During an outsourcing agreement the vendor becomes polluted with what is considered to be very proprietary intellectual property, says Gene Slowinski, director of strategic alliance research at the graduate school of management at Rutgers University. When a vendor works with a customer in an outsourcing relationship, the customer tells the supplier many things that are protected by patent, information protected by trade secrets, and vital company knowledge that is retained by the employees within the corporation. The customer and its new business partner the vendor must discuss these issues or it can be very damaging to both sides.
“An outsourcer is very likely to be involved in a number of other relationships that are along the same lines, including relationships with the customer’s competitors,” Slowinski says. ” So the question becomes: what are the supplier’s rights to use their customer’s intellectual property in an alliance with the competitor?”
There are two kinds of intellectual properties that a company has to consider, he says. One is background intellectual property, which is information that comes into the relationship prior to signing a deal with the vendor. Background intellectual property is such things as patents and know-how. This is information that one company created and the other side has no rights to. The second kind of intellectual property is called foreground. During the deal both sides will cooperatively create intellectual property. Since both sides work together to create new patents or know-how this is going to be protected by trade secrets. The rights to this type of intellectual property is different and the two companies must decide how these rights are distributed.
Intellectual Property and Procurement
There is a limit to how much information should be given out depending on the stage of the arrangement. During procurement all first contacts should only include publicly available knowledge, Slowinski states. During this stage the vendor does not want to be overexposed to its potential customer’s intellectual property and vice versa. Once the customer has the potential vendors down to a short list, it can sign a nondisclosure agreement so that the customer and the short-listed vendors can begin to exchange information candidly. However, even at this point the two sides must be careful. The companies should only delve into information that is pertinent to continue the process successfully. Only when a vendor has been chosen should the vendor begin learning as much as possible about the company.
“The risk in being overexposed is that the vendor begins a relationship with another customer that is similar to that of the customer they lost during procurement,” Slowinski says. “If they do the exact same thing with that customer or there are at least the same key components, then the lost customer can claim that everything that the vendor knows was learned from them. And then the vendor has a real legal battle on their hands.”
In a complex outsourcing relationship, the vendor and the supplier are probably going to also to do some marketing and manufacturing together. This makes intellectual property issues very complicated. Customer lists, business practices and software that is developed to manage the business are all intellectual properties that are jointly created together or are brought into the equation by one of the two parties. And if the vendor has no rights to the marketing information, then it is basically out of business, Slowinski says. The customer can always say that the vendor learned about the market from them. So marketing must be treated differently. The sides have to take the risk that the partnership is going to work, and allow each other to have unlimited use of marketing information.
The termination provisions of the contract will completely detail what rights the vendor and the customer have to the intellectual property, including marketing information. “Typically if one side wants to use the other’s background intellectual property a royalty has to be paid, which is usually a percentage of the revenue stream and is capped at a certain amount, Slowinski says. “If one side wants to use the property that was created together then there is either no royalty or less royalty. But this is not a universal truth.”
There are two types of terminations to consider, he says. The first is an expected end and the deal is terminated because the end of the deal has been reached. And the second is breach, where the deal was cut short because of a failure by the vendor to meet deliverables. Under an expected termination, both sides should have greater rights to intellectual property, and under breach the two parties should have fewer rights or no rights.
Boundary conditions should be established from the beginning. These conditions clearly outline the boundary around a deal. Inside the boundary the two sides are allied and play by a specific set of rules. These rules will be determined by both sides working together, Slowinski says. Outside that boundary the sides are not allied, and the parties either play by no rules or a different set of rules.
“One of the biggest problems in outsourcing relationships is that a boundary is never clearly identified. Some of the intellectual property is put inside the boundary, others are not,” Slowinski says. “If the boundary is not established then the sides are going to have problems form the beginning, and the problems are going to continue until boundaries are established. So it is essential that the boundaries are established early on and they are crisply defined.”
Besides his work at Rutgers University, Gene Slowinski is the managing partner of the Alliance Management Group, a consulting company that helps people create and manage alliances.