Companies are selecting two distinctly different options when they negotiate international outsourcing contracts. Which option is best depends on the history and operating culture of the head office, according to Robert Zahler, an attorney specializing in outsourcing at Shaw Pittman in Washington D.C.
The decentralized approach uses a master agreement that the parent company of the buyer signs with the parent company of the supplier. This master contract discusses only the principles of the outsourcing transaction. Zahler says the master contract is cursory with no discussion of pricing, scope or service level agreements.
These issues form the core of the local agreements. These contracts are between the buyer’s local affiliate and the supplier’s local office. Zahler says these contracts are robust because they contain all the details that make an outsourcing arrangement work.
The lawyer says these contracts work best when each country needs special attention. Local entities feel comfortable dealing with each other since they are intimately familiar with local customs and business practices. There are no currency problems because the contract is written in the local currency. The same applies to tax issues. Both parties understand the idiosyncrasies of the national tax code.
The disadvantage is that the parent company has to negotiate a separate agreement in each country. Even though the legal departments try to draw up a document that serves as the paradigm for all of them, Zahler says this rarely works. “Contracts never look alike,” he reports. This can be a lengthy and costly procedure.
What’s more, Continental Europe’s legal system is based on the Napoleonic Code. The U.S. and the U.K. systems use common law as their underlying premise. The basic viewpoints of these systems are very different, making it difficult to mix and match them.
Controlling The Entire Relationship
Since there is no central authority responsible for the relationship, the parent company has to work hard to control the entire relationship. For example, the parent company must treat certain legal issues globally. These include indemnity, dispute resolution and guarantees.
Zahler says the risk with the decentralized approach is that these standard issues can be resolved differently in each locale. Inconsistent interpretations can cause legal problems.
The other tack is the centralized approach. Here, the master agreement contains all the details. The local agreements, instead of being robust, just list local topics that are uniquely affected by local law. “The local contracts are as minimal as possible,” says Zahler.
One of the most common topics in a decentralized local agreement is human relations, according to the attorney. Many countries have strict rules when an employee moves from the customer’s payroll to the supplier’s. These usually must be spelled out differently.
The Benefits of Centralization
Centralized outsourcing contracts are easier to do because there is only one large negotiation that covers most of he major issues. The issues that are left are sent to specialists in the locale.
There is only one headquarters. All bills go to one place. Problems end up in the same department. One central authority is responsible for managing the relationship around the globe.
But there are disadvantages to this approach. Taxation can become a problem since each country has its own arcane rules. Currency translation becomes a factor, too, since the contract is usually written in dollars.
Sometimes the head office will negotiate an outsourcing agreement without the knowledge of the local offices overseas. These units then receive a big surprise when the contract is consummated. Because they weren’t consulted, the head office may have overlooked some major items.
Which type of contract is better? In theory, it should be the centralized version because one of outsourcing’s chief benefits is the ability to impose consistency. There are cost savings when divisions around the globe all use one software package and do things exactly the same way. However, Zahler says “some very sophisticated global companies have a difficult time accepting a master agreement.”
Choosing A Master Agreement
One of the best examples of a single master contract is when J.P. Morgan outsourced its telecommunications to the Pinnacle Alliance in 1996. Morgan’s major hubs were New York and London but there were other secondary but not inconsequential operations throughout Europe. “Morgan wanted a single, global IT solution,” Zahler says. The only local agreements dealt with personnel.
On the other hand, a large pharmaceutical company he recently worked with selected the decentralized route. The company grew through mergers and acquisitions, so they were used to operating on an individual basis.
“There no best option,” says Zahler.
Lessons from the Outsourcing Primer:
- There are two approaches to global outsourcing. However, there is no best option.
- Decentralized contracts have the details of the contract in the separate local agreements. Decentralization makes it easier to handle taxation and currency issues, but it is harder to manage the relationship.
- Centralized contracts are easier to negotiate because there’s only one contract to negotiate. They are easier to manage because all the operations are centralized.
- A company’s history is a good indicator of which plan will be best. If a company created a global presence through acquisitions, a decentralized plan may work better.