02 Feb Marching Orders 2016: Avoid Long-Term Contracts
We’re going to offer some advice for the coming year that on its surface seems counterintuitive, but when looked at practically, makes a great deal of sense. It’s the fallacy of the long-term (i.e., three-year) contract. Say what?
Standard advice for IT services executives is to lock in that long-term contract, thereby assuring a steady stream of recurring revenue for at least the length of the deal. Sounds right, but hold on and think for a minute about an alternative. We’ve been advising our clients to get behind the idea of a one-year, evergreen contract, automatically renewed annually, with built-in price increases to cover the cost of inflation and with a one-month termination clause. Here’s why.
- Long-term contracts don’t necessarily add value to the business. What adds value is the stability of your client base and the class of revenue derived from the technologies and services you offer that are of value to your customers. Contracts no longer guarantee this stability. Customer satisfaction does.
- Customers tend to shop their business more often at the end of a three-year contract than at the expiration of shorter contracts. Things change, clients get antsy, new technologies emerge, and it simply seems the right thing to do to see what else is out there.
- Three-year contracts aren’t the security blanket they are made out to be. Customers have been known to terminate a contract before its expiration date, and the truth of the matter is there isn’t too much you can do about it. Sure, you could take legal action, but that costs time, money and frightful PR if the fight goes public, at which point prospects might decide to pass on doing business with your company.
- Short-term contracts can dramatically shorten the sales cycle. It can take two to three months to negotiate a long-term contract — months with no revenue coming in the door. Multiply that by the number of new customers you are taking on, and it can add up to serious dollars. Shorter-term contracts tend to be less complicated with fewer objections and obstacles, and therefore they get executed quicker, resulting in a faster path to the recurring revenue.
- Companies with long-term contracts can get lulled into a false sense of complacency about servicing the business. With a one-month exit clause, you’ve got to earn your stripes every day. Think of it as a built-in incentive to drive excellence in customer satisfaction — which, when all is said and done, is the primary driver in keeping and attracting customers.
For your next contract negotiation, give this alternative approach a shot. You may discover a competitive advantage appealing to your customers and beneficial to your company. If you’re a bit hesitant and need some more ammunition to go forth, give us a call. We’d be happy to share with you our experiences in these types of contract negotiations.