Why Does Contract Negotiation Matter to Financial Institutions?

It may sound simplistic, but every contract signed by an organization obligates the parties to do certain things for a set period of time. As such, contracts for essential services greatly impact what a Financial Institution can and cannot do and what it offers to its customers. In fact, in many ways that obligation drives the organization’s business, according to Tony Baumgardt, PRI debit card consultant.

In addition, as the BAI article Leveling the Playing Field with Vendors rightly points out, the contract embodies the relationship between a bank and its vendors.

“The level of consolidation in the vendor community has made many of these vendors very powerful, and it is important for banks to establish and improve these strategic relationships in a way that levels the playing field between the bank and the vendors.” (Leveling the Playing Field with Vendors, BAI)

Because contracts drive the FI’s business and embody the relationships between the bank and its vendors, it’s important to get the contract negotiation right.

“The goal is not to beat either side up, but to negotiate terms that set up a win-win situation for both the FI and the vendor,” Baumgardt said. “Contract negotiation is a critical element to the long-term profitability of the FI.” 

Any time a contract is up for renewal, the terms and conditions should be closely reviewed, preferably by outside experts who have deep experience with contract negotiations and how they impact a bank’s profitability and success. By using outside help, FIs can gain access to valuable experience and information they wouldn’t otherwise have.

Terms and Conditions

Multi-year contracts

As times change, institutions merge and costs rise or decline, being stuck in a multi-year agreement with a vendor could limit the FI’s ability to re-negotiate a better deal or create the need for an expensive buyout of the remaining term, Baumgardt said. On the other hand, some longer-term contracts make good financial sense depending on the FI’s size and strategic objectives. It may not be practical for a community institution to be reevaluating and renegotiating its contracts every three years or less. In addition, there’s little downside in getting into a long-term contract for an FI’s debit card brand.

“It’s important to find the right balance,” Baumgardt said. “Contract negotiation is a systematic, careful process that should sometimes be initiated up to three years in advance of contract expiration, allowing the FI to really evaluate the contract and whether they want to put it out to bid.”

Some types of contracts, such as technology contracts, should be decreasing in cost as technology advances. Baumgardt recommends staying away from auto-renewals of these kinds of contracts to avoid overpaying and letting the vendor know they will need to earn the business each term.

Limitations on liability

What happens if there is down time or breakdowns in the vendor’s product? How will they cover losses that the FI incurs and how will customers be reimbursed? Most companies will limit their losses to what the FI has paid for the service, but that may not be enough to cover real losses and damage caused by provider. Core processes and other essential services are so entwined with the FI’s business, it’s important to understand who pays when something goes wrong.

Price increases

Terms that allow for annual price increases need to be understood so the FI will know what to expect over the term of the contract. Terms that require taking on new services at “list price” need to be struck from all agreements. These price increases can negatively impact the FI’s profitability over time. It’s important to examine the effects of cost not just today, but years into the future.

Baumgardt emphasizes that contract negotiation is a critical piece of an FI’s business and must ultimately align with its strategies and needs. Partnering with a firm like PRI that is experienced in complex vendor contract negotiations can help the FI identify red flags and take advantage of opportunities to save money and strengthen their offering to their customers over time.  

In Part 2 of this blog, we will tackle how to be prepared to sit down at the table and negotiate the contracts that drive the FI’s business today and in the future.

Profit Resources specializes in identifying profitability improvement areas for financial institutions through revenue growth, cost control, streamlining processes, and effective use of technology. Contact us to learn more about our personalized approach to propel growth and improve profitability.