A key vendor has just provided notice that fees for the upcoming contract renewal term are increasing substantially and your company has little or no ability to switch vendors in the required timeframe. Sound familiar? This situation highlights the risks of vendor lock-in.

Vendor lock-in occurs when a company becomes reliant on a vendor to the point that resources required to switch to a different vendor (including time, money and personnel) are significant. Your company becomes “locked in” with the vendor because, in most circumstances, the costs of switching to a new vendor outweigh the benefits achieved. The company is now in a vulnerable position with such vendor. The vendor has significant leverage in the legal and business arrangement.

While vendor lock-in risk can never be completely eliminated via the contracting process, attention to this risk by the business and legal team from the outset can significantly mitigate the risks. Here is a list of some strategies to help mitigate vendor lock-in risk via the contracting process.

1. Vendor Due Diligence. This may be obvious, but companies often get tunnel vision due to the perceived benefits of a particular service (speed, cost savings, or brand reputation). Companies should thoroughly vet several potential vendors via a formal RFP process. This process should confirm that the vendor and services are worthy of reliance by the company. Further, this process will allow the company to develop relationships with potential replacement vendors that do not win the initial RFP. Such relationships may allow for a quicker transition to such vendor, if the need arises.
2. Fee Increases. Vendor lock-in often becomes most visible when the vendor exercises its right to increase fees. Once your operations are deeply integrated with a vendor’s service, fee increases can feel non-negotiable because the vendor knows your company has little ability to go to another vendor. To mitigate this risk, the vendor contract should include transparent and enforceable procedures for price adjustments, including periods during which vendor may not increase fees, significant notice for fee increases and percentage caps for fee increases.
3. Termination Rights. Termination provisions are often generic and standard, permitting the company to terminate for vendor’s uncured material breach. Your company may consider more flexible termination provisions. You may consider: (1) defining certain occurrences as material breaches that are incapable of cure, (2) shortening the applicable cure period, and (3) obtaining a termination right if fees are increased by a certain amount. Of course, your company should always ask for a termination for convenience right, but the vendor will oftentimes reject such request outright. A compromise position may be obtaining a termination for convenience right if you pay a certain termination fee. On the other side of the coin, your company will want to narrow vendor’s termination rights. The vendor should not have a termination for convenience right, and your company should require long cure periods. Termination rights need not be completely “mutual” in a mission critical vendor agreement.
4. Nonrenewal Rights. Nonrenewal provisions are closely related to termination provisions, but not the same. Nonrenewal provisions allow a party to “opt out” of an automatic term renewal if such party provides notice within a required timeframe. The required timeframes are typically the same for the vendor and company (30 or 60 days), but your company should not be afraid to attempt to remove vendor’s nonrenewal right or require very significant notice (one year or 18 months) for vendor to opt-out of an upcoming renewal.
5. Transition Assistance and Portability. Every vendor contract will terminate or expire at some point (whether in one year or 20 years), and your company will need assistance from the vendor when taking such services in house or switching to a new vendor. It is important to define these required services from the vendor in the contract, before such services are required. Moreover, the parties should negotiate the fees for such services at the time of contracting. Such services should include: (1) continued provision of the core service, (2) additional professional services from vendor to assist the transition, and (3) data and intellectual property portability. You do not want to be in the position of negotiating transition assistance services and fees at the time of contract termination or expiration. The vendor has significant leverage at this point in time and may refuse to provide such services or require significant fees for such services. Finally, the contract should set forth standards and architecture that maximize portability of you company’s data, workflows and custom IP.
6. Continuous Innovation. Vendor innovation is a double-edged sword. As services become more tailored, transitioning becomes harder. Yet, stagnation can leave your company with outdated tools while competitors move ahead. Ideally, you can require the vendor to say up to date with innovation while delaying deployment of such updates until you review and test the service updates. Contract requirements of this nature will help mitigate the need to explore alternative vendors because your current vendor is not improving their services.
7. Backups. A company should never rely exclusively on a vendor for data backup. Cyber incidents, insolvency, or natural disasters could result in permanent data loss. Maintain regular backups, either on-site or with a secondary vendor. These backups should be frequent, encrypted, and tested regularly for integrity. A robust backup strategy ensures you can recover quickly and maintain operations even if your primary vendor fails.
8. Audit Rights and Transparency. Transparency is the foundation of trust. Retain the right to audit the vendor’s operations, especially in areas related to data handling, compliance, and security. These audits can be periodic or triggered by specific events. Require regular reporting on performance, incidents, and remediation efforts. Access to this information allows you to identify issues early, enforce accountability, and make informed decisions about the vendor relationship.
9. Exit Strategy and Knowledge Retention. Transition assistance is only part of the equation. Your internal team must be equipped to operate independently of the vendor. Document workflows, system configurations, and integration points throughout the engagement. Cross-train staff and maintain internal expertise to reduce reliance on external support. This proactive approach during the life of the vendor contract ensures that when the time comes to transition, your organization is ready.
10. Personnel. Vendors may commence the sales process and early stages of the relationship with the vendor’s “A team,” only to move the “A team” players to a new account after your reliance on the vendor has significantly increased. Your company can combat this risk by including provisions that name certain key personnel and give your company veto rights in the event vendor wants to remove such personnel from your account.

This list is not exhaustive and should be tailored to the specific facts and circumstances of each business arrangement. It is essential to consider the legal, operational, and strategic implications of every agreement. Considering the vendor lock-in risk from the outset of a vendor relationship can significantly mitigate the risk and potential impact of such risk.

Koley Jessen regularly advises clients throughout the procurement and negotiation process for mission critical vendor agreements. Please reach out to our Commercial and Technology Contracts team if you have any questions about vendor lock-in risk generally or a specific vendor arrangement or contract.

_{This content is made available for educational purposes only and to give you general information and a general understanding of the law, not to provide specific legal advice. By using this content, you understand there is no attorney-client relationship between you and the publisher. The content should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.}