Properly managed, they can cut noninterest expense.
By Brad Downs
Obtaining a better efficiency ratio is always at or near the top of the list of priorities for banking executives. To achieve this goal, considerable time is spent focusing on the delicate balance between revenue and spending. However, a surprising number of executives do not consider another option that can make a material difference in their efforts. Properly managing vendor agreements can make a significant impact on a bank’s bottom line without ever eliminating services or even changing partners. In some cases, this can reduce 1 to 3 percent of non-interest expenses.
Instilling a set of best practices around vendor contract management will help ensure that the fees paid to suppliers are market competitive.
There’s a right time for everything and contract negotiations are no exception. Given the demands on bankers and the sheer number of contracts a financial institution has, many of them start negotiations at a point that leaves most of the leverage with the vendor. To determine how to avoid this situation, a bank must consider two factors: What type of service the contract covers and whether replacing the incumbent supplier is under consideration.
Generally, it is best to start negotiations with vendors a minimum of 24 months before the contract expires. Contracts with vendors that provide core banking solutions are an exception to this rule, requiring a minimum of 36 months before termination to negotiate properly. In both cases, an institution may even want to start earlier if there is a plan to replace the incumbent vendor.
Be Mindful of Changing Regulations
Regulatory oversight is a reality of the financial services industry, and changing regulations can have a direct effect on an institution’s vendor contracts. For example, a regulatory action could remove restrictions that have a direct impact on the number of transactions that are being processes within its debit network. This could occur with the lifting of certain measures that artificially suppress interchange or restrict how institutions promote their products. With better interchange rates and more money to promote a product (e.g., a debit card), the number of transactions will likely increase and could impact long-term payment network contracts. Finding out volume limits have been exceeded after the fact is not the type of surprise any banker wants. Being aware of how regulatory developments might impact vendor contracts allows a bank to be proactive in renegotiating terms and conditions that could be affected by such developments.
Explore All Options
Exploring contract options does not necessarily mean switching vendors. Considerable investments of time and resources go into developing good partnerships with suppliers. It would be foolish to jettison this type of relationship simply because of price. However, it also is easy for longstanding vendor relationships to become overvalued. It is important to ask, “Is this relationship happening because it has always been this way, or is it because this is the best business option for this institution?”
Successful contract negotiations all have one characteristic that maybe easily overlooked — communication. This means that all the parties involved understand how to clearly articulate their needs while also comprehending the needs of the others involved. One area that is particularly difficult to discuss is pricing and payment terms. Not discussing these elements openly and directly will create a dysfunctional and, sometimes, adversarial environment. Any third party a bank uses to assist in vendor contract negotiations that does anything to limit this need for transparency — e.g., not allowing vendors to speak directly with the institution — compromises the quality of the outcome of the process.
Audit Your Bills
Imagine licensing services from a vendor that your bank never has any intention to use. Not likely, right? Yet, banks that do not review vendor invoices to ensure they are still using all the services they contracted for risk doing that. Often, refunds can be issued for services that are no longer active, or perhaps were never used. Tracking the detail in vendor invoices can be time-consuming but many firms like our own offer services and software that tracks and audits these details over the life of a contract.
Just as certain characteristics are required in signing a contract that represents the best interest of an institution, there also are warning signs that may develop that should not be ignored. For example, if a vendor comes to a bank with an unsolicited contract renewal offer that includes signing incentives, it may indicate that the contract is not drafted to the bank’s benefit. Conversely, if during a renegotiation process a vendor submits a proposal but then declines to continue to participate in the bid, there may be something behind the scenes that would merit exploration. Usually this has to do with a vendor feeling that a lack of communication and transparency is creating an unlevel playing field.
About Termination Fees
Remember, just because the early termination fees in a contract are painful to imagine, renegotiation of that contract is not out of the question. A good vendor partner will work with a financial institution to find a middle ground that addresses the needs of both parties. On the other hand, if a vendor relationship is such that a change is needed before a contract expires, a new vendor may be willing to explore ways to mitigate the impact of the termination fees.
Help Is Available
A good third-party contract management partner can be particularly useful in guiding an institution through the negotiating process. Banks evaluating such partners should pay careful attention to the firm’s areas of expertise and how it it compensated. Seldom is any one firm good at everything.
In the quest for a better efficiency ratio, do not overlook what best practices around vendor contract negotiation can do to support the effort.
Brad Downs is CEO of SRM (Strategic Resource Management). For more information, visit www.srmcorp.com.