A Legal Perspective On Initial Considerations
Airlines, IT vendors, MROs (maintenance, repair and overhaul providers) and host of other aviation-related service businesses have engaged in outsourcing activities for many years. But recently, the pace and scope of aviation outsourcing has increased. For example, between 1985 and 1999, the 10 largest U.S. passenger airlines experienced a tenfold increase in their MRO outsourcing, representing more than $2.4 billion a year in revenues to outsource suppliers.1
While considerable opportunities exist, airlines need to prepare carefully and take into consideration a plethora of strategic, business, operational and legal issues in deciding what to outsource. This article presents a perspective on a number of such initial issues:
- How to maintain flexibility when outsourcing a particular function or service that may change over the life cycle of assets such as aircraft and airport facilities;
- When to smart source or niche-outsource;
- How to work within the framework of global airline operations and global airline alliances; and
- How to protect and manage the collection, use and distribution of business data across global airline alliances, and control the use of such data by third parties.
Flexibility and Durability
Airlines outsource many functions to help them focus on core activities, achieve efficiencies and maintain competitive advantages. The outsourced functions include: passenger or cargo reservations systems, accounting and traffic management systems, operational systems (flight operations, crew scheduling, gate operations, ground handling and catering), fleet maintenance, and office systems and functions.
Some of these outsourced functions relate to the use of long life span assets, such as aircraft and airport facilities, which present airlines with duration issues relating to how long the activity should be outsourced - for the life cycle of the asset or a lesser period of time. Many airlines in the U.S. historically have provided most of their airframe and engine MRO services inhouse. As the composition of aircraft fleets has changed, MRO work on small fleets, or non-standard aircraft and engines, or engine and airframe types nearing the end of their life cycles, may be outsourced to third party MRO providers. What is a core asset to the airline at one stage of the asset life cycle may not be at its inception, when the asset is innovative and untried, or towards the end of its life span, when it is being phased out of service. Airlines need to evaluate their outsourcing opportunities at all phases of an asset's life span.
Another challenge facing airlines is that technological innovation is constant, yet there are periodic industry-transforming quantum leaps in technology and business practices. The introduction of the Boeing 707 and Douglas DC-8 (the first successful mass-produced jets), the Boeing 747 (the first commercial wide-body), U.S. airline deregulation in 1978 and the beginning of airline fortress-hubs, and the growth of door-to-door airline integrators such as FedEx and UPS, have all transformed the aviation industry.
These types of transformative events signal that successful outsourcing needs be flexible to enable both parties to deal with change. Long-term life cycle arrangements may be appropriate under certain circumstances, but outsourcing arrangements must include supplier inducements to implement and integrate non-disruptive and tested "state-of-the-art" technology. When negotiating, both suppliers and buyers should consider clauses providing for asset substitution, upgrading, and modification, along with commensurate adjustments in pricing tied to industry indexes, most-favored-nation clauses or appropriate "objective" adjustment mechanisms, in order to address and manage change.
Evaluating "Smart Sourcing" or "Niche Outsourcing"
Airlines may opt to "smart source" or "niche outsource" part of their functions. "Smart sourcing" is where the outsourcing solution combines the benefits of different suppliers to come up with the optimal solution. This is best where no readily available "off-the-shelf" solution exists that fits an airline's particular needs. Smart sourcing may enable an airline to combine the best technology with another supplier having a proven track record for managing IT infrastructure, service delivery, and customer service and project management."
The key issues involve how well the multiple "bundled" service suppliers are able to work together. When smart sourcing, airlines should inquire how the parties will access, use and manage the key intellectual property and other proprietary data necessary to the bundled solution. Other considerations include
(i) whether it is possible to substitute one party for another in the event of a default or dissatisfaction with the service; and
(ii) whether the teaming arrangement is specific to the project, or does it have a "life of its own". Joint ventures and teaming arrangements can be notoriously unstable and fickle, especially if the legal risks and economic incentives are not properly balanced.
"Niche outsourcing" is appropriate for outsourcing specialized and discrete business processes, such as non-core functions that require access to best practices and the latest technology (e.g., ASP outsourcing). Strategically, airlines should seek non-exclusive and fairly short-term relationships. They also should examine the impact of change on integrated solutions. Some suppliers offer access to services that are part of a larger suite of interrelated services. It may be difficult to cherry-pick the desired specific services and then integrate these with inhouse or other outsourced services.
Even though niche outsourcing may be very focused, airlines should not lose sight of the complex legal issues relating to integration, support and transition services. Draft agreements that provide for access to proprietary IP for integration, customization and maintenance, and for appropriate transition services at the end of the outsourcing relationship.
Global Spread and Dealing with Airline Alliances
Airlines conduct business over a wide geographic swath, which presents unique legal challenges. The larger and more globally-focused the airline, the more complex the web of legal and regulatory issues will be for a service supplier required to have resources or capabilities in locations that match the airline's operations. Airline route systems and operational requirements change over time, and these factors tend to militate against long-term, static, single source arrangements.
Another consideration is the extent to which global airline alliances might be opportunities or impediments to suppliers. As airlines move towards more seamless, transparent integration, especially from a customer service perspective, outsourcers face a number of opportunities. For example, can the successful relationship with a dominant carrier in the alliance be translated into a more broad-based outsourcing arrangement with other alliance members? Given the potential for more economies of scale, can the outsource relationship expand to related services? Especially with IT services, what new outsourcing opportunities are presented either to perform integration services, or to provide the integrated platform services, as stand-alone legacy systems are no longer "sacred cows"? Outsourcing agreements might have exclusivity or right-of-first-refusal clauses, which might need to be reviewed in light of new opportunities. Could these types of "doing business" restrictions reasonably relate to opportunities presented by airline alliances? Both parties should address these issues in major long-term agreements, especially in connection with provisions such as premature termination, non-exclusivity and options.
Access and Use of Proprietary Information
Data is core to airline business. A stream of transaction, tracking, monitoring and other functional data appends each passenger reservation, cargo shipment, or flight operation. Much of this data contains non-public personally identifiable information, especially in the PNR (passenger name record). Airlines also have volumes of proprietary and confidential information relating to their business operations and IT assets. Moreover, much data is created in one country and follows a passenger or cargo shipment to its ultimate destination in another country, while often transiting numerous other countries en-route. Outsourcing adds yet another layer of complexity, in that numerous third parties will need access to airline customer data.
Airlines need to ensure that their agreements with suppliers properly protect the confidentiality of airline and third party trade secrets and limit the use of non-public proprietary information as required in all applicable jurisdictions. Restrictions on cross-border exchanges of non-public personal information, especially following the model of the European Union, are likely to make this process even more complex. Airlines also need to examine the extent to which data flows relating to money transfers and settlement functions have special money laundering and suspicious activity reporting requirements.
Outsourcing suppliers are often perceived as "invisible" insiders. They are clearly not covered by confidentiality procedures in airline employee manuals. Lax non-disclosure agreements may not provide any relief against release or misuse of data by outsourcer employees, who may often be providing services to competing airlines. Outsourcing arrangements must settle who will have access to airline data and under what circumstances, and provide enforceable remedies against misuse and disclosure in appropriate jurisdictions where outsourcers store or use airline data, while facilitating the use and access of such data in the outsourcing arrangement.
Lessons from the Outsourcing Journal:
- Aviation outsourcing arrangements need to have the durability to provide meaningful and cost effective solutions involving long life span assets, but at the same time provide the flexibility to encompass technological and business innovations rapidly and efficiently.
- Smart sourcing and niche outsourcing arrangements, although focused, need to be integrated and include provisions dealing with, among others, relationship maintenance, substitution of parties, access to IP, and the provision of customization, maintenance and transition services.
- Where appropriate, aviation outsourcing arrangements should specifically address opportunities presented by airline global alliance arrangements.
- Aviation outsourcing agreements should clearly address who will have access to non-public personally identifiable customer and other confidential airline data, and under what circumstances, and provide enforceable remedies against misuse in appropriate jurisdictions.
R. Allen NaudÈ is a Partner at Baker & McKenzie (Miami office) and practices in the firm's Global Information Technology Law Practice and additionally in aviation law matters. He can be reached at [email protected].
1 Will the Outsourcing Boom Continue?, Overhaul & Maintenance, May 24, 2002.