Practical Tips in Negotiating an Outsourcing Contract
Principally, outsourcing is a strategic perspective adopted by any corporate entity typically to undertake better delivery process by hiring the services of third party, normally specialists, with proper (if not best) pool of skills and resources, to undertake certain operational or business aspects of the corporate entity, which is usually undertaken by the corporate entity itself, for the desired results at the desired pace and costs.
This approach enables the corporate entity to focus more on the vital aspects of its business issues and operations with the objective to achieve efficient products or services offering, optimum coveted outcome and healthy investment return by unlocking latent potential and exploring new ideas.[1]
For context, in respect of a transportation company aiming to perform certain successful deals within certain period of time, outsourcing is a viable option; the transportation company may engage service providers to manage some noncore features of the deals for example IT support or software services while the former handles core activities of the deals such as building adequate infrastructure or providing sufficient facilities.
All in all, outsourcing is a feasible method in dealing with both the competitiveness of a particular field and overcoming practical shortage in action. More often than not, outsourcing is cost-effective and hassle-free.
Indeed, outsourcing offers commercial benefits to the particular corporate entity, but ill-thought-out outsourcing ‘presents’ the corporate entity with challenges and risks throughout the outsourcing life-cycle whether during the provider selection process, in the course of contract negotiations, during the implementation and day-to-day operation of the outsourced services, and on exit from the outsourcing contract.[2]
In other words, corporate entity should apply risk management and risk mitigation, where applicable, all the time during negotiation on the outsourcing contract, during commencement of the outsourcing services and for the preparation to exit the outsourcing arrangement.
Deciding on outsourcing contract is paramount as it will fundamentally affect the particular corporate entity in both the medium and long terms. Therefore, irrespective of whether the outsourcing contract is to be negotiated first time or re-negotiated, significant consideration and attention should be spared in analyzing and negotiating the terms of good outsourcing contract to ensure productive and sustainable outsourcing partnership with the chosen provider can be attained.
Practical Negotiation Tips
i. Allow enough time and effort
Dedicating sufficient time and effort for the negotiation of outsourcing contract does not necessarily mean that the negotiating parties should spent lengthy time for deliberation and conduct multiple negotiation meetings respectively. To clarify, corporate entity should not take lightly or underestimate the necessity to have a stable negotiation process. Negotiation phase should be properly utilized; the negotiating parties should identify and tackle all major issues and hurdles (if not all issues) so that significant shortcomings can be avoided post-negotiation i.e. performance of the outsourcing contract for example lack of important management clauses in the outsourcing contract itself. Definitely, if poorly planned and executed, the negotiation of an outsourcing contract can be long, tiring, costly and frustrating affair.[3]
As a precautionary step, the corporate entity is reasonably expected to conduct its own pre-negotiation exercises for instance conducting initial investigation and thorough risk assessment to better and correctly understand its business objectives and needs for outsourcing services.
Besides that, the corporate entity may also consider devising a strategic roadmap showing how to achieve objectives and identifying the potential risks as well as expected benefits. This includes formulation of a well thought-out negotiation process and timeline/timeframe.[4] Consequently, a clearly-formulated negotiation process will enable the negotiating parties to avoid entertaining unnecessary repeated iterations and wasting time waiting for each other’s responses.
ii. Involve the right person
Theoretically, right person provides right inputs. With that in mind, corporate entity should assemble a negotiation team which should ideally be led by a commercial representative who is experienced in outsourcing negotiations and who understands all areas of the deal. The negotiation team should also include, where appropriate, any sales representative, senior operation staff member and at least one person that will be involved in service delivery on an ongoing basis. It is important to ensure that commercial proposals are deliverable in practice.
In the context of outsourcing for IT support or software services, the negotiation team of a corporate entity should ideally comprises of at least one IT expert from its side to advise on IT-related technical matters.
This arrangement is crucial in order to avoid common major problems in the form of unnecessary delays, incompetent decision-making and omission of pivotal considerations and critical points, which undoubtedly will adversely affect the delivery of relevant outsourcing provisions.
iii. Focus on key terms
Typically, a good outsourcing contract should have the following key components:
- Service-level agreements
- Time frames and performance measurements
- Scope of services
- Pricing and fees
- Penalties for under-performance
- Rewards and incentives
- Regular performance reviews
- Scope for renegotiation and revision
- Warranties and liabilities
- Defaults and breaches
- Termination or exit strategies and compensation
Therefore, the negotiating parties should always focus and elaborate on these key components during the outsourcing negotiation process especially on the scope of services and its level of deliverable expectation. The negotiating parties should try making these key components as clear detailed as possible to the effect that they can benefit from the outsourcing contract and not disputing over the same. To the extent necessary, it would be preferable to have these key components laid down objectively rather than open ended. It is very essential that the contracting parties are translucent on each other’s roles and responsibilities and what is to be expected by and from each other.
iv. Design a flexible contract
Any outsourcing contract should always be treated uniquely depending on the general needs and requirements of a particular field being the subject matter of the outsourcing contract or the special situations and circumstances surrounding the outsourcing arrangement. Although the negotiating parties should ideally reach explicit and operationally implementable terms, the outsourcing contract should also allow adequate flexibility to consider special cases and emergencies. For this purpose, clear provisions and correct languages with modification- tolerable terms and clauses should be put in place.
However, corporate entity should be mindful that such flexibility accorded under the outsourcing contract should always be limited or restricted to certain allowable circumstances only, for example in a situation where duly modified term will avert fundamental breach of the outsourcing contract or frustration of the same. In addition, the contracting parties may adopt check and balance mechanism to the same effect.
In the end, a flexible outsourcing contract will most likely contribute to the longevity and lasting effect of the outsourcing arrangement.
v. Be realistic[5]
Being realistic works twofold. First, the corporate entity should understand its own operational needs and business situations; it should not be agreeing on service level expected from the chosen provider without it itself being able to accept and utilize the provided outsourcing services. Often, the outsourcing deliverability is dependent on the actual needs of the corporate entity. By way of illustration, a trading company carrying typical trading business should not seek for outsourcing of supply of construction employees. In this situation, such trading company will incur unnecessary costs and expenditures, which is detrimental to financial health of such trading company.
Secondly, the corporate entity should consider the capability of the chosen provider and deliverability of the outsourcing services. It is impractical for the corporate entity to seek for outsourcing services for every aspect of its operational needs and business situations.
As an example, a food manufacturing company should not expect its chosen provider to manufacture certain food products for it in totality in accordance with the exact recipes and formulas without it disclosing the same to the chosen provider. Even assuming that the food manufacturing company has disclosed the recipes and formulas to the chosen provider, issues on intellectual properties would arise. Normally, outsourcing arrangement is not a proper avenue for this situation.
Final Thought
As a conclusion, negotiating on the right outsourcing contract requires thorough consideration, diligent effort and considerable time in order to arrive at a profitable and maintainable conclusion. However, corporate entity should remember that negotiation is not entirely about persuading the opposite party to accept its propositions; it is also about accepting workable alternatives to such propositions.
It should also be remembered that negotiation is a relationship-building exercise; the success of which will be critical to the success of the deal as a whole. As such, successful negotiation will always allow re-evaluation of priorities and deliberation of feasible solutions.
Truth be told, sustainable partnership is mainly built on mutual understanding and co-operation. The same applies to outsourcing partnership; it is a long-term relationship where the contracting parties may re-negotiate between themselves for the purpose of re-establishing the outsourcing arrangement. Hence, successful outsourcing negotiation will eventually lead to sustainable long-term outsourcing partnership.
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- Business Process Outsourcing Adoption: An Exploratory Study Among The Malaysian Government-Linked Companies, Ahmad Kaseri Bin Ramin & Wan Fauziah Wan Yusoff (Kolej Universiti Teknologi Tun Hussein Onn, Malaysia & University of Victoria, Australia), pages 1 & 2.
- Managing Risks in Outsourcing: Part 1 – Supplier Selection, Ian Ferguson, Sourcing Speak: News and Analysis of Outsourcing, Insourcing and Beyond, 29 September 2011 (https://www.sourcingspeak.com/managingrisks-in-outsourcing-part-1-supplier-selection/).
- 3 Managing Risks in Outsourcing: Part 2 – Contract Negotiations, Ian Ferguson, Sourcing Speak: News and Analysis of Outsourcing, Insourcing and Beyond, 5 October 2011.
- Outsourcing: Negotiating a perfect fit, Arif Mohamed, ComputerWeekly.com(https://www.computerweekly.com/feature/Outsourcing-Negotiating-a-perfect-fit).
- My top tips for good outsourcing contracts – How do you avoid the pitfalls, Karin Dale, Mindpearl, 20 May 2014.
Written by:
Omar Saifuddin Abdul Aziz (general@azmilaw.com)
Mohammad Ashraf Mohamed Sopiee (Senior Associate) ashraf.sopiee@azmilaw.com
