These are all the required variables to generate the lattice for the

underlying asset. Then by using backward induction and placing

equation (6) at every node, the option valuation lattice can now also be

generated and this lattice provides the option value €744,150.46. The

lattices have been placed in Appendix D.

4.7.1 Case example: New capability

If, for example, a client thinks that there is a possibility that their com-

pany will want to add something new to the contract within three years.

This is not certain, but, if the client does, then the implementation must

be rapid. To be able to feel certain of obtaining the resources in time

from the supplier, perhaps a new capability option should be consid-

ered.

The assumption is that the client has estimated a future discounted cash

flow for this particular capability to be €400,000, and the projected



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volatility to be approximately 45%. Time to maturity is three years and

the risk-free rate is 5%.

In order to calculate a new capability, the option to execute must be

used, since there is no existing state. This means that it is almost the

same calculations as above but instead of using equation (6), equation

(7) will be used at every node in the option valuation lattice.

Table 4.4 New capability

Factors Values

DCF €400,000

Time to maturity 3 years

Exercise price €600,000

Risk-free rate 5%

Volatility 45%

With the binomial lattice approach the option value is €87,626.67. This

can be confirmed by using the Black-Scholes calculator. The individual

approaches can be seen in Appendix D.



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5 Discussion This section contains the analysis of the results given in the previous

chapter.

5.1 Robustness & TP Vision

Robustness is definitely a valuable flexibility. If the variation of the

capacity is not specified in the contract, then the client could be paying

for capacity which is not being used. In some instances, it is possible

that the client might not increase the capacity as rapidly and efficiently

as desired. This would mean a loss of profit for both parties.

The option value given in the TP Vision case is obviously very high. The

reason is because, with Real Options, the maximum profit path is

always calculated. In this lattice the optimal profit path is to expand in

the last month, which gives the high option value. TP Vision is operat-

ing in an environment where the assumption is that expansion will take

place, as soon as the limit has been reached. Neglecting customers while

waiting for the most profitable period to expand, is bad marketing and

will generate unhappy potential customers. This means that TP Vision

has to expand when the limit of one million unique users has been

reached. This means that the option value will significantly decrease.

TP Vision projects that they have the potential to reach two million

users in one year. With a variance of 100,000 users a month, they should

reach the limit in about 3-5 months, if the projection is correct. A reason-

able option value would be between €85,000x3 and €85,000x5, which

would be €255,000, and €425,000 respectively. To force an expansion at

an earlier stage would reduce the option value. To force an expansion at

month four, an option value of €311,257.23 would be obtained. The

newly obtained option value is within a reasonable interval. The lattice

to expand at month four can be found in appendix E.

If TP Vision had chosen to expand from the beginning, it would have

generated an additional cost of €85,000 a month. In a one year period the

additional cost would be €85,000x12 which is equal to €1,020,000.

Comparing this with the initial option value obtained, which is €744,150

this can again be recognized as being too high a value. To pay the

options price of €744,150 and exercise it at month four will mean a total



2012-10-09


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payment of €1,509,150 (€744,150+€765,000). This value is €489,150

greater than €1,020,000, which it would have cost to expand immediate-

ly. The latter option value obtained is a better estimate. The option value

and its exercise price provide a total of €1,076,257 (€311,257+€765,000).

In this scenario expanding at the beginning would actually have proved

to be the most profitable. There is still a very high possibility for the

market to react in a different way, which makes having the option

valuable.

In relation to the uncertainty of the market; the higher the volatility the

greater the importance of acquiring an option, because the client could

end up with not expanding at all. A great deal of money would then

have been wasted if the client had expanded from the beginning.

Whereas, by having an option, the client would only have spent the

money to acquire the option. It should be borne in mind that the option

value is the maximum amount to pay for acquiring an option. A rec-

ommendation would be to negotiate the price with the supplier after a

Real Options calculation has been made.

5.1.1 Pay per use VS Options

Pay per use, can be seen as a type of flexibility in which a client has the

option to vary the capacity use on a daily or hourly basis. The

calculation of this option would be significantly large and complex. As

the result states, the costs of the services are calculated using the ABC

calculation method, and there is no additional cost for the pay per use

price. This means that there is no interest in comparing the different

methods. The pay per use method will always be preferable if that

option exists. For TP Vision, the pay per use method would also have

been the optimal solution, if offered. In some instances it is not possible,

because of the huge amount of reserved capacity and other variables. In

these cases an option to expand is optimal. The supplier receives a small

amount of money for the reserved capacity. This makes the contract

more flexible and profitable for both parties.



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5.1.2 Modifiable & New capability

If it was not possible to modify or add new capabilities, companies

would not be able to adapt to the rapidly changing environment, and

thereby not be able to keep up with competitors. In all the interviews it

was confirmed that there are clauses about change/renegotiations. There

are, however, different views amongst companies about the actual value

of the clauses. No matter what point of view is held, the

recommendation would be to always include these clauses, in order to

avoid conflict.

5.1.3 Case example: New capability

For new capability options to function in reality, all aspects must be pre-

defined in order to calculate an option value and exercise price. By

using the new capability options, the customer will know the exact

amount required to execute an option. The supplier will, in advance, be

aware of the changes that might occur and thus be able to plan

accordingly. This will benefit both parties and create more flexible

contracts.

This type of option has the same characteristics as a financial option. In

this case we bought the right but not the obligation to in a future stage

add a new capability. Since this case is so close to a financial option, the

Black-Scholes formula gives the same result as the binomial lattice

method. The individual methods can be seen in Appendix F.

If there had been an option to expand as in the TP Vision case, then the

Black-Scholes formula and the binomial lattice method would have

provided different results. This example contains the same variables as

the case in chapter 5.1. For a detailed analysis refer to chapter 5.1.



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5.1.4 Modifiable

It has not proved possible to determine a method to calculate the

options in relation to modifiability. However, it could be interesting to

calculate how much money it would be worth spending in order to

conduct a benchmark. If a client is certain that the price of the service

provided is higher as compared to the service provided by another

supplier, it could be worth conducting a benchmark. It is the belief of

the authors that a lattice could possibly be created with the underlying

cash flow, with the up and down factors of the uncertainty (σ) of the

cash flow increasing after it has been conducted. For real option theory,

it is believed that the problem would be the duration.

On the other hand, it is possible that a very simple calculation could be

made, by using the option thinking. If the client believes that, after the

benchmark, it would save them €1,000,000 until the end of the contract

and that there is a 20% certainty of this assumption then, the option

value would be €200,000 (1,000,000*0.2) subtracted from the cost to

renegotiate the price. The obtained value must be compared to the cost

of conducting a benchmark to determine if it is worth performing the

process.

5.1.5 Ease of exit

To terminate a contract before the expiration date could be a valuable

option for a client to acquire. This would be particularly true if the

supplier does not deliver what has been promised. If the insourced

services do not create what has been expected, then the agreement will

no longer have any value. It will only be an unnecessary cost. However,

a client must have a very strong case and be prepared to take it to the

court, where it is possible that the case will be lost.

Terminating a contract for convenience is less valuable than the above,

since the agreement is still functional. Terminating a contract for

convenience is really expensive, and should not be attempted without a

really strong reason. In the opinion of the authors, it will never be worth

exercising this clause, at least not for a normal five year contract. This

clause can, however, have an implicit value. Meaning, that the client can

exercise the clause to avoid bad publicity or for moral values.



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Because of the above reasons, the amount of unknown variables and the

lack of knowledge of the authors in relation to Real Options this will not

be dealt with in this thesis. However, the value of this dimension

increases with the length of the contract's duration, and with the

companies’ environmental uncertainty. Another aspect to investigate

before entering an agreement is how many former clients of a supplier

have prematurely terminated their contracts. The higher the amount of

premature terminations, the higher the value of the clause.



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6 Conclusion

By answering the sub research questions, the main question (how can an

outsourcing contract be more flexible and yet profitable for both parties?) will

be answered and the purpose of this research can be seen as having

been fulfilled.

How is the flexibility handled by vendors today?

Vendors offer flexibilities in each dimension.

The flexibilities in contracts today are highly integrated.

The value of flexibility is not clear.

There is usually no clear upfront cost.

In today’s situation flexibility is always worth having.

The cost is calculated using the ABC method.

How can we measure flexibility?

Flexibility in a contract is similar to an option, where the client

has the right, but not the obligation, to exercise certain flexibili-

ties.

Real Options is a good approach for determining the value of

flexibilities and the upfront costs.

By using Real Options, it is possible for clients to determine

whether certain flexibilities are worth acquiring.

Robustness flexibilities can be determined by means of an expan-

sion option.

New Capability flexibilities can be determined by means of an

execute option.

Can Real Options be applied to better a contract?



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Benefits:

Clients will know what they are paying for.

Clients will know how much to pay for certain flexibilities.

Clients will reduce the amount of risk taking.

Clients will receive the required resources exactly when they are

necessary.

Suppliers will be more flexible.

Suppliers will know how much to be paid for the extra work that

has been involved, if an option is exercised.

Clients & suppliers will know which directions their partnership

can take.

To vary capacity usage, add something new and innovate with

new options over the agreements duration is a good means of

creating a successful partnership.

Flaws:

Prices and options that are decided today might not be the right

price or the right option required in the future.

Option values can be very difficult and complex to calculate.

Some parameters can be difficult to determine.

Suggestion for future research

As far as is known, this thesis is the first of its kind, covering flexibility

in outsourcing contracts with the assistance of Real Options Theory. It

has only been possible to arrive at a method for calculating the value of

flexibility in two of the four dimensions (Robustness & New capability).

It would therefore be interesting, in the future, to be able to cover the

remaining two dimensions (Modifiable & Ease of exit). It is also possible

to experiment with other types of options such as the option to abandon

rather than only using the option to execute or expand.



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Appendix A: Interview I With F. Winnubst, Atos

1. What does Atos insource?

Basically the whole area of IT except from traditional telephony and

printing/scanning (document) services that you usually have in offices.

To that we use subcontractors. Mainly IT infrastructure (80%) and

application management (maintaining the applications 10-20%).

a. How does the service work?

Pay per use(on demand)

2. What’s the general duration of most of Atos contracts?

Most usual 5 years. Some are 3 years and there are some rare contracts

that are for 10 years.

2. Do Atos offer their clients flexibilities like for example; ‘new

capacity’, ‘early termination’, ‘changes’ clauses in the contracts?

Early Termination

There are always termination clauses. Termination for cause, termina-

tion for convenience, termination for “bankruptcy” and many more.

Within termination for cause there are several clauses. One clause the

client always asks for is “poor performance”. If the supplier doesn’t

deliver, this clause can be used.

Another clause within termination for cause is “change of control”, this

one can be used if a competitor of the client takes over the contract from

us(the supplier), which can happen in rare cases.

Termination for convenience is basically if the client doesn’t like the

supplier anymore or if the client feels they can’t be partners for differ-

ent reasons. In those cases compensation must be paid to the supplier,

since the supplier has done a lot of investments and will lose future

turnover.



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Changes

Irrelevant. Because even if there is such a clause that allows our clients

to make changes for a certain amount of money, it will never be used.

Because the client will force the supplier to renegotiate. Even if there

are set prices for different services in the contract the client will still

force renegotiations since the world is constantly changing.

Benchmarking

Client hires an external firm every year that is benchmarking our

services against our peers. And we need to score between for example

5.5 – 7.7. If we score below we get penalties and if we score above we

will get credits. And in almost every outsourcing contract there are

rules written down about reward and penalties. There can be a mutual

pay for this clause.

There is also benchmarking on the price. The client can check if the

prices are competitive, if not prices will be renegotiated. In this case the

client always pays for the benchmark.

Innovation

Hard to arrange in a contract. The client always has a different view on

what innovation is. There is a clause in the contract that says that we

have to invest in new technology and not keep on “milking the cow”.

Usually what happens is that there will be an innovation board estab-

lished between the supplier and the client. The innovation board is a

part of the overall governance structure of the contract. The govern-

ances is usually at 3 different levels, operational (daily contact, formal

meeting every week), tactical and strategic(board to board, maybe

twice every year). The innovation board reports to the governance

board and the innovation boards task is to monitor if there is sufficient

innovation inserted into the contract (service delivery).

a. Is there any statistics on how often clients usually use them?

Ease of exit: Only happened once in 50 years

b. How much does it cost to use the clauses?



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Ease of exit:

1. Outstanding (not yet depreciated) investments that were made

for this contract;

2. Outstanding (not yet depreciated) transition cost (one-time

cost made for this contract);

3. Missed profit for the period of the contract that was not

realized.

3. What kind of flexible services does Atos offer their clients?

We categorize our services in 3 different towers or domains. Adaptive

workplace solution, application operations(running applications on

machines and making sure they are accessible) and manage infrastruc-

ture services

a. How is the cost calculated?

Pricing is per/unit or (on demand) - Today

ARC = Additional Resource Capacity. - past

RRC = Reduced Resource Capacity. – past

You expect a certain volume of the services and you agree upon a price.

When more resources are required to produce that volume beyond a

certain bandwidth, you pay additionally and when less is required you

get a price reduction.

This was prior to the pay per unit, when it was impossible to keep

track of what was consumed in number of units. So instead it kept track

on resources that were used in producing those units (Input required

by the supplier to deliver the services and volumes) and you would be

benchmarked to see if you were efficient enough.

Nowadays we use the simple P*Q model where P = price and Q =

quantity. Price is of course decided by the SLA. But in this case the

client pays for the service.



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There are also different levels in the pricing and in the quality of service

you will get. There are bronze, silver and gold. Of course gold will cost

more than bronze, but it will also provide a better service but to a

higher price.

The level decides the price but also the quantity. If a client wants a

higher quantity of something they will probably get a price reduction if

they ask for it. Of course it will be negotiated and written in the SLA.

What’s important to know is that in the end there is no predefined

price. For example if you pick the level gold and a certain quantity,

Atos will not be able to give a predefined price, because every client

always wants something special or different. What will happen is that

the price is being calculated by breaking down the services into all

simple activities and look how many resources(people, machines,

cycles, etc) required to provide that service(activity based costing)

b. Are there any typical trends in usage, capacity in-

crease/decrease through the duration of a contract?

Storage cost and prices (per GB or TB) have decreased in the last 5 years

with (on average) annually (year-on-year) 15%.

c. Is there any other type of flexibilities that Atos offer their cli-

ents that’s not pay per unit?

There is one when we charge per unit but also depending on the

economic success. So if the client does well we do well. If the client does

badly we do badly. There was a minimum so we could get some

certainty. There was a complicated formula that was connected to this

and the P*Q calculations. What we were trying to achieve with this was

to build stronger relationships and say that “if your economic is bad,

our is bad” “if your economic is well our is well”. But this was not a

success because we started using this just before the financial crisis so

the economy was bad for most of our client.



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Appendix B: Interview II With G. Delen, an outsourcing consultant

1. What is the usual duration of an outsourcing contract?

Min: Public sector 2 years. Usually contracts are 4 years.

Max: Public sector 10 years can be finished every year. There is a fixed

amount to pay for the exit. The reason for that is that the supplier

makes investments, so the supplier needs to get paid for the invest-

ments of each year. So if a client wants to exit, he needs to pay the

investment of the upcoming year.

2. How the costs of services & flexibilities are usually calculated

from the supplier perspective?

ABC-calculations. You would hope that the supplier makes the costs

transparent, but that isn’t always the case. If you make the calculations

transparent you gain more trust from the client because they know

exactly what they pay for. IBM for example needs approval from USA

on how much they can negotiate on prices which makes it less trans-

parent and a bit inflexible.

3. Is it still according to you and your experience worth to have

clauses like modifiable and new capacity in a contract?

Even though renegotiations might be an ongoing process it’s still

important to have clauses like these in the contracts to have rules and

regulations clear incase issues might occur.

4. Are there any other flexibilities under these categories which you

can think of that a supplier offer their clients?

There are different levels of quality a client can get. There is Gold,

Silver and Bronze. And depending on how where the supplier scores

they will get paid accordingly. Contracts should contain rules for

negotiating, so all parties all clear on how they will take place. Never

really heard about postponed payment. If a client would like to pay

later it would make me more worried and I would want my money as



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soon as possible and not postpone it.

5. Are there any services that you know where clients like to pay for

a fixed amount instead of pay per unit?

a. What would the reason be?

Nothing I can think about. Most clients usually pay for the amount they

use. Also with clouds nowadays it’s mostly pay per use.

b. What different units can you think of?

Pay per cycle, TB, it’s also important to know how fast you can retrieve

the data. KB etc. Number of seats for end-user computers. Develop-

ment and advice if paid/hour.

c. Do you know of any prices of some of these services?

I will send spreadsheets and pricing models but price for a seat is

around 1000euro/year, depending on how many applications are

supported by the seat.

d. Is there any common increase or decrease of these services over

time?

20% volatility.

8. What different early termination clauses do suppliers offer their

clients?

a. Do they always exist in every contract?

Nowadays all contracts have an exit clause. There have been contracts

in the past which haven’t had it. With exit it is usually the case of the

transfer from provider A to provider B. European regulations in the

public sector says that a client has to give the contract to the provider

that can provide the best price, therefore a client might have to switch

provider after the duration of a contract is over.

Providers must always have the documentation and technology ready

to be transferred to another supplier. Therefore documentation must

always be up to date.

b. Which are the most common to have in a contract?

Termination for convenience and termination for cause

c. What is usually the cost/price for having them and using them?



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Usually what you have to pay is what’s left of the investment for the

supplier and also the cost of transferring everything from provider A to

provider B.

d. Do you know of any statistics on how often clients usually use

them?

14%, 7% convenience and 7% for cause



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Appendix C: Interview III With Eric Bruinsma, IBM

1. What is the usual duration of an outsourcing contract?

Min: 3(short) normal 5 years.

Max: 7 years, rare 10 years

2. How the costs of services & flexibilities are usually calculated?

ABC based on what the client need, and how many people and what

kind of people IBM need to provide the services. So people, software,

network, third-party services. We also have the gold, silver and bronze

depending on how good quality the client is expecting.

3. In which services can IBM offer capacity increase and decrease?

a. Services that IBM offers pay per unit method?

In BPO more capacity usually means more people. Application out-

sourcing, more capacity is more changes in the application, so it’s about

coding, which is more people. Infrastructure outsourcing it usually

means more or less server capacity and storage, which grows and

usually never decreases.

i. What different units are there?

BPO = People and based on numbers of transactions or pay per

call/support. Application outsourcing it’s per person or per seat,

sometimes it’s price per function point depending on how big the

application is (international standard). Infrastructure it’s price per

server image or price per gigabyte.

b. Services that IBM offer fixed cost method.

There is a fixed price, but if you go beyond a certain range, you pay

more but within the new range. So it’s basically a sort of pay per use.

4. Is it still according to your experience worth to have clauses like

modifiable and new capability in a contract?

I do not agree with Frank. IBM doesn’t squeeze the margins on an

existing contract. If a client doesn’t have the budget we can have a look,

but it doesn’t indicate that we have to. If a client decides that they need



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something different for example after 3 years, it will still cost to make

the changes. Here it’s interesting to adapt the option theory so a client

before signing a contract can add options that the client knows the price

of when they will be exercised later on during the period of the contract

if needed for the pre agreed price.

There is a change procedure in every contract so the client and supplier

can negotiate and agree on new things if both parties agree on it.

5. Are there any other flexibilities under the categories which you

can think of that a supplier offer their clients?

We have found: ‘benchmark on service’, ‘benchmark on price’,

‘renegotiating’ and ‘postponed payment’.

Benchmark on price is when you hire a third-party to check the market

and compare your services to other supplier services and see if the

price is competitive with the competitors. Benchmark on service is not

that common to us, happens rarely.

Postponed payment or what we call it “flexible payment terms” is a

unique service IBM offers. We have our own financing company. The

client can sign a contract with us but also a contract with our finance

company (IBM Global Finance). So for each invoice the client can

decide to postpone the payment up to 180 days. The insourcing

department of IBM will then get paid by the financing company and

the financing company will take an interest from the client depending

on how late they pay. So the financing company works as a bank. Every

customer can use this service.

6. What ease of exit clauses are there?

Convenience, cause and change of control

a. Which are the most common to have in a contract?

Convenience, cause and change of control.

b. Do you know of any statistics on how often clients usually use

them?

Not very often. It is very expensive.

c. What is usually the cost/price for having them and using them?



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You cover all the investments for the duration of the contract. You pay

for the amortization of machines and other stuff that still has years of

value. You also pay around 5% of foregone revenue of the years left of

the contract.



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Appendix D: TP Vision case Lattice I



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Appendix E: TP Vision case Lattice II



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Appendix F: New capability Lattice



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Black-Scholes

flexibility in outsourcing tobias schavon afshin yavari · värdet av flexibilitet i ett...

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