Beware of Mixing IT Assets and IT Managed Services

by Pillsbury Global Sourcing Practice
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In the early days of outsourcing IT as a managed service, it was not at all unusual for a managed services price to be all inclusive of assets, services and facilities. That bundle of services and assets usually came with a "black box" style pricing that was devoid of transparency and created a myriad of challenges from changes in technology to addressing equipment refresh. Worst of all, these "all in" deals made it virtually impossible to fire your service provider because of the challenges of removing the assets from the supplier upon termination. Despite these challenges, there are times when a customer's asset strategy still calls for acquiring assets from their service provider. In those circumstances, customers should be aware of the inherent risks in including IT assets in an IT managed services agreement and structure the transaction to minimize the risks.

Assets could be included for just about any service category of a managed services agreement. For the purpose of this discussion we are going to focus on the Servers and Storage assets that comprise the central compute services for a company.

Margin Expansion
It goes without saying that anything being provided by a supplier will come with its attendant margin; nobody is going to do anything for free. Therefore, from a pure dollars and cents perspective, keeping the assets on the client's side of the ledger is more than likely to produce a lower cost alternative. If the overall deal is going to include the asset acquisition as part of an agreement with the managed services provider (presuming they sell equipment), at a minimum, consider unbundling the services and assets components of the agreement and acquire the assets as a separate transaction using the service provider's finance division or other department as it varies from one supplier to the next.

Firing the Maid without Selling the House
Another important consideration in keeping the assets out of the managed services pricing is the degree of flexibility to get out of the transaction. If the supplier is providing services on their equipment and in their data center, it's going to be a lot harder to fire the supplier if service levels are not meeting your expectations. Conversely, if you own the equipment - and even better have it housed in a 3rd party CoLo data center - then the transition to a new service provider is far easier and with a much lower operational risk.

Pricing Transparency
If, for whatever business or tactical reasons, you still want the supplier to provide the equipment and services as an integrated managed services price, then require them to segregate the pricing such that you have a services price (i.e., $X for a Windows Image, $Y for a terabyte of storage), an assets price (by device and/or software title), and a facilities charge. Having this level of granularity will allow you to interrogate the pricing to ensure market competitive rates as well as gaining a clear understanding of the split between services, assets and facilities. You will also be able to test the asset pricing by having your VAR provide a quote for a similarly configured bill-of-materials.

Refresh and Future Hardware Acquisitions
Another consideration with regard to hardware being included is the problem of forward-pricing assets. In older deals, a contractual price for each element is established for the term of the agreement. The price suppliers used to forward price those assets is very likely not producing the best outcome for the client. If you are going to have the supplier provide the assets as part of your agreement, after the initial acquisition include a provision in the agreement that allows for the price to be determined for future purchases at the time of the purchase. This will give you the ability to independently determine what the market rate is for a particular device at the time of the future acquisition. The agreement should also allow for the client to purchase future equipment if the supplier is not able to match the market rate as determined by the client.

Changing Rules on Accounting for Assets
One other reason some clients had suppliers provide the assets as part of a transaction was to cause a particular accounting treatment of those assets to occur with respect to the client's books. Because of changes in accounting guidance over the last few years, make sure your accounting professionals are consulted with respect to any asset strategy you are intending to deploy in a managed services contract.

In summary, the lowest cost and most flexible solution will likely see the client retaining ownership of the assets in a managed services transaction. Having the supplier provide the assets not only increases the cost (margin on assets), but increases the difficulty of unwinding the transaction. If assets are to be provided by a supplier, ensure you obtain separate services, assets and facilities pricing in order to still obtain the best pricing possible (i.e., avoid "black box" pricing) both in the beginning of the contract and throughout the term.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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