- At Kemp Little, we are known for our ability to serve the very particular needs of a large but diverse technology client base. Our hands-on industry know-how makes us a good fit with many of the world's biggest technology and digital media businesses, yet means we are equally relevant to companies with a technology bias, in sectors such as professional services, financial services, retail, travel and healthcare.
- Kemp Little specialises in the technology and digital media sectors and provides a range of legal services that are crucial to fast-moving, innovative businesses.Our blend of sector awareness, technical excellence and responsiveness, means we are regularly ranked as a leading firm by directories such as Legal 500, Chambers and PLC Which Lawyer. Our practice areas cover a wide range of legal issues and advice.
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How can growth-stage businesses manage the outsourcing challenge?
Done well, outsourcing can be a powerful tool not just to deliver cost efficiencies, but to help drive competitive advantage, improve business performance, and deliver business transformation. Yet, despite its maturity as a model, these outcomes are not guaranteed, and achieving success in an outsourcing relationship remains a challenge for many businesses.
In this article, we discuss:
- the key ingredients of a successful outsourcing and how to avoid some of the common pitfalls
- the impact of multi-sourcing
- legal tips for growth-stage businesses
What is outsourcing?
Outsourcing transactions typically fall into three broad categories, each with its own unique issues:
- First generation outsourcings: where a customer transfers responsibility for providing services using its own resources (i.e. its employees and equipment) to an external supplier
- Second/third generation outsourcing: where a customer that has already undertaken a first generation outsourcing changes suppliers
- Insourcing: where a customer that has already undertaken a first generation outsourcing brings the outsourced services back in-house.
Key ingredients of a successful outsourcing and how to avoid common pitfalls
It is important for an organisation that is considering the outsourcing of any of its IT or business functions to understand what the market can offer by way of service scope, service levels and pricing. This is typically achieved through a competitive tender process, in which the customer invites several potential suppliers to bid to provide the services. A properly run tender process will create competitive tension between suppliers and should help the customer obtain a competitive price and service levels for the outsourced services on robust terms.
Understanding both parties’ commercial drivers
The supplier and customer must have a clear understanding of they each expect from the outsourcing arrangement:
- the supplier must understand the customer’s business requirements, and the key drivers for the outsourcing (cost savings, service improvement, access to better skills, or a combination of these) – without this understanding, delivery of a successful outsourcing relationship will be difficult to achieve
- the customer must understand the supplier’s operating and financial models so as to ensure that the contract delivers the levels of financial return required to keep the supplier engaged in properly performing the services over the life of the contract.
Outsourcing arrangements often relate to the customer’s core business. It is vital, therefore, that the supplier and customer maintain a good working relationship through which issues around service delivery can be dealt with quickly and efficiently, and the relationship is managed to deliver maximum return for both parties.
This means having in place an effective governance programme under which the supplier and customer routinely meet to discuss the services; it also means having an effective escalation mechanism in place to deal with any service performance issues. It is also important for the supplier to commit to formal service reporting obligations which allow the customer to understand how and to what standard the services are being delivered.
Responding to change
Outsourcing arrangements are typically long term engagements, and change over the life of the contract is inevitable. These changes can be driven by the customer’s requirements (merger, acquisition, divestment, organic growth), industry developments (such as the emergence of new technology or service delivery models), or changes to the economy (as many businesses experienced during the last downturn). A good outsourcing contract will include mechanisms to deal with these changes, including flexible pricing models (to allow for upward and downward fluctuations in the customer’s requirements), price benchmarking provisions (to allow the customer to benefit from any downward pricing trends in the market), and a robust change control process to govern how change will be managed by both parties to avoid unnecessary operational and commercial risk.
Incentivising good performance
An outsourcing arrangement should be structured to incentivise the supplier to continually improve service performance over the life of the contract. There are a number of established methods of incentivising service improvement including:
- gainshare mechanisms through which service delivery efficiencies achieved by the supplier are shared by both parties (for example, by sharing a percentage of any cost savings achieved, or the use of outcome-based pricing mechanisms which reward the supplier for achieving defined business outcomes for the customer)
- bonus payments where service levels are exceeded, or customer business outcomes are achieved
- allowing the supplier to legitimately and fairly increase its charges during the contract term (to deal with unavoidable increases in its cost base) whilst at the same time ensuring that the supplier is incentivised to ensure its charges remain competitive (through price benchmark provisions)
- Requiring the supplier to routinely update the customer about technology and service delivery developments which might improve the services being delivered
Correcting poor performance
The outsourcing contract should include tools enabling the customer to control and address poor supplier performance. These tools commonly include:
- Service credits to compensate the customer for poor performance
- A right for the customer to withhold payment until performance improves
- A right for the customer to “step in” and take over management or performance of elements of the services, either through its own staff or by appointing another service provider
- A right for the customer to require the supplier to provide more frequent and detailed reporting until the services improve
- A right for the customer to force the supplier to comply with a “remediation plan” setting out the specific actions it must undertake to improve performance, and
- Ensuring that the parties have agreed an effective dispute resolution/escalation procedure that ensures the supplier’s senior management are fully engaged in addressing service performance issues.
Planning for exit
One thing that is certain in any outsourcing arrangement is that it will come to an end at some point. It is important that the customer's exit strategy is addressed before contract signature, and regularly updated during the contract term. One of the biggest mistakes a customer can make is to ignore exit until contract termination is on the horizon. The customer should build sufficient protection into the contract to ensure that the supplier is committed to assist with transition to a new supplier on termination.
The impact of multi-sourcing
The traditional approach to outsourcing has been for a customer to appoint a single supplier to provide all of the customer’s outsourced services (e.g. IT helpdesk, software development and maintenance, and infrastructure services). This approach often appeals to customers on the basis that they have “one throat to choke” if services aren’t delivered.
In recent years, customers have moved away from the single supplier model towards a multi-sourcing approach. Multi-sourcing enables customers to choose several “best of breed” suppliers to supply different services - this allow customers to select smaller and often more experienced providers to supply cutting-edge services, and to maintain competition between suppliers post-contract signature. There are, however, some potential downsides to mult-isourcing - the most obvious being that it can be difficult to work out the root cause of a service failure when multiple suppliers are involved. A multi-sourcing approach also means having to manage a variety of contracts and suppliers who may not be motivated to collaborate with each other. These issues can be addressed through effective contractual and governance mechanisms (including collaboration agreements and joint service bonus pools). Ultimately, multi-sourcing can deliver significant customer benefits, but only if the risks and challenges of multi-sourcing are properly understood by the customer, and addressed early on in the contract planning stage.
For further information please contact Rupam Davé.
This article first appeared in Business Zone.