By May 1, 1998 Read More →

Strategic Outsourcing: The Contractual Perspective | Article

strategic stickman with moneyStrategic outsourcing — what does that phrase really mean? Discussions on the subject usually are focused on two things: structuring a strategic relationship with one or more outsourcers and the process by which the outsourcers are selected. Such discussions, however, overlook an important element. The outsourcing contract itself will have much to do with whether or not a truly strategic outsourcing relationship can be successfully established.

Outsourcing deals by their very nature are contract intensive. In many situations, the contract will determine the direction of the discussions and negotiations — with respect not just to legal terms, but also the very structure of the outsourcing relationship. That fact can set the stage for a devastating mistake.

The principals negotiating the deal may have had the best of intentions when they agreed conceptually to a strategic relationship, but not every attorney or contract negotiator will understand the nuances of such a relationship. If that is the case, most likely the proposed contractual document will run counter to the notion of a strategic relationship in a number of important ways. It is critical that the attorneys and other parties responsible for drafting and negotiating the contract understand the nature of the strategic relationship and that they have explicit instructions from both parties to implement that relationship. Without a contractual framework to support it, an otherwise successful strategic outsourcing can be in serious jeopardy.

Focusing on Intentions

That danger, when understood, can be avoided. If the parties are really serious about forming a strategic relationship in outsourcing, the senior principals of both the customer and the outsourcer may want to consider preparing a term sheet or executive summary which states their intent very clearly and openly. The term sheet or summary will, of course, address the key terms of the agreement but should include an emphasis on the strategic intent and basis of the transaction. In other words, the contract team members should face no ambiguity or opportunity for misunderstanding as to their mission in negotiating the contract. With the intentions and commitments of the parties stated clearly as an objective, the attorneys and other negotiation team members are free to pursue this objective in open and creative ways.

So how can an outsourcing contract serve as the framework for a strategic outsourcing relationship? There are a number of ways. A strategic outsourcing relationship has characteristics that may not be present in non-strategic relationships. These characteristics include a willingness by both parties to continue doing business in the long term because they are both gaining continuing value. The customer is receiving valuable service and assistance in implementing information technology in competitive, creative and cost effective ways and the outsourcer is getting opportunities for additional services it can provide to the customer. So the contract must include terms that will foster this type of relationship. Here are a few examples:

Communicating Clearly

There must be a well-conceived structure for frequent and open communication between the customer and the outsourcer. There must be adequate attention on both sides paid to quality account management and relationships, with assurances that personnel continuity will be emphasized. The parties should spend ample time structuring these communications mechanisms in a pragmatic manner that is appropriate for their circumstances. Contract boilerplate will not suffice.

Open communication may extend to the level of “open book accounting” which affords both sides the opportunity to understand the cost structure of the other party. The outsourcer also must understand the broad information technology objectives and needs of the customer. The customer, in turn, must understand the full range of service offerings and potential for value-added services offered by the outsourcer. The goal behind this type of information is to foster the chances that new ideas can be generated for joint value initiatives undertaken for mutual benefit. The contract itself could include a provision that both parties will regularly provide these opportunities to the other party. Of course, the contract will have to include appropriate confidentiality provisions to ensure that each party can share sensitive information openly with the other.

Building the Basis for Trust

The contract must be perceived by both parties as a fair contract, with neither party in a position to take advantage of the other. Without that understanding, there will be no opportunity for the development of trust that is the basis for an ongoing long-term strategic relationship. Fairness means that both sides have achieved a clear definition of their expectations in the deal, as to pricing, division of responsibilities, scope of services and expected service levels.

The outsourcer is able to achieve its expected profit margin, and the customer is able to receive the services it expected to contract for and at the price it expected to pay. A fair contract should comprehensively address the issues that could be the basis for disputes between parties. For example, the customer should be able to expect adequate assurances of performance of the contracted services and meaningful recourse if the services are not provided. Likewise, the outsourcer should not be forced to perform services under adverse circumstances, such as arbitrary holdback of fee payments.

It is important that the parties establish adequate means for dispute resolution. The goal in these circumstances will be to resolve disputes quickly, fairly and quietly. Typically, internal mediation steps and private arbitration procedures will be most suitable to these circumstances.

Flexibility: The Essential Element

And finally, the parties must do everything they can to structure a flexible contract that allows the customer and the outsourcer to continue to do business together, even as the customer’s information technology needs continue to evolve. The need for flexibility probably is a primary reason that “master” arrangements are becoming more popular in outsourcing deals. These are designed to set up an umbrella under which new service agreements can be added by the customer and the outsourcer without having to renegotiate general terms and conditions each time. With such a structure, if the strategic relationship is working as it should, the outsourcer — through short-term individual service agreement contracts — will provide services of various kinds under the same master agreement. The fact that these “master” arrangements are becoming more prevalent is testimony to the role that contract structure plays in creating the flexible but accountable environment essential to strategic outsourcing.

Bill Deckelman is a shareholder with Munsch Hardt Kopf Harr & Dinan, P.C., a law firm specializing in outsourcing, with offices in Dallas and Austin, Texas.

Lessons from the Outsourcing Primer:

  • Prepare term sheet or summary to ensure clear communication of intentions to the team negotiating the contract.
  • Understand the characteristics specific only to strategic outsourcing relationships.
  • Create a structure for frequent and open communication.
  • Avoid contract boilerplate. Create an agreement tailored to the needs of both parties.
  • Structure in the flexibility that is essential to ongoing relationships.

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