Leaping Offshore - Ten Stepping Stones

27 February 2004

Dominic Cook, Nick Perry

The news on offshore outsourcing is proving mixed. On the one hand the number of stories relating to companies in an increasing variety of industries taking the leap offshore increases daily. On the other, there is a growing number of column inches being devoted to some of the problems: employee relations, the issues for the wider UK economy, decreasing service quality being provided by some offshore operations, and most recently, increasingly worrying security issues.

While the offshore concept is not popular with many, a salary of £1,200 p.a. as opposed to £12,000 p.a. per person is pretty compelling economics from an employer’s perspective. Added to this is the fact that the £1,200 p.a. person is likely to be a highly numerate and enthusiastic graduate who is proud to have the job that they have – mention “call centre operative” to the average school leaver in the UK and the reaction may not be quite so positive.

Senior management in organisations of any size will need to be brave not to at least have an outsourcing strategy and to have included in that consideration of the offshore option. This is so, even if that strategy is, ultimately, to have thought about it, but to have decided to retain everything in-house. We are likely to see many more outsourcing/offshoring questions being raised at AGMs.

The focus for offshore outsourcing is, inevitably, on the bottom line. However companies looking at “offshoring” neglect the practical, legal, tax and regulatory factors at their peril. Proper project planning in these areas will not only pay dividends from a management perspective but can also contribute materially to the bottom line.

For example, structuring a subsidiary as a software technology park (STP) unit in India entitles the company to substantial tax benefits subject to it meeting certain export commitments. The permitted activities of an STP are far broader than the label would suggest. They could include software development, digital signal processing, business process outsourcing and call centre operations.

The mantra for any company looking to “offshore” should perhaps be: “simple pragmatism must prevail”. One could negotiate the most comprehensively drafted and exhaustively discussed contract in the world, but how attractive is it to be party to a dispute which could run for years in a different jurisdiction to your own involving local issues being heard by local people? The answer is not complicated, which is why pragmatism must prevail. Our work in this area has shown that careful consideration by management of a number of key areas when considering a leap offshore pays significant dividends in the end result. The following ten stepping stones should be considered when launching an operation offshore:

Step One – Choose your contract vehicle carefully

  • Should you establish a subsidiary or contract via a third party? A long term commitment could make the subsidiary route worthwhile. However, look out for foreign investment regimes that may restrict equity levels – there are often exceptions to these rules. The third party contract route may be attractive especially if married to a purchase option (the build, operate, transfer model), as much of the local compliance and employee risk is transferred.

Step Two – Be cautious in your choice of Law, but think local

  • If one party is a foreign entity then the contracting parties can choose the law governing the contract. Typically the parties would also choose a foreign venue for arbitration – care needs to be taken to ensure any arbitral award would be recognised in the local jurisdiction. It is vital that, to the greatest extent possible, local litigation is avoided as this will be disruptive and expensive in terms of money and management time.

  • Delays in the local justice system make the rapid recovery of money difficult. Thought should be given to more innovative “remedies”. For example, where the contractor is obliged to put a sum of money in escrow that would be released upon certain trigger events such as poor performance or excessive staff turnover leading to higher training costs. Payment holidays/reductions can also be negotiated if triggered by pre-determined events.

Step Three – Protect yourself against insufficient resourcing

  • Does your chosen offshore partner have the resources to deliver what is required? If there is any question about this, then suitable protection in the contract should be included to mitigate any downside. Typically such mitigation may include small up-front payments to the supplier pending full operational effectiveness over an agreed length of time to a pre-determined standard. Audit rights over the supplier’s operation are also a good idea.

Step Four – Make it clear who’s in charge

  • Management and control is vital; companies looking to offshore are best advised to have people in situ from the outset, whether this is in a direct management function or a contract management role. This tends to prevent misunderstandings between the supplier and the company and often serves to focus minds.

Step Five – Check local employment laws

  • In our experience, there tends to be a prevailing view that employment laws in Europe are so well developed that other non-European jurisdictions are bound to be more relaxed. In fact, the regimes in some commonly used “offshore” destinations can in some ways be considered to be fairly restrictive especially as regards leave policies, flexible hours and dismissals. In one notable case, there are certain restrictions on night time working for women which may cramp the style of a planned 24 hour a day, 365 day a year operation. The risk of many of these concerns can be transferred to the supplier if there is a purely contractual arrangement in place – the problem would then be the resultant breach of warranty/contract should the supplier adopt a cavalier approach to labour law compliance.

Step Six – Intellectual Property

  • Software piracy in not unknown in many common offshore locations however there is a growing recognition of this problem and these country’s intellectual property laws are becoming ever more sophisticated – enforcement and the speed of enforcement remain issues. The contract should include robust document and electronic controls as well as management information supply obligations.

Step Seven – Does the contract satisfy any relevant regulatory body?

  • For example, financial institutions will be anxious to ensure that the FSA requirements as regards outsourcing are not only met but are seen to be met and any contract will need to be sufficiently flexible to address the FSA’s developing requirements.

Step Eight – Data protection – don’t leave home without it

  • Data protection is a key area as the offshore operation is highly likely to process information about individuals thereby ensuring care must be taken to comply with UK and EU data protection legislation. On the face of it this prohibits the export of this information to countries that are not considered to have adequate protection for personal data. Possible solutions include obtaining consent from affected individuals or using contracts blessed by the European Commission. Failure to handle this sensitively has caused public embarrassment for institutions in the past, with recent media comment tending to treat this risk as a “threat” to consumers.

Step Nine – Know your story

  • Political and PR issues must be thought through as part of the offshoring process. In the US, specifically in New Jersey, Connecticut and Maryland, there is a growing resentment to offshoring and this “threat” is being challenged by local legislation. Companies are best advised to have a defence to charges of unpatriotic behaviour and the like prepared in advance. PR is also key. Brand protection should be uppermost in senior management’s mind as should ensuring the presence of ethical provisions in the contract.

Step Ten – Do you want to do it at all?

  • There are clearly a number of potentially serious issues with offshore outsourcing which occur over and above the normal range of issues which apply in the UK. While most of these issues can and should be addressed in a contract, it is rare that they can be solved in this way. Often a practical solution will also need to be adopted, or the risk recognised as a risk and taken. When considering these projects often a momentum builds up which can be hard to stop, but it is always taking a step back after the analysis and asking whether this route is one that you want to follow at all. There are some circumstances where no amount of contractual or practical protection can adequately cover the risks involved, making it a logical, though sometimes hard to take, decision that offshoring is not suitable.

Clearly, there are a number of other issues that require serious consideration ahead of any leap offshore but the above considerations represent the fundamental steps that management must take ahead of any move.

In addition to the complex legal issues involved, at the end of the day, the contract is there to do a job, not only as evidence of a commercial deal between the parties and to ensure compliance with a raft of domestic and non-domestic rules and regulations, but also to be a pragmatic tool through which services can be delivered.

Whilst much of the focus is currently on call centres and software development, there is an increasing move further up the value chain. Business process outsourcing, offshore processing hubs, telemarketing and sales are all areas that have emerged from the high volume low value call centre phenomenon. These are areas that vast numbers of highly educated graduates are moving to service at a fraction of the cost of their western counterparts. The trend towards outsourcing is becoming increasingly compelling and it is a business imperative for companies to have a well thought through, coherent but above all, pragmatic offshoring strategy.

Written by Dominic Cook and Nicholas Perry. Also published in Oursource Magazine in April 2004.