Outsourcing - Managing from Afar

09 April 2003

Mark O'Conor

Companies have various reasons for deciding to outsource their IT functions; pressures to improve efficiency, increase flexibility and reduce costs are usually fairly high up on their agenda. It was not until the early 1990’s however that companies started to look at offshore outsourcing. The phenomenon, which has now become the trend in the 21st century, started in India when Cobol programmers were recruited to help companies prepare for the Year 2000. The National Association of Software and Service Companies (NASSCOM) estimates that India’s export revenues from IT services will grow from $6.1bn in 2001 to $50bn by 2008.

Vietnam is also trying to get in on the act. Not only is it cheaper to outsource to than India, but the Vietnamese Government in May 2001 introduced zero-rated tax for software exports and raised the personal income tax bracket for both foreigners and local employees to $1,000 per month (enterprise income tax is set at only 10%). The state of the telecommunications market is also another strong incentive. However, a major downside is that Vietnam is a software pirate’s paradise and its media laws restrict the free flow of information.

When deciding on the appropriate location, a number of factors should be considered, including:-

  • the cost (present and future) of software, hardware, labour and other materials;

  • the country’s safety and level of security; not only for your equipment (e.g., servers) but also your staff;

  • the state of the country’s legal system, in particular with regard to protection of intellectual property rights (including enforceability of such rights). Bear in mind that some software suppliers may not consent to the outsourcing if their software is to be used in a country which is prohibited by export law (e.g., North Korea, Iraq);

  • the political stability of the country;

  • the country’s ability to sustain long-term availability of skilled labour;

  • the state of the country’s infrastructure;

  • what support the country’s Government gives to outsourcing deals;

  • your supplier’s technical and financial capability to support you in the location you choose;

  • any language and cultural differences which may have an effect on the services. This will be of particular relevance if you back to back the services you receive from your service provider, downstream to your ultimate customers.

Assuming that location is acceptable, and the potential service providers have been identified, the next issue is to ensure that you give as much thought (and time) to the service contract so that your reasons for outsourcing are achieved. Your contract with your ultimate service provider should therefore clearly set out the following (which is provided as a model agreement checklist):-

  1. the length of the outsourcing arrangement (and the ability to renew) – set a sensible term (e.g., 3 to 5 years);

  2. the services to be provided – unless these are addressed in the contract, there will be no obligation on the supplier to honour any commitments it may have made during the negotiations;

  3. the responsibilities and obligations of the supplier and those that remain with you;

  4. the assets needed to provide the services and who is responsible for providing and maintaining them – if you are providing assets for the supplier to use make sure the contract is clear as to when, how and who can use the assets;

  5. who takes title and risk to any assets which are transferred – usually, the supplier;

  6. if you are outsourcing a function of your business which uses third party software/hardware, the owners consent will have to be obtain otherwise you may be breach of the scope of your licence - you may even have to transfer software licences, agreements and equipment leases (for example) to the supplier. (Unfortunately, this is often left until the last moment at which point you are vulnerable to being charged a premium for the consent necessary);

  7. a process giving flexibility to change/expand the scope of the services – your business strategy is bound to change and your outsourcing arrangements must be capable of aligning with this;

  8. the contract charges over the term of the outsourcing and transparency in pricing structures - do not write the supplier a blank cheque;

  9. performance/service levels from the cutover date which you want the supplier to meet and the consequences for failure, whether future credits or actual payback of monies;

  10. warranties/representations concerning performance of the service provider and its staff (including a right for you to request replacements if you are not happy with performance (either technical or otherwise));

  11. compliance with the laws (both local and international) which may apply to or have an impact on the services;
    limits of liability should be carefully negotiated - make sure the limits are both reasonable and realistic and that the supplier has the insurance in place to meet its liabilities;

  12. indemnities from the supplier in the event that a third party sues you for infringement of their intellectual property rights as a result of something which the supplier has done during the course of providing the services;

  13. your right of termination before the contract is due to end - you may want to be able to terminate if your business strategy changes during the outsourcing – the supplier may want compensation in return for agreeing to a right to terminate without cause;

  14. a right for you to step-in to the suppliers shoes (rather than terminate the agreement) in certain circumstances – for example, in the event of a force majeure event or breach by the supplier arising;

  15. exit arrangements in the event you want to either bring the function back in-house or outsource it to another supplier at the end of the term or if you exercise any right you have to terminate – including the return/destruction of any property upon termination (e.g., assets and confidential information);

  16. staff transfers and the Transfer of Undertakings (Protection of Employment) Regulations 1981;

  17. processes and procedures (e.g., monthly meetings, reports, ability to audit the suppliers records) to monitor the service you receive and oversee the operation of the contract (from start to finish);

  18. personal data and confidential information – in providing the services, the supplier must comply with Data Protection Act and 1998 and any security measures to protect confidential information; and

  19. the law and the jurisdiction of the contract should be English and England respectively.

Cover the above issues correctly and you not only outsource the relevant function, but you outsource much of the legal and commercial risk. Instead of entering into an arrangement filled with uncertainty, an innovative, technically relevant and legally watertight contract can help to remove much of the headache associated with IT outsourcing and leave instead a sure and legally enforceable set of rights and obligations to cover all eventualities during the contract’s life.

Written by Mark O'Conor and Lisa Comber. Also published in MIS magazine.