Smart Outsourcing: Avoiding the Pitfalls

Outsourcing continues to be a key part of many companies' supply and cost management strategy. The strategy has proven to be effective but brings with it significant risks that must be recognised and managed. In outsourcing, a company is relying on someone else to run certain business functions. If not properly managed, companies may negatively affect their operations and customers. Whilst there are a number of reasons for outsourcings to fail, the risks of failure can be managed with a well thought out and structured outsourcing contract.

The outsourcing contract should be a living document that directs and guides the parties throughout each of the stages of the outsourcing lifecycle; from engagement, transition to renewal or exit. Outsourcing arrangements are often long term relationships (contract periods of 5 to 10 years are not uncommon) and, as such, the outsourcing contract needs to be flexible and adaptable to the changes during the term. Changes in market practice, technology, pricing models, business strategies and the economic climate will result in parties having different objectives than they had at signing. The challenge is to develop an outsourcing contract that provides clarity and certainty whilst at the same time being sufficiently flexible to meet changing requirements. The following are examples of mechanisms which should be included in an outsourcing contract to ensure a "smart" outsourcing contract is developed:

• a change control procedure for processing and agreeing changes to the contact and schedules;
  
• contract management and governance provisions;
  
• technology refresh obligations and associated cost allocation;
  
• provisions for service measurement and regular review meetings;
  
• mechanism for price variations and rights to benchmark charges and services;
  
• flexibility to add or remove business/companies in connection with customer group restructuring activities;
  
• rights of partial termination and termination with appropriate financial compensation for the service provider; and
  
• practical remedies for dispute, including escalation, service credits, step-in rights and expert determination/mediation.

A substantial part of the detail in an outsourcing transaction is contained in the schedules to the contract. These schedules should address fundamental issues such as scope and description of the services, service levels, service credit regimes, transition and transformation timelines charges and payment, price variations and benchmarking and exit management. It is of little use to either party if the front-end of the contract i.e. the Terms & Conditions (Ts&Cs) have been carefully and appropriately drafted but the schedules themselves are incomplete, unclear or inadequate. The content in the schedules needs to be correct and complete, accurately describes the nature of the deal and includes language which creates legally enforceable obligations. It is crucial that a review exercise is undertaken to ensure that there are no inconsistencies between the schedules and the Ts&Cs.

It is certainly true that the process of negotiating an outsourcing contract can be frustrating and lengthy. However, managed properly, the process of negotiating and agreeing the outsourcing contract can be extremely important in establishing mutual expectations as well as identifying and getting the parties to address and find solutions to possible issues. This contribution is key as it offers the outsourcing relationship the best possible start for the long term. However, it must be recognised that it is only a start.

This article was originally posted by it-director.com and is the property of IT Analysis Communications Ltd.