What makes a great outsourcing contract? Part II

It takes two to tango… and it takes plenty more than that to ensure a successful outsourcing relationship. Part II of a two part series on how to smooth out the perfect contract for your organization. 

Read Part I of this series...


A contract needs to be firm as heck - but it also needs to be flexible if it’s going to facilitate a flourishing and successful relationship. Outsourcing arrangements need to cater for a vast variety of potential changes in the business and legislative environment of the parties in question: new laws and regulations, new technology, currency fluctuations, changing business needs of the end user or users, and different macro-economic circumstances can all have drastic impacts upon the way a company operates and interacts with its partners, and unfortunately a contract needs to be prepared for any and all of these changes. Being tied into paying your provider in their home currency while it suddenly appreciates 50 per cent in a year can suddenly make a contract an awful lot less attractive to a buyer of services…

Of course, the contract itself (especially if it’s going to get anywhere near the lean ideal) can’t provide for every eventuality. What it can do, and should do, is provide an adequate framework for both parties to come together and analyze how the operating environment has changed and what steps need to be taken to keep the relationship viable from both perspectives. Similarly to the need for a robust dispute resolution framework as discussed below, there is a requirement from very early on in the agreement for a structure intended to cope with the vagaries of doing business together in a hectic world; while events may conspire against the signatory parties, at least if their contract provides some form of blueprint for working together, some progress may be made.

Contemplating what events might require such contractual flexibility is a full-time job in itself - especially in a globalized business environment with services being delivered from a global platform. Nevertheless, a well-drafted contract and two parties looking for solutions rather than recriminations are the best foundation for overcoming whatever obstacles are thrown in the way of the relationship.


As stated above, the ideal outsourcing deal is a true partnership, a coming-together of ideas and talents. But even if an agreement doesn’t reach those dizzy heights it needs to display a suitable degree of fairness if the relationship’s not to break down terminally. A contract should be something both sides are happy to stick by for the duration of the deal, not look to work around or through as soon as the ink’s on the dotted line. The concept of fairness here doesn’t mean equality - there’s still a buyer and a provider, after all - but it does mean creating a contract where, as far a possible, all parties believe they’ve got a good deal.

The stereotypical example of an unfair agreement is one where the buyer’s negotiating team has, for want of a better phrase, done a number on their counterparts within the vendor organization, obtaining extremely favorable financial terms. What tends to happen in such cases is that the vendor is forced to operate on extremely reduced margins and, invariably, starts giving more attention to more lucrative relationships or even begins to think of ways to terminate the deal. With Outsourcing 1.0 where companies view the process as a cost-reduction exercise pure and simple, and where the emphasis at contract is on keeping as much cash as possible off the table, it’s easy to see how this lack of fairness can quite frequently manifest itself in unsatisfactory agreements - especially when the buyer is a very big player with serious economic clout, or in a buyer’s market where providers are constantly exposed to the danger of being undercut.

Because of the intimate and long-term nature of outsourcing relationships, however, it’s vitally important for a buyer to keep their provider happy (or at least content) and keen to keep their client’s custom - without, of course, becoming something of a soft target. Approaching a contract with the concept of mutual fairness, rather than penny-pinching, at the forefront of the mind will help reduce the possibility that the terms of the contract will be the tripwires that bring the entire agreement tumbling down.

Incentives and penalties

The aforementioned requirement for fairness notwithstanding, it’s crucial to specify penalties which will come into play in the case of  sub-optimal service provision - as well as the incentives encouraging both parties to up their games. However such penalties and incentives are going to be shaped, it’s important that they be, firstly, fair (of course), but moreover that they be designed as a result of the clear focus on the end result discussed earlier. The idea is not (NB, buyers) to recoup a substantial percentage of the fees through penalty fines; nor is it (here’s looking at you, vendors) to tie the buyer in to an increasingly exorbitant reward system for exceeding certain targets.

Rather, the point is to increase service quality, efficiency and effectiveness. Yes, financial rewards and penalties can help do this - but they’re not ends in themselves. Badly calculated incentives and penalties can scupper the most promising of relationships (and at the beginning of a relationship, with a lot of learning still to be done about where precisely the baselines may lie, it is at any rate advisable to be relatively light of touch when it comes to putting incentives and disincentives in place).

Intellectual property and data protection

IP is a huge issue in outsourcing - whole fields of study and practice are emerging from those mere two letters - but however complicated that issue may be, many serious problems can be headed off in advance by outlining IP responsibilities and entitlements at main contract stage. Who owns the rights to what - process, software, data - needs to be spelt out at the beginning of the whole affair to avoid some potentially extremely nasty clashes down the line. Buyers and vendors alike need to keep a close eye on any proprietary software or systems being used in any aspect of the outsourcing deal; likewise ownership of any brands, trademarks and copyrights which will be used anywhere along the line needs to be clarified from the off.

Similarly, the modern bane of data protection needs to be involved in the contract - specifically, who handles what data when, and what steps must be taken by both parties to ensure the security of said data. For instance, losing customers’ personal details can be devastating enough to a company’s image without invoking the specter of outsourcing or offshoring. If a provider is to be handling large quantities of potentially damaging data it is imperative that how that data is to be handled is specified at the contract stage, allowing the buyer at least some input into how that most precious and potentially devastating commodity is cared for.

Dispute resolution

In an ideal world, just as in marriage, partners in outsourcing would never argue… But - alas! - it’s not an ideal world and some form of dispute, however minor, is going to come up from time to time in any form of relationship as convoluted and complex as outsourcing. While the great majority of problems will be minor enough to be able to be sorted out quickly and without the need to turn to the rulebook, in some less happy circumstances a quiet word or two just won’t cut the mustard and more formal dispute resolution procedures will have to be put into play.

But what procedures? Again, this is where the contract becomes critical. By specifying the structure of the dispute resolution mechanism, a good contract - while not providing all the answers itself - will enable the signatory parties to work together to resolve their issues (and it’s rare indeed to find a dispute that genuinely doesn’t have a resolution lurking somewhere). Outlining how a grievance is to be addressed, how promptly, under what circumstances, and by whom, before the fact, is a great step towards ensuring that if disagreements do arise they can at least be ironed out by a pre-agreed process. If after that process has been carried out, one or other of the parties is unhappy with the resolution, they will at least be aware that they were partly responsible for the drawing-up of the resolution process itself and agreed to be bound by its decision.

Some contracts allow for the involvement of external conciliation agencies while others specify that resolution is to be achieved internally to the two parties. However it’s agreed, though, it’s important to note that the mechanism must be arranged in accordance with all relevant laws and regulations (compliance being as much of an issue here as anywhere else) and that this may result in external parties (such as unions or trades bodies) being involved as a consequence even if the contract specifies otherwise. Once again due diligence is vital here.
Termination preparedness

All things must end, so they say - and outsourcing deals are certainly no different. However, a great deal of pain and inconvenience can be avoided if that very fact is faced head-on from the beginning rather than swept under the carpet. A good contract will specify as clearly as possible how the relationship can be brought to an end smoothly and without disruption to the buyer’s core activities. Most deals agree that even if one side cancels the agreement unilaterally (with whatever consequences already outlined within the contract), whichever side that may be, the provider will still continue to offer the contractually agreed service until either a set period has elapsed or another provider has been secured. The consequences for a company’s reputation, of course, of not following through on those guarantees would be catastrophic and buyers should feel confident that even in the event of a total breakdown in the relationship, the service itself won’t be affected.

Some contracts specify a "right of step-in" whereby the buyer receives the right to take control of the relevant portion of the provider’s staff and infrastructure to ensure uninterrupted service; whether or not those rights are arrogated, some kind of answer to the question "what if the worst happens?" needs to be given at the contract stage.

Also useful is an agreement on transferring data and knowledge from one provider to a successor firm in the event of the non-renewal of a deal. Throwing toys out of the pram is all very well for infants but a multi-million-dollar service provider parting company with a multi-billion-dollar client can’t exactly just sulk and refuse to give back relevant data and systems - well, that is, it can’t if the contract specifies a certain process in such an eventuality. A mutual agreement needs to be reach which specifies that even if the buyer is transferring its deal to the provider’s biggest rival, it will be business as usual until the final day of the existing arrangement. The contract will presumably also specify early-termination penalties and, as mentioned, a dispute resolution process which can be utilized in an attempt to prevent a permanent breakdown in relations. 

Read Part I of this series...