Bad Customer Contracts

"Why would any customer sign that contact?"

May 15, 2009 Join TA / Subscribe  TA Home  TA Index

Ensuring Fixed Charges in Long Term Contracts
by Mark Del Bianco, Attorney

     Few people would sign a contract with their cable company that said “This contract runs for two years.  The initial price for basic service is $44.95, but we are free to raise the price when we want to, and you are still bound for two years.”  If you saw this clause, you would ask yourself, “Why would anyone ever sign a contract like that?”  Yet it is surprising how many otherwise sophisticated businesspeople will sign a business telecom agreement containing what amounts to an identical clause.

     This point was brought home again recently when a channel partner/telecom agent asked me to look at a contract that one of his small/medium business clients had signed.  It was a one page “Dedicated Voice LD Order Form and Term Plan” that (so the customer thought) provided fixed monthly recurring charges ("MRCs") on four T1s and fixed per minute charges for various flavors of inbound and outbound LD calls. 

     Unfortunately for the small/medium sized business ("SMB") customer, the plan contained this sentence:

“All services provided to Customer by [Carrier whose name has been changed to protect the not-so-innocent] are governed by the terms of a Service Agreement, which may be found at www.[carrier].com/terms and which are incorporated into this Agreement by reference.” 

Naturally, the SMB never read the website Service Agreement. Months into the arrangement, it received notice from the carrier that its new LD rates would be far higher than the initial rates.  When the telecom agent/channel partner came to me, I immediately went to the carrier website and found this paragraph in the Service Agreement:

      "Carrier may change this Agreement at any time. Carrier will notify Customer of any material change in this Agreement, in Customer’s services or of an increase in rates or fees prior to the billing period in which the changes would go into effect, except for international rates, which may be changed on one (1) day notice. Notification of any such change may be in the form of a bill insert or by a message within your invoice, by postcard or letter, by Carrier’s calling and speaking to Customer or leaving a message for Customer, by postings on our website at www.[carrier].com/terms, or by email."

      The carrier, like the cable provider in my initial example, had gotten the SMB customer to sign up to a long term contract without locking in a price.  It’s a great business model if you can get customers to agree to it. This happens most often because the customer doesn’t read the entire contract.  The key word is “entire.” 

     While the example that prompted this article is egregious, it is hardly unique.  Nor is the practice limited to resellers or SMB customers.  The old AT&T, for example, was notorious for signing agreements that gave large business customers a fixed percentage off the published rack rate.  Then AT&T consistently raised the rack rate.  De-tariffing didn’t help – instead of offering a percentage off the tariffed rate, AT&T simply offered a percentage off the price on its website, which was still subject to change on the carrier’s whim.  There is an analogous issue for channel partners – what to do if they sign up customers for a carrier based on a specific level of rates and service quality, but the carrier’s rates or service quality change, causing customer dissatisfaction and loss of commissions.

     What’s a customer or telecom agent/channel partner to do?  There are several options.  Those available in a particular case depend on a customer’s bargaining power, which naturally is a function of many issues, among them the size of the customer’s anticipated spend, the services involved, and the role of the telecom agent.  The customer’s best option is to sign a fixed rate, fixed term contract with a price comparison clause.  This protects the customer from unexpected price increases, and provides potential upside in the form of price decreases when product/service prices are falling (which has been the situation for most telecom prices over the last decade).  This type of clause is common in carrier contracts with large enterprises, but rarely available to SMB customers with less spend and less negotiating leverage.  Such clauses are unheard of in agent contracts. 

      The second best choice is a fixed rate, fixed term contract with no website “gotchas.”  There are various ways to achieve this.  The easiest is to include the entire website terms of service (including prices) as of the contract’s effective date as an appendix to the short master agreement.  This by itself does not resolve the problem; the master agreement must also “freeze” the website TOS as of the effective date and explicitly override any TOS provision allowing the carrier to make unilateral price changes.  Few service providers will agree to this restriction unless the potential revenue is material in absolute or relative terms (i.e., because it will enable the provider to become cash flow positive for that quarter).

      A more realistic option (less effective and with risks of its own) sometimes available to smaller customers is an “out” clause for material changes in the contract terms.  This type of clause (1) identifies specific parameters, such as uptime or electricity cost on data center collocation or price or call quality on certain long distance ("LD") routes, as being crucial to the customer in deciding to enter into the contract, and (2) provides that a material change in one or more of the factors opens a window for the customer to decide to opt out of the contract without any early termination penalty. 

     The devil is in the details in these contracts.  For example, a clause creating a window for a customer to cancel T1s and move their associated LD minutes to another carrier is an excellent idea, but if it is limited to 5 or 10 days it is generally pointless, since that is rarely going to be adequate time to move the circuits.  Rather than lose service for the 30 days or more that it may take to get T1s installed by another carrier, an SMB customer will swallow the price increase.

      A similar problem arises for agents, particularly those in the residential and SMB international LD markets.  Such agents may create sophisticated marketing campaigns aimed at niche ethnic or national expatriate populations.  The appeal of the service and the agent’s ability to build and maintain a customer base depend largely on call quality and price to a handful of international destinations.  If for some reason the carrier’s quality of service declines, or it raises its prices to those destinations, the agent is in a double bind.  First, its commissionable base with the carrier declines drastically through no fault of its own.  Second, under almost every carrier’s standard contract, the agent is prohibited from contacting customers to move them to a carrier providing better price or service. 

     Here, the issue is customer ownership (and the role of the agent) rather than the ability of the customer to move.  But the solution is similar – specify in the agent-carrier contract the price and quality parameters on which the relationship is based and allow an agent to contact and move customers without penalty if the key parameters change materially.  Of course, service providers hate such clauses.  But as more service providers become desperate for revenue during this period of economic recession, I expect to see more customers and agents asking for, and getting, such “out” clauses in their new contracts.

      Readers should glean several takeaways from this article.  First, if you are entering into a contract without using a lawyer, at least read the entire contract -- including the parts on the website.  Second, assume until proven otherwise that buried somewhere in the website is a clause allowing the service provider to raise your rates essentially at will, especially if the provider is reselling the service(s) you are buying.  Third, ask yourself how the contract really benefits you.  Why would you sign a long term contract that has no price stability? 

      Finally, realize that cash and monthly recurring revenue are kings in this recessionary period.  The negotiating leverage of good customers and effective channel partners is magnified.  Take advantage of this temporary increase in bargaining power by looking at your contracts now.  If they are on month-to-month or within a year of expiration and you believe your business needs will be similar or even growing over the next couple of years, then you should be looking to renegotiate now.  This advice applies to both end user customers and telecom agents.  

Mark Del Bianco, Attorney

 


Got input? Forward it to Dan@TelecomAssociation.com or call Dan Baldwin at 951-251-5155


 

Atty. Mark Del Bianco

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