Stop Before Signing a 10-Year Core IT Contract

March 27th, 2015

3-27-15-Paladin.pngHow can any of us bet on the function and value of technology 10 years from now? You cannot. However, vendors are doing a great job of convincing banks they need a 10-year technology contract.

Nobody except perhaps for the U.S. government should accept fixed IT cost structures and terms for 10 years. It is my opinion that proposing an eight, nine or 10-year contract is one of the biggest crimes committed upon bankers in recent years by core IT vendors. Frankly, they should be ashamed of tricking bankers into believing there is any strategic value in such an offering. How many banks offer a 10-year, fixed-rate commercial line of credit or a 10-year CD with guaranteed interest rate increases of 3 percent to 5 percent annually?

Bankers are doing their best to run their institutions, manage compliance issues, fight off margin compression and try to make a buck. I understand that some may think that a 10-year contract will lock their core IT vendor in to incredibly low pricing and favorable terms. A 10-year contract puts a check in the vendor management box and lowers bankers' distractions, permitting focus on what bankers know best...banking. If you really knew what a 10-year deal actually does to a bank, you'd realize that you just locked yourself into a bad deal.

An eight, nine or 10-year core IT contract guarantees the vendor that no-matter-what, you are going to pay premiums for a long time, even if the cost of the technology delivery drops to near zero. The institution may grow, contract or change its mission, but the fees are going to continue growing annually as consumer price index increases chip away at your efficiency ratio.

Bankers are at a terrible disadvantage and must typically wait five to seven years to restructure these contracts. Once you complete the wait, you find very little switching leverage since a true oligopoly exists. Eighty-five percent of the market is controlled by three companies, Fiserv, FIS, and Jack Henry & Associates. Vendors know that only 4 percent of banks change vendors annually.

Your World Under a 10-Year Agreement
Pretend you want to switch vendors because your provider is no longer providing quality service or was hacked by the North Koreans. Nope. You're stuck. Maybe your bank wishes to upgrade and buy a world-class Internet banking system because the version offered by your core is no good? You're stuck until your grand-children graduate high school in 2025.

Search the fine print in your agreement for the exclusivity clause preventing a switch of any ancillary service to a competitive offering. Consider complaining to the vendor about the service level agreement (SLA). Sure, they'll buy you lunch, but the complaints fall on deaf ears. Their nods of empty concern are backed by the fact you’re going nowhere for at least seven more years!

Imagine you happen to meet a colleague at a bank show and he tells you his bank is paying the same vendor 40 percent less for the same services? That's nice but you'll have to wait to get anything changed until the next two presidential elections. Decide to sell the bank? Get your shareholders ready to choke on millions in termination fees.

High Fives at the Water Cooler
I’m cynical about finding any value in a 10-year contract, because there isn't any, unless of course you're the vendor. In my opinion, the absolute longest term should be seven years, and even then, there better be a lot of language that begins protecting your backside in years five, six and seven. The sales guy that brings in the 10-year whale is immediately promoted to the corner office and is enshrined into the president’s club for the remainder of his career. Water cooler high-fives abound at any core IT provider that gets a bank or credit union to sign onto an eight, nine or 10-year deal. If you sign a 10-year deal and can’t find your sales rep, that’s because phones don't work on cruise ships.

Trust your vendor, but ensure that you are getting fair market pricing and making the right decisions about business language and terms. Going into these multi-million dollar negotiations alone is like playing poker in the World Poker Tour when you only play Texas Hold’em once every five years.

asilva

Aaron Silva is the president at Paladin fs, LLC.  Mr. Silva speaks regularly at banking and credit union association events nationally and is a published writer on strategic and technology issues facing communality financial institutions.