What’s in Your Contract?

Understand the basic types of HR technology contracts to avoid headaches with vendors.

By Bill Roberts Jul 1, 2010

0710cover.gifConsider this scenario: An HR software-as-a-service vendor advertises 100 percent network availability but refuses to commit to these service levels in the contract unless you pay a premium not stated in its advertising.

This is a common bait-and-switch tactic, according to Matt Karlyn, senior counsel at Foley & Lardner LLP in Boston. Some vendors "make broad statements in their marketing materials and then refuse to agree to contract terms consistent with those statements," he explains.

His suggestion: Include your preferred contract, prepared with the help of your attorneys, in the request for proposal. "Vendors tend to be savvy negotiators, so you, as the customer, need to set the ground rules," Karlyn insists.

Shawn Davis, director of HR technology and analytics at Intermountain Healthcare in Salt Lake City, agrees. The nonprofit health care system with 32,000 employees uses software-as-a-service (SAAS) and licensed on-premises software. "We have our own standard contracts with our requirements built in," says Davis, a member of the board of directors for the International Association for Human Resource Information Management (IHRIM).

About half the time, vendors accept Intermountain’s contracts. When they don’t, "we make sure the things in our contracts are in their contracts," Davis says. He urges employers to draft their own contracts because doing so will help them understand what they want from a contract and at what service levels and prices.

Following Davis’ advice is just one way to get what you need from a software, SAAS or outsourcing contract. Yet legalese and negotiating tactics aren’t everyday skills for HR information systems professionals. Here is some expert advice.

Start with a Strategy

A technology contract is a reflection of HR strategy, which should reflect organizational goals, according to Linda Merritt, research director for HR outsourcing at NelsonHall, a Newton, Mass.-based research and advisory service. "If you don’t know where you are going, any road will not take you there," Merritt says.

A founding member of the Human Resources Outsourcing Association—a group of customers, providers and others who are developing standard metrics for large HR outsourcing contracts—Merritt adds that if you don’t have a strategy for HR, then it is hard to have a strategy for HR services delivery. If you have a strategy for HR services delivery, that answers what functions should be internal, outsourced, centralized, decentralized, local or in the field.

The reasons you decide to own, rent or outsource flow into the contract. "An HR contract is a manifestation of your strategy," says Robert Zampetti, director of consulting services at Towers Watson, a New York-based firm with an HR consulting practice. Once you determine ownership, provisions such as upgrades and service levels ripple through your contract.

Everything’s Negotiable

Contracts fall into three types:

  • Software licenses you own.
  • Products you rent from vendors that run them, or SAAS.
  • The outsourcing of processes and technologies.

Some pitfalls are common to all, and some are specific to the type of contract.

Most HR information systems professionals are familiar with software licenses. Fewer have experience with SAAS. Many have experience outsourcing payroll and other functions, but few have experience with the multiyear deals for multifunction HR outsourcing.

HR managers need to be educated on their contracts, Davis says. "It is not something to put in your drawer and tuck away. You need to know what is in it. You need to know how to interpret it as the relationship evolves over time."

Software licenses are the least complicated. The buyer owns the product, the data and the process. Still, issues surround annual maintenance costs and the process of how the software code becomes available to the buyer if the vendor is acquired or goes out of business, called code escrow.

In SAAS, the vendor owns and operates the product; the buyer owns the data. Ownership of the process is less clear. The contracts are not as complicated as HR outsourcing contracts, but because the model is still evolving, they can contain land mines.

In outsourcing contracts, the vendor owns everything except the data. These contracts can be fraught with issues because you’re moving entire functions off-site to partners. The big risk is an out-of-sight, out-of-mind mentality; you still need to pay attention. Governance clauses can help. Experts also say customers and providers become so enmeshed that some contend they ought to have prenuptial agreements.

Common Problems

Pricing formulas, escape clauses and liability are common issues in all contracts.

A good contract spells out how pricing is set, how users or seats—the total number of users at one time—are counted, and what defines a user. Is each employee a user? What about retirees or seasonal workers who use the applications? "I see contracts that are very precise on pricing, volume and units but not on when or how they’re counted," Zampetti says.

Davis notes that this is just one area where a contract reflects HR strategy. If you’ve done workforce planning and you know you’re going to be growing, then you take that into account when negotiating the number of seats.

Escape clauses apply to individual pieces of software or services and to full contracts. If you pay for more modules than you end up using, can you lower your cost? What about terminating the contract entirely if a SAAS or outsourcing vendor relocates its data center to a place that no longer meets your criteria? Zampetti says he doesn’t see these details in contracts as often as he would like, although they are definitely negotiable.

All three types of contracts need to include precise statements of the features or work they will cover. Even if you’ve thoroughly tested licensed software before buying, you still want guarantees in case the product doesn’t do what the vendor claims.

This issue is even bigger for SAAS and outsourcing. For example, the payroll outsourcer demonstrates reporting features you like, but after the vendor implements its system, you discover that those features are not available for your European payroll. "You want to make sure you get what you pay for," Zampetti says.

Then there’s liability. Software licenses are straightforward on this matter. Except for warranties on technical functions, the licensee bears any data and process-related risk.

In outsourcing, you are buying the provider’s expertise—in federal payroll regulations, for example. Consequently, the provider usually is liable. "There typically are lengthy clauses around who is the fiduciary and under what circumstances," Zampetti says.

Some SAAS vendors, he cautions, don’t see themselves as liable for process—updating regulations, for example—although they may claim to provide that expertise. If you ask them to put it into the contract, they balk. Zampetti says the market is so competitive that there is broad room to negotiate, and that eventually SAAS contracts will look more like outsourcing contracts as far as liability is concerned. "This is still virgin territory," he says.

The Fine Print

Each contract type has specific issues.

The contract for a software license should detail the level of vendor support and consulting fees you pay during implementation. In addition, maintenance is a key factor.

Maintenance clauses should spell out problems covered, hours and days available (such as nights and weekends), response times, the protocol for escalating issues to higher managers, and any upgrades. Does the contract begin when you sign it or after the software is in use? These factors are negotiable. Most vendors charge a maintenance fee of 18 percent to 20 percent of the license price for each year the software is in service. "There isn’t a lot of negotiating room—maybe a percentage point," says Rich Berger, SPHR, senior director of HR information systems at Citrix Systems Inc., a Santa Clara, Calif.-based software developer with about 5,000 employees.

The trend is toward tiered maintenance models, according to Jason Corsello, vice president of Knowledge Infusion, a Minneapolis-based HR consulting firm. "Even in SAAS, we’re beginning to see different tiers and different fees associated with support."

SAAS has its own issues. Gartner Inc., a technology advisory firm in Stamford, Conn., recommends that SAAS contracts include clauses for disaster recovery, data security and privacy, exit and merger and acquisition protections, uptime (the amount of time the application is actually functional), performance service-level agreements, penalties and incentives, and pricing.

James Holincheck, a managing vice president at Gartner, says SAAS buyers often overlook renewal issues. "If you don’t have language that limits how much the vendor can increase the subscription fee, you can get into trouble," he says.

Customers also tend to overlook issues associated with termination of contracts. "When you end the contract, the vendor is not enthusiastic about being responsive, and I’ve seen glitches. You have to be able to get your data back," Holincheck says—and not just structured data from a relational database. A recruitment application, for example, might contain a passel of unstructured data—resumes, cover letters and sample work products. "You need to understand exactly what data you want back and how you will get it," Holincheck stresses.

Davis adds that the contract should cover purging your data: "After you get your data, make sure the data at the vendor site is destroyed, and that you know how it is destroyed."

Going Outside

Outsourcing contracts are by far the most complicated. There are best practices for payroll, benefits administration and other single processes, and there is more knowledge about multifunction HR outsourcing today than there was a few years ago. For either, Gartner’s best practices for SAAS contracts are a starting point, but there’s more.

Berger notes that outsourcing contracts are more detailed than the others because they describe how your HR services are going to be different in the future. Service-level agreements are more detailed than SAAS. For every service, there are multiple metrics in an outsourcing contract. Because of the complexity, outsourcing contracts may create the most confusion and issues, even when everyone has good intentions.

Berger also observes that too much is made of the financials of a contract, and sometimes HR professionals don’t understand the cultural impact of the move to an outsourcing model. First, for example, managers will try to negotiate the lowest price point. Second, to meet that price point, the vendor will have to change the model. Then, "HR and employees are not ready to consume those changes. In my experience, this is the biggest ‘gotcha,’" Berger concludes.

Say the initial outsourcing move is a lift-and-shift of an in-house call center, to be followed by a move to self-service intended to lower costs. This could be more than your employees can handle back to back. You and the vendor want to get to self-service as soon as possible, but the initial move to outsourcing is a tremendous cultural change in itself. Berger advises moving to outsourcing first, waiting a while and then moving to self-service. The phasing will cost more and must be spelled out contractually.

Berger, also an IHRIM board member, says the biggest concern with any contract is what happens if the vendor disappears through bankruptcy or acquisition. "It is scary because it typically is not covered in standard contracts, and there is a lot of consolidation in this space," Berger says.

Building In Protection

Whether you own, rent or outsource, you want the software code to be available if the vendor goes away so you could, if you wish, operate it yourself. Holincheck says code escrow is standard in software license contracts but not prevalent in SAAS contracts. SAAS contracts should also state how you get your data back, how soon, who pays the cost and what happens if there are problems.

If possible, you need guarantees that if your SAAS vendor is acquired, the new vendor will run the application under the same terms at least until the contract ends. With outsourcing, the new owner usually wants to fulfill current contracts and keep the customers, but HR managers still need to put these terms in writing.

In all cases, "Make sure you protect your investment so you have the ability to take ownership should there be a major change in the company," Berger says.

The author is technology contributing editor for HR Magazine and is based in Silicon Valley in California.

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