Business Process Outsourcing (BPO) can give companies a decided advantage in today’s marketplace. However, four legal issues have the power to derail an outsourcing contract’s success. If buyers include legal protections in their outsourcing contracts, they can enjoy the advantages BPO outsourcing brings, according to attorney David Pace, a partner in the Dallas office of Arter & Hadden LLP.
BPO is growing because companies want to focus on their core businesses. Pace says there is a growing sense in today’s marketplace that companies need to shed their ancillary processes. “Then they are not distracted from focusing on what they do for a living,” he says.
BPO also provides an accounting advantage. If a buyer sells its plant and equipment to the outsourcer, these items disappear from the asset side of the balance sheet. Now there’s no need to depreciate them over a number of years. Instead, these costs migrate to the expense side of the ledger as a cost of goods sold. Companies can deduct these expenses in the year they were taken, if it so chooses. Pace calls this “financial engineering.”
Outsourcing a process also means the buyer no longer has to manage the head count. This is an attractive benefit in today’s tight labor market. The unemployment rate in May was 4.1 percent. Recruiting and retaining talent in a tight market is difficult. The level of difficulty increases with the specialized knowledge required. The outsourcer, on the other hand, is adept at attracting the best and the brightest in its field.
Protect Your Proprietary Processes
BPO buyers can reap these benefits if they protect themselves when penning an outsourcing contract. Most important, companies must be concerned about protecting all proprietary processes they have developed.
Pace defines a proprietary process as a business process that gives a buyer a competitive advantage in the marketplace. Buyers, having spent time and money developing the process, don’t want their competitors to use it, too. Pace says if buyers don’t legally protect their processes, the outsourcer can gain a financial advantage by sharing the secret with its clients, which could include the buyer’s competitors.
“Don’t give away something you have spent a lot of time and money on,” says the attorney.
How do you outsource this special process without giving away your trade secrets? The best intellectual property protection is to patent the process, points out Pace. Trade secret status is another alternative. Pace recommends adding a provision in the outsourcing contract restricting the ability of the vendor to market that particular process to any of its outsourcing customers.
A second legal issue is the importance of clearly defining the process boundaries. Pace says BPO demarcation tends to be trickier than IT outsourcing. The pertinent question is: Where does the buyer hand off responsibility to the supplier? With IT outsourcing, the vendor typically assumes complete responsibility for a function, like a network. If a router misbehaves, it’s clear the supplier has to fix it. The lines are fuzzier in BPO.
The third legal concern is the limitation of liability. What recourse does a buyer have if there is a problem?
Pace says buyers must require their BPO service providers to carry enough liability insurance to protect the buyer’s interests. Public companies have a fiduciary responsibility to their shareholders to mandate adequate coverage. The attorney points out that even if a buyer wins a judgment against a supplier for violating the outsourcing contract, the claim is only as good as the depths of the outsourcer’s pockets. The outsourcing contract is the best place to put this insurance requirement.
Service level agreements (SLA) can also be problematic. BPO is relatively new compared to IT outsoucing. IT contracts have been around long enough to have universally agreed upon thresholds and industry wide best practices. BPO is “much more freewheeling,” points out Pace. He suggests buyers work closely with their internal staffs to develop appropriate benchmarks.
The first question to ask when determining an SLA is: What are you going to monitor? Next, buyers have to select the exact range of non-performance they are willing to tolerate. When performance falls below the acceptable range, the buyer should charge a performance penalty.
Prepare For The Worst
If there is a catastrophic failure, the buyer must be able to declare a breach of the contract and be able to move the process to another supplier or take it back in-house. Disengagement is a key element to negotiate in the initial contract. “Don’t hand over an essential if ancillary business process without a clear idea of what you will do if it doesn’t work,” says Pace.
Because breaking up is hard to do, buyers must spell out their disengagement terms clearly in their contracts. “These ancillary processes won’t make your company. But they can break it,” says Pace. He advises spelling out quick remedies to make the transition as painless as possible.
Lessons from the Outsourcing Primer:
- BPO outsourcing can be very beneficial to a company if it protects itself in its outsourcing contract.
- If you have a propriety process that you want to outsource for competitive reasons, patent it and have a clause in the outsourcing contract that forbids the supplier from sharing that process with its clients.
- Be specific when defining process boundaries and service level agreements.
- Include any disengagement terms in the original contract in case things don’t work out.