Legal Considerations When Starting a New Outsourcing Company
Without a doubt, the enormous growth in the outsourcing industry spells o-p-p-o-r-t-u-n-i-t-y for a company that can offer service expertise and economies of scale. But just recognizing the opportunity and hanging out a shingle is not enough.
Adequate financing is, of course, the prerequisite for going forward, and the new outsourcer will need capital for a variety of circumstances. At the outset, a new supplier might need capital to offer additional incentives to get business. Some begin with a “captive” customer of some sort in order to have operating revenue at the initiation of the company operations (otherwise, obtaining venture financing will be challenging). The first customers will most likely be very concerned with the financial stability of the new supplier. Depending on the contract length, the customer will probably become heavily reliant on the outsourcer for critical services, and the outsourcer will need capital to cover potential long-term problems. The new company might also need capital to purchase an existing supplier in a niche market, thereby gaining access to existing economies of scale.
Services and Pricing Strategy
When a company decides to become an outsourcing supplier, it must first spend time up front determining its strategy for services offering. Does it want to position itself in the market as a low-cost provider or a premium service provider? What types of companies are its potential customers? Many of the “new” outsourcers today are companies supporting other companies in their “e-commerce” web-based sites.
A key aspect of services will be the service levels the outsourcer offers. These have become very important to customers. The service level metrics should be industry standard and should be presented in some form of a Service Level Agreement that provides real benefit to the customer (including consequences for the outsourcer’s failure to meet the service levels).
The outsourcer must also spend time determining its pricing structure. Bundled services are confusing to customers; they need to understand precisely what they are paying for. Detailed invoices in terminology that the customer can understand are also important.
The outsourcer is then ready to prepare marketing materials and contract schedules that concisely and accurately describes the services offering and the pricing structure that was analyzed and determined up front. It is best to make sure the new company’s legal counsel reviews these schedules. Prospects will not be favorably impressed if it appears the company is making up its services and pricing strategy “on the fly” with each customer. They will be favorably impressed if the marketing materials and contract schedules have been professionally prepared and logically hang together.
It is important to remember that the contract is more than a document with legal terminology and consequences. It is also a marketing tool for the outsourcer and must not derail its sales effort with new customers.
The style of contract is the first consideration. Will it be short or long, with lengthy legal language? How will it be negotiated with the customer? Will each contract be customized heavily; or will the company adopt a corporate policy that certain provisions are “cast in stone?”
New outsourcers must bear in mind that customers these days look for contracts that provide flexibility. The outsourcer must decide how much flexibility it is willing to put into the contract for the customer’s benefit up front. Will the contract be customer-friendly or vendor-favorable in its terms?
The challenge in constructing a contract is to take the time and effort up front to think through all the issues that should be addressed. These issues are far more than legal terms and must be analyzed carefully. Regarding liability limits, for example, the company must decide the nature and how much risk it will assume for a potential breach of the contract. Exclusivity and term must be considered. To what extent will the contract “lock-in” the customer to the company’s services exclusively, and for how long? Under what circumstances could the customer terminate the agreement early “for convenience?” The issues need to be covered from the perspective of both the outsourcer and customer. Customers today are more sophisticated and knowledgeable about contracts than they were five or ten years ago. They will not react well to a one-sided contract that protects only the outsourcer’s interests.
There are, of course, generic issues that face any new business entry in any industry. The legal structure of the company is a matter of great importance. It may be a corporation, a limited liability company or partnership, a joint venture. The structure will likely have an effect on obtaining venture financing.
Then there are employee issues to decide. Recruiting methods, policies and procedures, benefits (including possible stock option plans for key employees) must be determined. Facilities issues are next, and these include procurement of the hardware, software and network components for the operations activities of the company. Careful negotiation is required here. The company must be sure that software licenses permit use of the software for providing outsourcing services to customers. It is also vital that the license fee structure fit the company’s economic model for pricing to its customers.
Role of Advisors
Entering into an outsourcing agreement with a supplier is a high-risk venture for customers and, to avoid high switching costs, they will check out the potential supplier very carefully. Therefore, establishing a new company in the global neighborhood of outsourcing suppliers is best accomplished with the advice of those who bring business and legal expertise to the table. The contractual terms and consequences of what happens in the event of a failure to achieve service levels are the work of a lawyer. Among other expertise, an outsourcing consultant has the technical and industry knowledge regarding services levels, industry standards, service descriptions necessary to help the new outsourcer shape its strategies. A lawyer does not follow the industry as a consultant does, and a consultant seldom has a license to practice law. Their advice goes hand in hand for a new outsourcer. The most effective plan is to use a company that offers integrated services.