In-house counsel are often expected to take a lead role in negotiating outsourcing transactions, dealing with a wide variety of technical and business issues as well as legal ones.
Successfully managing and negotiating an outsourcing transaction entails coordinating the efforts of a diverse group of internal stakeholders (e.g., IT, finance and human resources) and outside experts (e.g., technical and financial consultants and outside counsel).
Because of the relative uniqueness of these transactions, as well as their infrequency in the corporate lifecycle, attorneys who do not specialize in outsourcing often lack familiarity with many of these issues.
The issues that arise during an outsourcing negotiation are varied and complex; however, the outsourcing process itself is manageable, and it is the coordinated management of this process that often holds the key to properly addressing the issues and establishing a successful outsourcing relationship.
By taking certain early measures to control this process and direct it in an orderly manner, the in-house counsel, even if he or she is generally unfamiliar with outsourcing, can do much to encourage a successful outcome.
Four Basic Steps in Outsourcing Negotiations
Most outsourcing negotiations include three basic stages: assessment/planning, service provider selection, and contract negotiation. While each stage is critical to the overall transaction, the in-house counsel can take certain early steps during the assessment/planning stage to lay the foundation for a successful outsourcing transaction.
I will discuss the assessment/planning step in detail below. In the service provider selection stage, the buyer sends a Request for Proposal (RFP) to potential service providers, evaluates the service provider proposals and selects one or two for final negotiations. During contract negotiation, the buyer negotiates with the selected service providers to finalize the contract documents.
Step 1: Invest in a Quality RFP
The RFP serves as the foundation for the overall outsourcing relationship, documenting the buyer’s operational and financial requirements, as well as defining the outsourced function itself. A well-developed RFP accurately describes:
- The scope of the outsourced function
- The resources currently used to perform the function
- The financial base case
- The desired service levels
- Preferred pricing methodology
- Special requirements regarding impacted buyer’s personnel
- Key legal provisions governing the relationship.
The RFP also describes the buyer’s selection criteria, which provides its internal stakeholders (and potential service providers) with the added benefit of a documented, objective selection process upon which to base its decision.
The commitments providers make in their initial proposals are generally based on the information contained in the RFP, and the buyer’s service provider selection decision is often based in large part on these initial commitments.
During contract negotiations service providers may need to reconsider these early commitments if, during due diligence, they find that the RFP contained inaccurate or incomplete information.
In order to minimize the chances of unexpected changes to a service provider’s proposal, as well as to maintain negotiating leverage, it is important that the in-house counsel closely coordinate the efforts of internal stakeholders and outside experts to produce a high-quality, accurate and complete RFP.
Step 2: Commit to a Competitive Process
One of the key factors in achieving dramatic savings in outsourcing transactions, as well as negotiating favorable contract provisions, is to commit to a competitive selection process. This may entail negotiating specific contract provisions with two or more service providers and then selecting the provider with the most favorable combination of solution, price and legal protections.
However, the benefits of competition – so easy to recognize in the abstract – can be difficult to achieve in an outsourcing negotiation. A documented competitive process is often very resource-intensive in the short-term, but may substantially enhance the buyer’s negotiating leverage and make possible the significant financial savings and service level commitments that form the basis for an excellent outsourcing relationship in the long term.
Step 3: Encourage Early Cooperation Between Consultants and Outside Counsel.
The buyer’s technical and financial consultants often take a lead role in drafting the RFP, gaining an enormous amount of institutional knowledge in the process. This knowledge may be lost when the project is “handed off” to outside counsel for contract negotiations.
The best way to ensure that outside counsel negotiate the relationship envisioned by the internal stakeholders and outside consultants, and that the contract documents dovetail with the technical documents, is for in-house counsel to encourage early cooperation between the consultants and outside counsel. Ask outside counsel to help draft certain provisions of the RFP and participate in the provider review process.
Step 4: Measure Internal Service Level Performance
In many cases outsourcing service providers initially will provide the outsourced services using the same resources — software, equipment and personnel — that the buyer was using prior to the outsourcing.
A buyer may find it difficult to convince a service provider to contractually commit to meeting desired service levels, and the buyer may lose leverage during outsourcing negotiations, if it is unable to provide the service provider with historic data showing the provider has met those desired service levels using those resources.
If the buyer is unable to provide this data, the service provider may require a measurement period following contract execution during which the service provider will establish service levels based upon its actual, measured performance – a situation fraught with obvious risk for the buyer.
Because the buyer has ceded control of the outsourced function to the service provider, contractually binding service levels serve as critical control points in the outsourcing relationship. Establishing these service levels after contract execution leaves unresolved a key component of the overall outsourcing relationship.
As one of the early steps in the outsourcing process, the in-house counsel should encourage internal project leaders and consultants to identify and, if necessary, begin to measure internal performance against the desired service levels. Providing several months of performance data enhances the buyer’s negotiating leverage and make the service provider more comfortable committing to them.
Following the early steps described above, the in-house counsel should be better able to manage the necessary resources to lay the foundation for a successful outsourcing transaction.
Lessons from the Outsourcing Journal:
- In-house counsel can take steps early in the assessment/planning stage to ensure success. They include:
- Invest in a quality RFP.
- Commit to a competitive process.
- Encourage early cooperation between outside counsel and consultants.
- Measure internal performance levels.
Stacy Schultz is counsel in O’Melveny & Myers LLP’s Intellectual Property and Technology Department. His practice focuses on domestic and international information technology and business process outsourcing transactions.