Recent and marked changes to the outsourcing landscape will have some profound effects in 2003. The economic climate has changed the way customers look at outsourcing and how suppliers respond. While outsourcing continues to provide significant business opportunities for customers, it also represents new risks. At the same time, the outsourcing market is continuing to evolve toward the newer terrain of business process outsourcing.
As we “gaze into our crystal ball,” the following are some of the trends in outsourcing that we expect to see in the coming year.
Priority on Savings
Cost savings will continue as a priority for most customers in outsourcing deals as customers continue to adjust to the challenging economic environment. While cost savings was a common outsourcing objective, in past years it was only one of many, and often not the most important. As in this past year, cost savings will continue as a key driver for customers pursuing outsourcing transactions. In some cases, cost savings may serve as the only meaningful customer objective.
However, customers are being careful. Lessons of past deals gone awry have left customers wary of mortgaging near-term savings for long-term losses. Customers are demanding savings as well as protections to ensure that they maintain market rate pricing for the life of their agreements.
Focus on Supplier Stability
In response to the recent financial turmoil among outsourcing suppliers, customers will focus carefully on the supplier’s financial strength. WorldCom’s bankruptcy and the declining forecasts of other major outsourcing suppliers have led customers to carefully scrutinize the financial strength and stability of prospective suppliers. Customers have also started to demand and receive contractual protections designed to minimize their exposure to a supplier in financial distress or bankruptcy. As a consequence, customers have exhibited greater reluctance to start-up or thinly capitalized providers.
Supplier Investments More Difficult
Suppliers are finding it more difficult to make front-end investments in deals. Their deteriorating financial condition has increased the cost of borrowing, making it more difficult for suppliers to come up with the cash often required to fund asset acquisitions and other start-up costs. In addition, analysts are scrutinizing suppliers and their deals more closely. Suppliers will look for deal structures that enable them to maximize cash flow and minimize investments. In some cases, this may take the form of complex financing arrangements, which can impact the flexibility of the outsourcing arrangement. In other cases, it may involve the customer’s retention of assets that the customer would normally sell to the supplier.
The combined pressure of customers demanding cost savings and suppliers faced with a capital shortage will lead to a higher percentage of deals not closing. Customers and suppliers are having a harder time finding common ground on which to reach an agreement. In some cases, suppliers have created problems by promising more than they can deliver. More deals have started as sole-sourced negotiations on suppliers’ promises of quick savings, but later transform into competitive deals as customers encounter difficulty in translating the suppliers’ initial promises into real savings commitments.
These deal strains have placed a premium on the customer’s careful planning and execution of the outsourcing negotiation process. The customer will have to pay careful attention to detail to ensure that it obtains its required savings, as there will be less margin for error.
The trend toward more renegotiations will continue, as customers find the need to extract more savings from their existing arrangements. While customers work diligently to build in contractual rights to enable them to adapt to changing circumstances, many of the sourcing arrangements entered into in years past did not have those protections. Consequently, customers are forced to re-open negotiations to take advantage of additional cost savings opportunities and adapt to new economic standards. The lure of new business or the threat of a declining scope may serve as the motivation for renegotiation.
Business Process Outsourcing
The market focus on business process outsourcing will continue. The landscape for business process outsourcing is still unsettled as large integrators jockey for position in competition with the specialty suppliers. Despite a near miss in this past year, expect to see a mega deal in BPO in the coming year. There is great interest among the supplier community in business process outsourcing. Suppliers recognize that business process outsourcing, which often involves the outsourcing of the functions that have a large IT support component, is a natural extension of IT outsourcing. Suppliers who do not offer BPO services run the risk of a diminished market for their services. This is an opportunity for the early customers in large BPO deals to demand and receive equity and other consideration, in exchange for providing the suppliers with a platform for future expansion of their BPO business.
Legal Outsourcing Trends in 2003:
- Savings will continue as the key driver for customer outsourcing deals in the coming year.
- Customers will carefully scrutinize a vendor’s financial condition and look for contractual protections to limit their exposure to a financially distressed supplier.
- To conclude deals that meet their sourcing objectives, customers will need to incorporate careful preparation, planning, and pay attention to details in their outsourcing strategy.
- Renegotiations of old outsourcing deals will increase, primarily in response to financial need or a desire to take advantage of new market rates.
- Business process outsourcing will continue to grow, with the prospect of a mega deal substantially changing the playing field.
Based in Chicago, attorney Paul J. N. Roy is a partner in the Information Technology and Outsourcing Practice of Mayer, Brown, Rowe & Maw, an international law firm headquartered in Chicago, Illinois with 13 offices in the United States and Europe. Paul regularly counsels clients on technology and outsourcing transactions. You can reach Paul at [email protected].