You can’t complete an outsourcing deal without the lawyers. That gives attorneys a bird’s eye view of trends in the outsourcing world. Two partners at Baker & McKenzie, a global law firm with expertise in outsourcing, share their insights.
Trend 1: Outsourcing Deals Are Becoming Global
“Global players are looking for global solutions from global players,” observes Michael Mensik, co-chair of Baker & McKenzie’s Global IT/Communications Practice. Attorneys “papering” outsourcing deals last year faced a learning curve – they had to understand how to structure a global outsourcing transaction. In the past, buyers signed one contract that covered every corner of the globe or their attorneys selected a contract from one country and tried to replicate it for the others.
Neither solution worked with today’s offshore realities. So a hybrid approach came to prominence last year, according to Mensik, who is based in the Chicago, Illinois office. Now lawyers are penning a master global agreement as well as companion agreements the parties implement locally to provide for things like local invoicing.
Trend 2: Offshoring Increasingly Becomes a Component of a BPO/ITO Deal
Buyers like the advantages of labor arbitrage, so they embraced offshoring during 2003. To achieve efficiencies — especially in global deals — suppliers divided up the functions and sent them where it was most economical. For example, a human resources outsourcing (HRO) deal might have global payroll processing in the Philippines and the global executive transfer “high touch” function in England. Mensik says many buyers created a redundant operation just in case.
Because of this trend, Mensik says buyers had to do more careful due diligence at the outset concerning the supplier’s offshore arrangements. In addition, they had to put monitoring mechanisms in place in their legal agreements to manage this new type of outsourcing relationship.
Trend 3: As BPO Became More Prominent, It Pushed Suppliers Into the World of Regulation
Mensik points out suppliers “don’t need to know a lot of law” to fix desktops. But once they enter the realms of finance and accounting outsourcing (FAO) or human resources outsourcing (HRO), they suddenly have to deal with stringent government rules. “You have to know the law to properly perform,” he says.
The difficulty of that job increases exponentially when the employees are in different locations, each with its own distinct rules. “There may be a time when a supplier has to know the laws of a distant province of China,” Mensik says.
FAO suppliers now have to comply with the Sarbannes-Oxley Act, which requires the CEO to be personally responsible for the accuracy of the company’s financial records, among other things. What if a buyer outsources part of its F&A process and the supplier sends some of the work to India? “How does a CEO know with certainty all the records are accurate?” Mensik asks rhetorically. He says the best way to do that is to clearly define each party’s compliance role and put that into the contract. “Just saying the service provider is responsible is not enough,” says Mensik.
What happens when the regulations change? When a law like Sarbanes-Oxley enters the picture three years into an outsourcing relationship, the service provider has to change its system to comply. Who pays for that? Mensik says buyers now have to consider those questions at the outset when drafting their outsourcing contracts.
In addition, BPO requires better governance and relationship management than ITO, says Mensik. “ITO was easier,” he sighs.
He says members of the European Union have been doing multinational outsourcing deals for some time and “faced these challenges sooner than companies in North America.”
Trend 3: Longer Negotiations for More Precise Service Level Definitions
Harry Small, a Baker McKenzie partner who heads the IT Group in Europe, agrees that increased due diligence and more precise service level descriptions are necessary. He says outsourcing deals negotiated five years ago are coming up for renegotiation. Some of these older transactions suffered because of this lack of definition of who was going to do what. Buyers now know better and are not willing to leave the definitions of work for later, he reports. “I see redoubled efforts for more precise negotiations. Now they are taking longer,” he adds.
Trend 4: In Australia, Buyers Prefer Many Suppliers to Just One
Anthony Foley, the leader of the IT/Communications Practice in Asia/Pacific, reports “an increasing trend” to selective outsourcing. Last year buyers chose to sign contracts with providers for specific functions based on their expertise in that function. “Not all suppliers are equally good at everything,” he notes. Foley says that “with selective sourcing, customers fundamentally trade the benefits of having one supplier assume responsibility for all functions for the benefits of specialization and increased competition for particular functions.”
Foley reports that IT outsourcing was one of the hot spots in a slow IT market last year.
Trend 5: In Europe, Suppliers Have to Deal With Increasing Regulation Protecting Employees
Small says European suppliers had to deal with increasing regulation. Last year saw an increased focus, driven by trade unions and others, on the rigorous enforcement of the Acquired Rights Directive, a law that protects employees transferring between enterprises. In many IT outsourcing transactions outside Europe, a supplier will either hire the buyer’s IT staff for a period of time and then cherry pick the best employees; or simply not take on the customer’s staff on the transfer of the services. Either way, the redundant staffers are dismissed. The European law makes dismissing one of these employees very costly, Small explains.
“If you are outsourcing within Europe and you can’t save money by pruning staff, you have to find other ways to save the buyers money,” Small says. One way to do that is offshore the work out of Europe.
Trend 6: Suppliers Have to Deal with Telecommunications Regulations in China
Nancy Leigh, a partner in Baker & McKenzie’s Hong Kong office, says “China has become a hot spot when people think about outsourcing.” However, most companies “invariably end up sending their work to India,” she observes.
Why? Language is one reason, but it’s not the only one. The Chinese government closely regulates its telecommunications. One of the reasons offshoring works economically is that global telecom costs have fallen dramatically over the last few years, so it’s affordable to send work across the planet. Offshoring to China adds costs because of these regulations. “If a supplier sets up a data center or a back office in China, they have to deal with the telecom regulations,” Leigh reports. That includes obtaining the necessary licenses and permits. She says attorneys have to be creative to legally get around the telecom issues.
Trend 7: More Foreign Companies Set Up Their Own Back Offices in China
Leigh says foreign companies started setting up their own captive companies, outsourcing all their own work to their Chinese back office during 2002. But that trend accelerated in 2003, according to the attorney. Hong Kong Bank and Cathay Pacific Airways are two examples.
Looking Ahead to 2004
In Europe, Small predicts there will be “very heavy attempts” to staunch the flow of jobs out of Europe by regulating offshoring. There have already been suggestions both at the European Union level and within the UK (which probably has the most developed outsourcing market in Europe) that the politicians “should do something to stop exporting employment,'” he reports.
European Union regulations take time to formulate, so this year Small predicts a lot of people will offshore while they still can.
For North America, Mensik says last year India “was at the top of the list.” This year he sees offshoring “spreading out” to other areas as suppliers search for the best labor arbitrage play. Canada, Costa Rica, the Philippines, and Russia will share the limelight, he predicts.
In China, Leigh suspects there may be a change in telecom regulations. A visit by the Chinese premier to India made him aware that India was much more advanced in the development of technology services.
This year Mensik believes buyers and suppliers will have a better idea of how to set up their governance structures. “They’ll have a history of what works and what doesn’t,” he says.
Mensik also predicts that the offshoring business processes may come under greater scrutiny from both labor groups and government, both with respect to the treatment of displaced workers and worries about security. In an election year following a jobless recovery, the transfer of jobs and expertise to developing countries may very well become an issue. Mensik thinks public relations will become an increasingly important part of the outsourcing transaction.
Foley predicts BPO will become more prominent in Australia this year. “The focus will shift from outsourcing arrangements that are merely about technology to transactions centering on technology enablement, especially in the back office. Because of this market interest in BPO, he projects there will be “more activity” in the Australian market this year than last, especially in the government sector.
Finally, Mensik believes BPO may invade a corporation’s legal department. “Why stop at F&A?” he asks. He says there may be opportunities for law departments to move routine paper work and document processing functions overseas. On the other hand, Mensik believes the US may still enjoy a comparative advantage over other countries in the high-end legal expertise. “Where else are you going to find so many talented lawyers?” he quips.
Predictions for 2004:
- The offshoring market will expand beyond India to other areas, including Canada, Costa Rica, the Philippines, and Russia.
- Offshoring will increase at a rapid pace in Europe because companies will want to get their transactions done before regulations prohibit exporting jobs.
- BPO and offshore governance will improve based on the results of the trial and error experiences of 2003.
- Corporate legal departments may be the next big BPO area.