Different Approaches for Renewing Vendor Agreements

Navigator Edition: August 2014
By: Myron Schwarcz and Ryan Allen

Relationships between issuers and their respective card brands, processors, and other service providers tend to be highly complex. This complexity is in part due to the nature of the services being performed and to the high cost of transitioning providers, which together create lengthy relationships with extensive integrations. As such, the agreements governing the relationship between service providers and issuers are complicated and challenging to negotiate. Many issuers seek to extend agreements reaching maturity at existing terms or default to automatic renewal provisions, rather than going through a rigorous renegotiation process.

However, there are trade-offs associated with such an approach.   In general, the costs for card brand and processing services decline over time, while service provider performance obligations tend to increase. The expiration of vendor contracts provides opportunities for issuers to assess current relationship dynamics and target enhanced value in subsequent terms. However, the process employed (e.g., competitive or sole sourced) can materially affect the issuer’s ability to achieve its desired outcome. First Annapolis, through its experience working with many issuers over 20+ years, has identified key factors to consider when determining whether to pursue direct negotiations with a single provider or execute a competitive bid process with multiple providers, including:

  • state of the relationship;
  • current proximity to desired business terms and pricing levels;
  • strategic and risk factors;
  • compliance obligations; and
  • internal guidelines, timelines, and resource availability/constraints.

Issuers that are reviewing incumbent vendor relationships should evaluate these factors in parallel. To facilitate a comprehensive evaluation, it is essential that all key issues and their respective importance to the overall business strategy be identified early in the process. When evaluating an incumbent provider, issuers should consider the state of the relationship and major pain points. If the relationship has soured due to poor performance, service quality, functionality gaps, and the like, it is likely in the issuer’s best interest to evaluate alternative providers. Soliciting competing proposals not only provides issuers the ability to evaluate market features, functionality, and pricing against their current relationships, but it can signal that considerable changes are required for the incumbent provider to maintain the business. If issuers employ this tactic, it is important to manage the incumbent effectively by clearly, and frequently, communicating its objectives throughout the process, regardless of the outcome. Moving forward with a competitive process does not necessarily mean that an issuer will ultimately migrate the business. Our recent experience has found that in 75% of competitive situations, the issuer remains with its incumbent provider.

This competitive dynamic creates the necessary leverage for issuers to optimize value regardless of the appetite for changing providers. Additionally, issuers are better equipped to address functional, financial, and performance issues related to the incumbent provider after understanding what other service providers are willing to offer. Our issuer clients that have sourced vendor relationships through competitive selection processes have generated higher levels of financial savings relative to those that have sole sourced negotiations. The data in Figure 1 highlight the financial aspect of this dynamic. Insofar as myriad factors influence pricing for such services, the competitive process alone does not explain these observations, but the relationship is clear.

Figure 1: Competitive vs. Sole Sourced Process Savings

Fig-1_-Competitive-vs-Sole-Sourced-Process-Savings_v2Source: First Annapolis Consulting research and analysis.

A competitive process is not always the best option in situations where issuers, having evaluated incumbent relationships, have not identified material opportunities for improvement in business terms, pricing, or service performance. The timelines, resource commitment, and costs required to execute a competitive process are considerable. These processes often require months of work, dedication of critical staff to support the evaluation, and the assistance of outside advisors and attorneys. In addition, the process itself may stall negotiations that could have otherwise begun at the same time, thereby delaying potential benefits of a renewal agreement. As such the potential benefits of conducting a competitive process may not always justify the costs. To effectively run a competitive process, an issuer must begin about 18 months in advance of agreement expiration to allow time to evaluate and select a vendor, negotiate an agreement, and potentially perform a conversion. Though, timing flexibility may exist depending on the nature of the rights and obligations of issuer and vendor in the agreement governing the existing relationship.

While achieving optimal contractual and financial results is often paramount, it is also necessary to consider the strategic and risk factors inherent in the decision making process. If an issuer has multiple strategic relationships with a vendor, it may be necessary to consider the implications of maintaining that relationship versus implementing a competitive process and selecting a competitor. There can also be implications in agreements that have financial contingencies based on the enterprise value of relationships that, if broken, could severely impair affiliate business units.

In summary, many factors will determine the process by which card issuers select and negotiate with service providers. It will be important to balance the need for improvement in business and economic terms with the timing, resource requirements, and potential impact to incumbent relationships.

For more information, please contact Myron Schwarcz, Senior Manager, myron.schwarcz@firstannapolis.com; or Ryan Allen, Senior Analyst, ryan.allen@firstannapolis.com. Both are members of the Deposit Access Practice, specializing in Strategic Sourcing.

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