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Morrison & Foerster’s Study: How the Recession Has Changed Outsourcing

The common wisdom is outsourcing is counter-cyclical, so it should be going gangbusters in the down economy. But that’s not what actually happened. “The economy hasn’t changed outsourcing at all,” says Christopher D. Ford, a partner at the international law firm of Morrison & Foerster. “There wasn’t a huge uptick as the economy deteriorated. Instead, there has been steady, consistent activity.” He says outsourcing has enjoyed the same growth rate over the last four years.

At the start of a new year, the lawyers of the Global Sourcing Group poll their clients, outsourcing advisers, and service providers to look for emerging trends likely to shape the market over the next 12 months. They also seek to identify key business and legal considerations in today’s sourcing deals and highlight new sourcing-related developments in various regions. “Today our clients want to be reassured in this economy’s shifting sands,” he reports.

The study found an uptick in interest in ITO deals was balanced by a downturn in interest in BPO. Alistair Maughn, partner, doesn’t find that surprising. “During a recession, people urgently need to find a way to save money that shows up immediately on the bottom line. ITO can do that much faster than BPO,” he explains. In addition, he points out ITO doesn’t need much up-front capital and doesn’t require a long pay-back period.

“Today people are focused on what will directly impact the bottom line,” he continues. In an environment where Fortune 500 companies disappear overnight, a successfully executed outsourcing deal could make a difference in a company’s ability to ride out these challenging times,” says the report.

If things improve in 2010, it’s possible “the dam will break for BPO deals that no one could afford to do in 2008 and 2009,” Maughn posits.

Changes due to the downturn for buyers

Ford points out the economy has “forced people to look at different outsourcing models.” He says this systemic change was in the works before the recession, but the downturn “speeded up the rate of change.”

The change he is talking about is multi-sourcing, which the law firm defines as selecting a host of best-of-breed suppliers instead of using one monolithic outsourcing partner that often becomes a general contractor. “Multi-sourcing allows buyers to control their costs more effectively” because they attempt to wring cost savings from each supplier, he explains. However, Ford notes that multi-sourcing “puts greater emphasis on contract governance.”

Buyers today are “flying to quality” after the Satyam scandal, adds Maughn. “Buyers view Tier-One suppliers as safe ports of call in the storm. Buyers believe they won’t go under,” he reports.

Changes for suppliers

Another change wrought by the economy: the disappearance of financial engineering. These were deferred investment deals financed by the supplier; they were attractive to buyers because they could buy now and pay later. “Service providers can no longer finance any deals. Today they need their money up front,” says Maughn. That’s because the balance sheets of most suppliers have deteriorated in the last 18 months, he continues.

Suppliers, especially Tier Ones, are becoming more restrictive in accepting risk, especially in the data security and credit card compliance areas. For example, in the past Maughn says buyers would have excluded breaches of confidentiality from their limits of liability.

Today he says “some suppliers want less than the liability limits for data loss.” More than ever before, the risks of experiencing a data security incident include not only financial costs (the costs of notifying individuals alone can be high), but also significant embarrassment and reputational damage to the culprit company.

Buyers “are devoting significantly more energy to incorporating new risk and liability provisions with respect to data loss and the consequences of breaching security data obligations,” says Ford. The attorney adds some suppliers are walking away from deals if they can’t mitigate their risks appropriately. Ford adds suppliers today are “in a better economic position to refuse this risk because buyers have fewer alternatives.”

The offshore suppliers have “circled the wagons and dealt with their data security leaks,” says Ford.

Changing deals

The law firm has dubbed 2009 “the Year of Re-Sourcing.” Renegotiation is on the upswing because buyers “want to do more with less,” says Ford. The two sides are looking at their deals and are either removing scope, extending the term, or reducing the service level agreements. The attorney warns this often cuts out the value-creation portion of the outsourcing deal. “You can only do this once,” he points out.

Today’s deals have shorter terms “that allow for restructuring so they can be more aligned with the marketplace,” continues Ford. This benefits buyers “because it forces the service provider to modify the contracts to the buyers’ benefit.”

Other findings

The Morrison & Foerster study found the U.S. outsourcing market is “faring better and bouncing back faster” than both Asia and Europe, especially in ITO. In Europe, and especially in the UK, the study found ITO remains flat. In fact, the study found the European outsourcing market “has slipped back after two years of strong growth. But there is still latent demand and more scope for first-time outsourcing than in more mature markets like the UK and U.S.”

In the past, financial services companies fueled significant growth in outsourcing. This has changed dramatically in today’s climate with the turmoil in the banking industry, notes Ford. He predicts retail and entertainment, industries previously slow to embrace outsourcing, “will pick up some of the slack.”

Here’s the good news: The freezing of the credit markets and the shortage of liquidity means companies that emerge from the downturn will be more inclined to avoid seeking capital and instead partner with others that can provide the necessary people, processes, and tools. Ford predicts “outsourcing will be at the vanguard of the recovery and will kick-start growth toward the end of 2009 and into 2010.”

Lessons from the Outsourcing Journal:

  • Shorter outsourcing contracts with renegotiation clauses allow buyers to better align their relationships to the marketplace.
  • Buyers and suppliers are at odds over data security. Buyers want the suppliers to increase their security to prevent breaches while suppliers want to limit their liability. Some suppliers are walking away from deals that they consider have too much risk.
  • Renegotiation to do more with less often cuts out the value-creation portion of an outsourcing deal. The buyer can only do this once and only for short-term results.

How this study was done: Morrison & Foerster’s Global Sourcing Group lawyers in Asia, Europe, and the United States survey their clients, service providers, and outsourcing consultants on the state of the world’s outsourcing market, The law firm conducts this survey during the first quarter. It released the 2009 report in June.

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