OUTSOURCING

Practical considerations

2010

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 OUTSOURCING

Practical Considerations

This article sets out the common characteristics and effects of outsourcing in general, its
challenges and potential areas of complexity and dispute. We also try to provide general
pointers and suggestions for avoiding or solving disputes that may arise.

In today's economy, temptation of substantial costs savings associated with outsourcing of

infrastructure, process or even a business function is tempting more and more businesses to
consider various outsourcing arrangements. Outsourcing is no longer only cost effective for
larger businesses - ever increasing number of smaller businesses are seeing the advantages
in outsourcing as the market space becomes more commoditised and increased competition
results in lower prices.

The term "outsourcing" itself can mean diverse array of service provision. More common
examples of outsourcing include:

§ infrastructure outsourcing, which allows businesses to gain a competitive advantage

by reducing the cost of entry into a particular market or at a particular level in the
market;

§ outsourcing manufacturing, whereby a third party manufactures products at your

specifications, hopefully either at a reduced cost, faster or better;

§ Hosting services, which allows a business to host either part or its entire IT
infrastructure in specialist and dedicated centres, increasing reliability and security,
without having to incur substantial capital expenditure for the same technology and
equipment.

§ On-demand or managed services allows a business to custom order the type and
timing of services they need with the aim of making their suppliers flexible and cost
effective;
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 § Business process outsourcing (aka "BPO") in its various guises, whereby a business
contracts with a third party for provision of a particular (usually non-core) business
function such as human resources, procurement, call centres or secretarial services.

There can be many advantages to outsourcing, main amongst which is the substantial
savings both on capital as well as on operating expenditure. Savings can come from reduced
cost of infrastructure, reduction in head count, tax savings (e.g. offshoring) or generally
lower cost per transaction. Other and more indirect advantage of outsourcing includes core
streamlining of a business, allowing it to concentrate on what it is best at. In turn such a
business offers a better service to its customer.

For all of the advantages brought by outsourcing arrangements, all options must be fully
considered prior to making a decision to outsource. Dependence upon a third party for
betterment or even survival of your business can pose a considerable challenge for any
organisation. Any outsourcing agreement is a contract which must operate, function and
meet the business needs of both parties for a considerable period of time - sometimes for
many years at a time. Therefore such agreement must be comprehensive, but also
adaptable and flexible in a relatively transparent way so to allow each party some
understanding of maximum exposure on price and risk. In this, bargaining positions are of
significant importance. SMEs who do not have a great deal of experience of such business
arrangements usually have tougher time and, as with all other businesses, go through a
period of maturity which ends up being more expensive than it needed to be.

As a business outsources one or more of its functions, it looses its in-house skill in those
areas. Bringing such functions back in-house becomes difficult and the business itself will
become more dependant on the outsourcing company. In such circumstances, it is
important to ensure that any outsourcing agreement gives necessary visibility into the
processes of the outsourcing company and its ability to cope with the demands of your
business, not only today but also tomorrow. The risk is not limited to just diminution in

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quality of service or attention, care must be taken to ensure that regulatory requirements
which affect you are effectively passed onto your outsourcer and updated as and when
relevant. Data protection obligations and audit rights should be clearly addressed by any
outsourcing agreement.

Closer affiliation of outsourcer and outsourcee can however have its difficulties as well. If
transfer of employment has taken place between your organisations, care must be taken to
ensure that terms of such transfer do not contradict the provisions under Transfer of
Undertakings (Protection of Employment) Regulations 2006. Such efflux of employees may
also inadvertently transfer intellectual property assimilated by such personnel whilst
working for you. Care should be taken to clarify what IPR is being transferred and what is
retained. More about IPR licence terms and confidentiality below.

Specific suggestions regarding terms

The outsourcing agreement should in any event contain a detailed and clear service level
agreement (SLA) which sets out the base obligations regarding quality and timing of work to
be carried out by the outsourcer. Both parties should ensure that their respective project
teams or co-ordinating persons have seen the terms of the SLA and agrees that it is detailed
enough for their business needs. Such SLA should also spell out what would happen if the
minimum requirements have not been met. It is not practical, cost effective or rational to
sue the outsourcer every time the terms of the SLA have not been met. If monetary amount
is set to compensate for non-compliance with the SLA, advice should be sought to ensure
that such payment does not amount to a penalty (prohibited under law and unenforceable).

It is more useful to ensure that appropriate warranties are given in relation to the SLA and
the correct liability levels are set. As your business is just another customer for the
outsourcer, your perception of business risk, or more importantly, your quantification of
that risk as total level of liability that the outsourcer may have to pay in the event of a
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serious breach, may not meet with the outsourcer's view of the same risk (especially if
commoditised services are being provided). In such circumstances, it is useful to negotiate
separate and appropriate levels of liability for different types of breach - this is usually more
agreeable and enforceable.

As mentioned above, loss of IPR is a very real risk in outsourcing situations. The agreement
should be extremely clear regarding each party's stance on IPR. If any intellectual property is
required for performance of the service by the outsourcer, you may wish to grant a limited
licence for the same. If transfer of such IPR or confidential information is unavoidable, you
may wish to include a licence-back provision which grants your business an exclusive licence
for the IPR in question without any restrictions.

If the outsourcer is domiciled outside of Europe or USA, it is worth considering and taking
advice on your business' ability to enforce the terms of the outsourcing agreement on the
outsourcer. To reduce your potential risk in this regard, shorter term agreements with
options to renew for predefined periods may be considered as well as amending the
payment terms so that substantial part of the fees are paid to the outsourcer after they
have met their obligations, not before. Parent company guarantees may be helpful if the
outsourcer's parent company is domiciled in a country where it is easier to enforce a
judgement or if parent company has a more prominent reputation and would therefore
yield to threats of litigation.

In order to ensure that the various points mentioned above do not grow into serious
disagreements, both parties to the outsourcing agreement should maintain effective risk
registers and dedicate knowledgeable and empowered team of individuals who will drive
the progress in the relationship and ensure that the outsourcing agreement continues to
meet the needs of both organisations.

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NOTES:

Pathways is a legal consultancy specialising in provision of the best-in-class legal resources and commercial
solutions to businesses. We help our customers achieve upfront transparency on legal costs and partner with
them to mitigate transaction and organisational risk.

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