What makes a great outsourcing contract?

SSON News and Analysis
Posted: 07/09/2012

It takes two to tango… and it takes plenty more than that to ensure a successful outsourcing relationship. Collaboration, co-operation and bucket-loads of good old-fashioned hard work are the order of the day when it comes to creating the perfect outsourcing deal - and, as those who’ve gone through it will agree, you should expect plenty of teething troubles and unforeseen gremlins even in the most promising and smoothest deals. 

Read Part II of this series... 

There’s no way to avoid simply every obstacle that might come your way, of course. However, a good contract can definitely help you navigate around a host of otherwise potentially pernicious problems. Getting things down in black and white at the start of the journey not only gives the parties some binding fabric to their agreement; it also shapes the entire ethos of the deal - as well as providing processes to turn to in the light of the unexpected or the downright unfortunate.

So what makes a good - even a great - contract? Of course, each has its own idiosyncrasies and quirks - but there are some aspects which every outsourcing deal should contain to ensure the best possible framework within which these business-critical deals can develop and thrive. While no single contract can be hailed as the perfect example of its species, here are a few elements which, combined, will help lift your own agreement up out of the mire towards outsourcing heaven…

Due diligence

To begin at the beginning: the first step towards a perfect contract happens a long, long time before an agreement ever gets near paper. Finding the most suitable partner, and the due diligence that goes along with that quest, is of course an absolute prerequisite for any half-decent agreement, in that the buyer needs to be completely confident in the ability of their prospective provider to fulfill their side of the deal: residual mistrust or a lack of complete engagement between the parties in question means that worries about performance can (and almost certainly will) color contractual negotiations to the extent that the document may take on a very different aspect as the putative client’s concerns manifest themselves in ways - extra clauses, hyper-sensitive penalty trigger mechanisms and the like - which can effectively ruin the relationship from the off.

Incidents such as the high-profile Satyam affair have - understandably - created a good deal of trepidation among would-be buyers of outsourced services. The big problem with the Satyam scandal in particular was that the fraud was so well concealed for so long that the company appeared from the outside to be both healthy and reputable - and was moreover certified as being so by external auditors - so even pretty thorough due diligence missed the rather large black hole at the center of the provider’s accounts. One positive consequence of the whole sorry affair is that potential buyers have really been forced to up their game in terms of due diligence; companies thinking of entering into an outsourcing agreement should now be both more aware of the possible dangers and better prepared to seek them out, and stress-test their putative partners.

By the time discussions reach the contract stage, the buyer should feel entirely comfortable with the vendor’s financial health and capabilities; a well-informed buyer (while not of course allowing any laxity into the contract: regardless of the level of trust, the usual protections must be observed) is less likely to spend precious time agonizing over decisions which in the end only obstruct the path to contract and partnership perfection.

Similarly, the buyer should be thoroughly confident that they have found not only a secure and trustworthy partner, but a reasonably-priced one, too. It should go without saying, but possible buyers of services - even if they already have providers incumbent - should shop around for the best deal and tie down an awareness of market value for the services in question before negotiations begin, let alone contracts begin to be discussed. What this also means - and this tends to be less robustly adhered-to - is that buyers need to know what services are going to be required, in as minute a detail as possible. This can be worked out in partnership with the vendor, certainly - but if that’s the case it needs to be done before, rather than during, the actual contract stage, since otherwise may result not only a potentially damaging loss of focus, but a lack of clarity around the financials which the contract looks to set in stone.

Keeping focused

Key to driving all parties along through the contract process is a firm focus upon the end goal - going beyond the formation of a mutually acceptable agreement to the actual provision of a high-quality service. For both (or all, in the case of multilateral agreements) parties the intention of the contract is not to be a work of art in itself, or to keep the lawyers in Armani for another month: it’s to facilitate the provision of a service or services, the carrying-out of certain work at a required standard.

With that in mind it’s important to involve the end users as much as is feasible. Something that might seem logical and unremarkable to a specialist in contract law might appear utterly implausible or even potentially disruptive from the perspective of an end user within the buy-side organization; getting the input of those who will actually be dealing on the ground with the service being provided should help keep thoughts focused well and truly on the task in hand.

Likewise, a firm focus on the scope of the agreement will have benefits throughout the drawing-up of the contract and, more importantly, throughout the lifecycle of the agreement. Understanding what a contract should cover, and why, will not only make for a better contract: it’ll also increase awareness around what isn’t covered by the contract and thus help to direct attention in the right direction in the case of trouble down the line. A tight focus will also, of course, help limit "scope creep" among the more enthusiastic participants in the negotiations - and help keep things as lean as possible.

Lean and keen

Who says contracts have to be long and complex? If companies the world over are going Lean, surely they should be doing so in their contracts too? Obviously when it comes to something as critical as drawing up a contract - possibly for hundreds of millions of dollars - it doesn’t pay to skimp on the details… On the other hand, plenty gets included in outsourcing agreements which simply doesn’t need to be there. Excess baggage on a contract isn’t just inefficient in itself (although those legal fees sure do add up); it leads to much more troubling inefficiencies in the service process.

For example, a SLA-heavy contract might appear nice and tight to a buyer - but by including a vast number of service levels, and thus requiring significant reporting and checking resources on both sides of the agreement, the buyer is effectively driving up costs both within their own organization and within that of the provider. These extra costs will eventually be borne by the buyer - who suddenly might not feel they’re getting such an attractive deal after all. 

SLAs are of course crucial, but the buying organization should be wary of diminishing the advantages of outsourcing by tying its provider to a surfeit of service levels. It may be, though, that SLAs can take on a rather political significance during contract negotiations, in that companies might feel it advantageous to appear to compromise on what are, in fact, lower-priority SLAs in exchange for more attractive pricing. Going into the negotiations with 100 different service levels and coming out with 10 absolutely crucial ones and a massive reduction in the cost of the provision might not be particularly bad business if those 10 are the only ones you really, really wanted anyway… 

Partnership

It may sound like a cliché but it’s true anyway: a good outsourcing deal is a real partnership and has to be approached as such by both (or all) parties right from the off. Speak to anyone involved at the upper end of a major outsourcing deal and they’ll stress the values of collaboration and deep connection rather than espouse the "hands-off" approach of days of yore.

In an article he wrote very recently for SSON, International Association for Contract and Commercial Management (IACCM) CEO Tim Cummins looked at a discussion around the following hypothesis: "It has become widely acknowledged that ‘smart contracting’ is the key to a successful BPO relationship. However, traditional legally-driven negotiations often create 'structured adversarial relationships', designed to punish failure, rather than encourage the growth of a strategic relationship. This tendency is aggravated by the efforts of procurement experts to view BPO as a commoditized service rather than an incentivized business partnership."

Under the traditional view of outsourcing as a cost-saving tool it’s relatively easy to come to view the provider as just that - a provider rather than a partner. However, as provider capabilities have matured, and software and resource provision have become of an increasingly high quality, the question of what an outsourcer can add beyond cost savings has become ever more important. As such, constant dialogue between parties in search of the next value-add has become indispensable.

A partnership of ideas rather than a simple buyer-vendor dynamic is becoming the norm - and this needs to manifest itself at contract as much as anywhere else in the relationship. This doesn’t just mean the buyer working closely with the provider on the terms of the contract; it involves - where possible - a collaborative approach to issues which formerly may have stayed clearly on one side or the other of the provider/customer divide.

This can be encouraged by hard action as well as by well-meaning rhetoric, of course. For example, it’s now increasingly common for contracts to include contractual clauses requiring service costs to decrease over the course of the agreement - to factor in falling tech costs, certainly, but also to incentivize the provider to follow a course of continuous improvement. Going along with such clauses involves a degree of compromise on the part of the provider - but compromise is the secret to many a successful relationship, and at any rate if the provider believes that the savings in question can be made, presumably they’ll be happy to accept those terms as part of what could regardless mean an extremely satisfactory deal for them financially speaking. Some might say, it’s only fair.

(This topic also bears relation to another, earlier SSON article featuring the IACCM CEO: an interview with Tim Cummins in which he glances at the changing shape of business and commerce, with traditional organizational structures transforming towards a disaggregated business model. While that is in itself another, vast, issue, it’s worth noting that as organizations disaggregate the need for collaborative sourcing relationships will become increasingly imperative - as will, thus, the partnership ethos espoused above.)

Read Part II of this series...

SSON News and Analysis
Posted: 07/09/2012

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