Having A Good Outsourcing Process And A "Relationship-Based Contract" Helps To Ensure Success In An Outsourcing Transaction

Thursday, March 1, 2007 - 01:00
Morgan, Lewis & Bockius LLP
Akiba Stern

Editor: How should an organization organize for and conduct a successful outsourcing process?

Stern: Deliberately!!!

Most important, an organization should have empowered deal leadership that has the support of senior management needed to successfully drive the transaction to conclusion and overcome the internal and external challenges that always come up.

Subject matter experts representing all the affected line and staff constituencies (including security, compliance, finance, tax, HR and communications) should be added to the deal team and properly managed to provide an integrated and coherent effort.

It makes good business sense to get the lawyers involved early when the client is first approaching the market for the services it is considering and starting to speak with potential service providers. The end product of the outsourcing process is the contract. Early involvement by and the input from the lawyers will allow the company to build into the RFP or other preliminary deal documents items that must be in the contract (e.g., service level credits, risk mitigation provisions, data security, privacy, compliance issues, HR issues, tax issues, etc.), so that the providers have enough information to properly respond and price the services. Early involvement by the lawyers also mitigates expensive and embarrassing re-work of documents later in the deal - when such rework can cost the company a great deal of money and dissipate leverage that the company may have accrued.

Setting a realistic schedule is important for the customer. Customers need more time than the experienced and well-trained provider deal teams. Do not compromise the process to save time - this is a false economy. Finally, the experienced providers know how long these deals need to take and will often leverage customer haste to their advantage.

Editor: Why is it important for the customer to state its business objectives at the beginning of the bidding process?

Stern: This is an important element of how you structure an outsourcing process. We recommend that our clients write their objectives in order of importance. This allows the provider community to address the company's stated needs on a focused basis which results in a better response to the RFP. It also acts as a unifying tool for the company. Getting internal consensus for the company's objectives serves to bring together disparate stakeholders who have different priorities, which is critical for presenting a single and unified face to the provider community. It also gives the provider community something they can work with in putting together a response.

An important part of the outsourcing process is the learning that occurs as the process moves forward. When a company gets responses to an RFP, it is getting thoughtful solutions to the business challenge that the company posed in the RFP. A curious byproduct of this is that these solutions allow the company to test if the questions in the RFP, and underlying objectives, were correct. If the solutions do not address the questions or meet the objectives, the company is positioned to sharpen and refine its objectives and RFP questions and reissue them, or pull the plug on the transaction.

Editor: Should a company look at what a similar organization is doing with respect to outsourcing to benchmark its bidding process?

Stern: All clients do this in one form or another. In most cases, a business process that is being outsourced was previously done internally. Thus, it behooves the business to benchmark the proposal against in-house costs and performance to properly set a minimum baseline for the provider's performance and for the cost savings that the provider must deliver. In addition the customer should benchmark the costs and performance levels for similar undertakings by comparable organizations. The combination of the internal and external benchmarks should be used to help shape the requirements/parameters set out in the RFP.

Editor: Why is an organization's relationship with an outsourcing provider so important to the success of any venture?

Stern: Because, on day 1 after the provider takes over, you no longer have the employees, equipment, know-how or direct control you previously had with the IT or business process being outsourced - all you have is a contract. AND the relationship with the service provider.

Our experience is that contract-based relationships fail while relationship-based contracts succeed. That is to say, getting favorable terms will not guarantee success in an outsourcing transaction. Rather, success is mostly dependent on the customer's relationship with the provider, and, if that relationship is principally determined by a contract, and not the other way around, the transaction has a high probability of failing. On the other hand, if the contract is based on the relationship, it has a much better chance of succeeding.

What I mean by a "relationship" is not one that is formed on a golf course or at a health spa. Instead, it is a set of compatible organizational behaviors and values. If the two organizations are compatible in the way they do business, then, when problems come up, the provider is more likely to do what is needed to meet the customer's needs. For example, if the provider organization follows a top-down decision making process and the customer is consensus-driven, perhaps this is not the right provider. Investigating the extent of the organizational compatibility of two entities and testing how they will deal with challenges during the term is what should happen during the outsourcing process. As the normal difficulties arise during the RFP and contract negotiations, how the prospective provider makes decisions and resolves conflicts gives the customer a good indication of how the provider will deal with the problems that will arise during the term of the contract and whether they have compatible governance processes.

Establishing that compatibility and, as a consequence, a good working relationship between customer and provider before the two entities commit to each other sets a good precedent for how they will deal with problems later. Once the contract is in place, large outsourcing transactions are difficult and expensive to unwind or work-out. Termination for breach is hard to allege and harder to prove, and termination for convenience charges are usually quite high. Thus, a company should test compatibility in advance to determine if the appropriate relationship is likely to develop during the course of the contract.

Editor: What assessment should the customer make at the time of contract renewal?

Stern: Renewal is a good time to retest and reset the relationship. After a 5-7 year deal, the customer may not be best served by simply lowering the price and maintaining the same relationship. It is an opportune time to re-test the relationship and ensure that it does not need to be reformed.

Editor: Why should overbearing RFPs be avoided?

Stern: For a commodity sale, where a provider offers a specific service for a specific price, a customer can be very prescriptive about what it puts in the RFP and the focus can be on terms and price.

However, most outsourcings are far from being commodity sales. By being very prescriptive in an RFP, a company is not giving the provider community the opportunity to show what they are able to do or for the company to take advantage of the "free" learning that it gains from different proposed solutions.

Imagine that a company's first interaction with its future "business partner" (which is, by the way, how most of our clients think about the outsourcing providers) is a thick document with a lot of small print that tells a provider what it "must" do or be "eliminated"!!! That is not an approach that is designed to establish a relationship. Customers should give providers an opportunity to distinguish themselves. There will be plenty of time during the process to ensure that the provider's promises are documented and a strong contract with consequences for non-performance is developed.

Editor: Why is inclusion rather than exclusion of would-be providers in a bidding contest desired?

Stern: There are only a few providers that can provide a global solution to multinational companies for many business processes. The notion of the "Process of Inclusion" is that you want to keep as many of these providers engaged in the bidding as long as they are in the position to provide an appropriate solution. The moment that a prospective provider encounters a condition (as opposed to an objection) that it cannot overcome, the prospect will naturally eliminate itself because it will not continue to invest in a transaction that it cannot win.

Editor: What do we mean by "governance" in a customer/provider relationship?

Stern: A contract administration/relationship management structure is very different from an internal management structure. This calls for a different skill set than managing people or managing projects.

Editor: Why do many formal governance structures fail?

Stern: They are not well thought through. We often put a canned governance structure into a contract. Frequently, enough money is not allocated for governance. Much turns on the capabilities of the administrators themselves. Often people who get the job managing these relationships are people who previously managed people and do not have the skills or experience to manage contractual relationships.

Editor: What are your recommendations for organizations that enter outsourcing relationships?

Stern: Planning and forethought are musts. Think through what the process should be, what the objectives are, getting the right teams of people together and aligning those teams. Put together a realistic schedule and manage to it. Understand how to deal with the organizational stresses that will arise. Ensure that senior management is engaged and attentive to the undertaking, but convince them to empower the deal team to do what they need to do. Budget enough time, money and resources to do the project properly. Hire outside help if you need it. Remember that the providers do this for a living and know what they are doing. You do not have that experience, even when you hire outside experts to guide you through the process. You need the time to let the changes that must occur filter through the organization.

What I discussed is applicable to large and small, and both domestic and international deals. I have done many types of outsourcing for many clients over many years of practice.

Please email the interviewee at astern@morganlewis.com with questions about this interview.