Current Critical Issues in Outsourcing
25 September 2014
Mayer Brown Newsletter
The critical issues in outsourcing have evolved with changes in the marketplace, the growth in second- and later-generation outsourcing, and new technologies such as cloud and big data. Lawyers handling outsourcing deals thus deal with new challenges in a wider variety of deals. This article will discuss those challenges and how you can mitigate the risks for your company as an outsourcing customer.
Demand for an efficient but effective negotiation process
Early strategies of broad scale outsourcing to a single provider are giving way to strategic and specialized sourcing to multiple providers. The smaller deals still involve mission critical services, so sacrificing diligence or contractual protections can create substantial risk. Fortunately, you can get good results with the tools, processes and experience now available. These include proven contract and schedule templates, checklists, guides to help the business team gather and record needed information, a process designed to reduce the number of cycles to get to closure, and the experience both with the tools and processes as well as with the counter parties and similar transactions.
Resourcing not outsourcing
The traditional outsourcing model assumed that the provider was taking responsibility for an existing internal function. For example, the traditional dragnet clause requires the provider to perform all the functions previously performed by the customer at the existing service levels (unless those functions are explicitly excluded). As more customers are moving toward second-or-later-stage transactions, they need new approaches, including more robust service descriptions.
Need to integrate across service providers
As customers have an increasing number of outsourcing providers, the customers increasingly need to integrate and ensure close working relationships among providers. To build a working provider ecosystem, customers need to establish rules and relationships that protect the vital interests of each provider and reward collaboration. Because this approach is different from the traditional separation between competitors, you need to address this requirement early in the sourcing process and follow through in governance.
The double-edged sword of short term deals
In the face of increased uncertainty and dramatic change, customers have sought to increase flexibility with shorter terms. While customers may believe shorter term contracts protect them, the reality is that exit would be costly, time consuming and disruptive. Consequently, you would be prudent to include long-term contract protections even if the nominal term of the contract is short.
Establishing rights in critical provider technology
Customers are increasingly outsourcing to use provider technology instead of to find a lower-cost workforce to operate customer technology. For example, there is a rise in SaaS and cloud transactions. While customers still retain rights in their data, the bigger issue is what replacement system will be used to process that data. The risk can be mitigated by obtaining options to license some or all of the provider’s technology and commitments to provide replacement systems and transition support at predictable costs for substantial periods.
Securing “big data” rights and services
Advances in “big data” technologies have allowed companies such as Google and Amazon to create spectacular value with secondary uses of data. Traditional and even current service contracts often permit these secondary uses without compensation. For example, contracts often permit providers to retain aggregate and anonymized copies of customer data which allows the providers to benefit from data. In addition, customers often overlook opportunities to partner with their providers to gain the benefit of insights that be generated from the provider’s broader market data.
Retaining rights to protect business
As providers increasingly deliver with a global service delivery model integrated with provider processes and technology, traditional “step in” rights increasingly provide false comfort. However, customers continue to face the risk of providers becoming financially, operationally or otherwise unable or unwilling to perform specific mission-critical functions. To protect their businesses, customers increasingly value options to take specific work back quickly (including rights to take over assets and license materials) and commitments to provide information on an ongoing basis to make these options effective.
Minimizing risk, cost and surprises on exit
With more transactions reaching end-of-life, we too often see customers surprised by their vulnerability on exit when they seek to move the services to a replacement provider. Whether due to lack of motivation by the replaced provider, a lack of governance attention by the customer or a problem relationship, common complaints include (a) exit rights designed for the technology at the signing date not fitting the technology at exit, (b) incomplete or poorly organized data, and (c) inadvertent waivers of exit rights needed to transition the services. You can mitigate these risks with flexible exit rights, including rights to key data, and by conducting regular audits of the data and using financial incentives for the provider to properly maintain that data.
Governance and follow-though (and follow-through, follow-through, follow-through)
Too often, carefully drafted contracts are ignored and both parties operate without regard to the carefully considered processes and allocations of risk. Customers can, and frequently do, lose value by overlooking an important right, cost or protection for a long period. Like internal operations, outsourcing agreements must be persistently monitored to retain and build value. Adjustments to the contract should be reflected by deliberate mutual agreement and not by default.
Resolving disputes while preserving (or even building) the relationship
Disagreements in outsourcing agreements are inevitable, but resolving them is not. Experienced outsourcing customers have found that disputes that accumulate and remain unresolved can fester, weaken trust and destroy an otherwise productive relationship. Finding ways to quickly and efficiently force a resolution is the best way to maintain, and perhaps even build, trust and a strong working relationship. There are various strategies for accomplishing this ranging from novel governance structures to using third parties identified in advance to finally resolve disputes within specified dollar ranges.
The outsourcing market is growing more complex and risks are increasing
Yesterday’s contract will not overcome today’s challenges. However, you can manage that complexity and mitigate those risks using tools, processes and best practices developed over the decades of outsourcing.
This article was previously published by Inside Counsel.