How to Contract for Outsourcing in the Credit Crunch

Recent economic forecasts by Capital Economics suggest the UK is set for a worse economic downturn than the US. This is due to factors such as the British having on average substantially more unsecured debt than their US counterparts. But although speculation and media hype has been blamed for exacerbating the situation, there is little doubt that the UK is entering a period of economic uncertainty. In response, businesses are preparing to examine internal processes to see how spending can be cut to protect profit margins. Outsourcing in particular will be under scrutiny.

The common consensus is that the outsourcing market will not be affected by the downturn, as more C-suite executives use it to reduce costs. A recent Gartner report argued that cost is still the primary reason for most organisations to follow the outsourcing route.

However, there is a possibility that if a serious recession hits, companies might actually scale back outsourcing operations. If a company’s market share is hit, presumably its requirement for outsourced services is reduced. Faced with this dilemma, some companies might opt to bring those services back in-house.

The outsourcing market has changed significantly over the last few years and outsourcing contracts have changed accordingly. Gone are the days of the huge megalithic outsourcing deal where organisations would use one supplier to fulfil on the whole range of IT and business services.

End-user organisations have grown wise to the notion of not outsourcing a problem and have realised the need to retain a significant degree of in-house control. Companies often now use multiple suppliers to fulfil different aspects of the outsourcing. The credit crunch signifies that the focus on cost will intensify and end-user organisations will be assessing how to get the most out of their suppliers for the money they are spending.

So how can organisations ensure that they contract properly for outsourcing in these tighter economic times? Below are four guides:

DON’T RUSH

If organisations are panicked by an impending recession, there might be a temptation to rush into an outsourcing contract for a quick-fix solution. In their eagerness, they might spend less time on due diligence for example. But the preparatory stages of outsourcing are crucial in being able to structure the right contract.

The need for constant referral is vital in order to understand the outsourcing objectives and how the contract can help to achieve them, as well as the applicable contractual duties and the contractual standards.

The contract is a roadmap and following it will go some way to help outsourcing deals become more successful.

LIABILITY CAPS

The current economic climate increases the importance of contractual issues like liability caps. The liability cap is a safeguard in all outsourcing contracts to guarantee the end-user compensation if the supplier does not deliver. Liability caps are often a contentious point (take the ongoing EDS and Sky case as an example).

But if the supplier and the end user approach the issue cautiously, the supplier will be less inclined to over-promise on what it can deliver and will be in a position to manage its client’s expectations more carefully. When resources are tight, it is important that end-user organisations have a clear and realistic view on what can or cannot be achieved.

SCOPE CREEP

Suppliers and customers often cite scope creep as one of the biggest problems in an outsourcing arrangement – this arises when one party asserts that the parameters of the project have changed once the outsourcing is already underway. Customers can get annoyed when suppliers fail to respond to changing requirements.

However, these changes might well not be within the scope of the original contract. If a contract is particularly focused on cost reduction, the supplier’s obligations will be structured within very tight parameters. It is important that the supplier and the end user know what these are – if changes then need to be negotiated, the contract needs to be flexible enough to cope with this.

EXIT STRATEGIES

Exits are another element that organisations need to pay heed to, particularly in the current economic environment. The organisation must ensure that it has the technical and legal ability to ‘recover’ the outsourced services from the service provider either back to an internal function or to an alternative provider.

The need to retake control of the services could arise on an early contract termination or on the expiry of the original term of the outsourcing contract. In either case, the contract must provide details for the way in which the services and the underlying assets will be transferred from the original service provider to its successor or to the customer.

It will be interesting to see how outsourcing arrangements pan out under an economic slowdown. The focus will now swing firmly back to costs and whether organisations are formalising new outsourcing contracts, or renegotiating existing ones.

Regardless of the economic outcome – whether it’s a belt-tightening scenario or a full blown recession – organisations need to have a contract that prepares them for any eventuality, positive or negative.