In this article, master the art of negotiating service contracts with our expert guide.
As the trend toward business process outsourcing (BPO) grows, companies are faced with a new learning curve. They need to understand the elements of establishing a successful BPO relationship, beginning with the proper contract vehicle, which can play a critical role in fostering the chances for success. Customers and outsourcers entering into a BPO arrangement face the same challenges involved in other outsourcing engagements, such as outsourcing of information technology functions — but there are also several challenges unique to BPO deals.
The key ingredients to a successful BPO contract are: (1) establishing clear expectations in the contract for the performance of the services and the respective responsibilities of the parties; (2) ensuring that accountability and measurement features are included and clearly stated in the contract; and (3) reaching a fair balance of risk and reward between the parties. In short, it is all about clarity, fairness and balance.
Say No to Canned Contracts
While there are many tried and true outsourcing contract concepts that have been developed in recent years, a canned form contract with boilerplate provisions is not the path to a successful BPO. In fact, it is the contract negotiation process itself that drives the parties to a thorough understanding of their respective roles in the outsourcing relationship.
For example, the prospect of spending hours in contract negotiations wading through a proposed service level agreement (SLA) is usually, at first blush, not appealing to an outsourcer who may fear that the customer intends to negotiate an arbitrary SLA and use it to exact huge ‘penalties’ from the outsourcer. However, it is exactly this kind of careful and arduous process that is necessary to ensure a mutual understanding by the parties of the customer’s current environment and expectations for levels of services performance by the outsourcer. This level of understanding will often be the basis for the outsourcer to propose ‘value added’ services involving improved performance levels and a corresponding price sharing in the customer’s increased profitability. Of course, the customer will negotiate for invoice credits in the form of liquidated damages if the contracted service levels are not met, but the outsourcer should view these service level credits as a necessary and appropriate mechanism for the customer to ensure a degree of control and accountability in the relationship.
One other point about the ‘contract’ as a key success ingredient. Without question, one of the most often cited benefits of BPO is that the BPO relationship eliminates the distraction of managing the outsourced business process and allows the customer to focus on its own ‘core competencies.’ Certainly this appears to be a major benefit of BPO. However, it implies that once the business process is in the hands of the outsourcer, it no longer requires any ‘focus’ from the customer. The contract is in place, so why worry about it?
Many companies seem to fall victim to this faulty thinking. To the contrary, there are few business processes in any company’s operations that are not of some direct or indirect importance to the business. Not only must a company have a thorough understanding of that process before it outsources it (if it wants to negotiate the outsourcing terms intelligently), but the company must continue to monitor performance of the outsourced function so that it knows it is getting value for its payments and that the integrity of its business processes are being maintained over time.
Controlling and Sharing Risks
A key concern of BPO customers is the degree to which they will lose control of the management and accountability for the outsourced processes. Undoubtedly, this is a fundamental tenet of outsourcing — a third party now has significant responsibility for performance of the process. The challenge of any BPO deal is to decide and agree upon where the outsourcer’s responsibility and accountability start and stop.
Naturally, the less critical an outsourced process is to the customer’s business, the less the parties will be concerned about negotiating the issues associated with risks. In many cases, however, the customer will be very concerned with the risk negotiation because the BPO arrangement may place the outsourcer in a position to cause significant damage to the customer. This presents an interesting contrast to many IT outsourcing situations in which an outsourcer’s liability may be limited to an amount substantially less in many cases than the total charges the customer may have paid the outsourcer. Generally, the concept of ‘limited liability’ has become accepted in IT outsourcing on the basis that the outsourcer is merely providing ‘behind the scenes’ processing services to the customer and is not assuming (nor has it priced into its service charges) any direct responsibility for the customer’s business risks.
In a BPO arrangement, the outsourcer may have a much more direct and ‘hands on’ involvement in which it is dealing directly with a company’s customers, suppliers or regulators and thus exposing the customer to significant risk. Therefore, negotiating service contracts will involve discussion of shared liability risks and the outsourcer will be required to assume more liability in these situations, although limits will generally be agreed to at some level as well.
A Three-Step Approach
The following is a three-step approach to this negotiation:
- Clearly describe the service responsibilities of the outsourcer and the retained responsibilities of the customer.
- Assess the business risk associated with the responsibilities delegated to the outsourcer and agree upon the level of authority retained by the customer.
- Negotiate the liability risks assumed by the outsourcer in the areas of potential damages to the customer directly and liabilities that could potentially be incurred with respect to third parties.
Again, there is no ‘standard’ answer as to how the customer and the outsourcer will agree to share these risks. That will result from a mix of various issues, including the level of criticality of the outsourced process, the respective levels of risk aversion of the parties, the levels of authority and control the customer desires to retain, and pricing. What is critical to the success of the BPO relationship is that both parties feel that the contractual allocations of risk are fair, given their respective responsibilities. At the end of the negotiation process, the fact is that most risks will be shared and the parties will turn to process controls and insurance policies to mitigate the risks they have retained.
Accountability and Reward Sharing
Another key area for an effective BPO contract is a balanced approach to accountability and reward sharing. The BPO provider’s sales pitch will invariably include improved productivity in the outsourced business process. That’s fair enough, as experience is proving that many outsourcers do deliver on this promise. However, this is not the case in all BPO arrangements nor with all BPO providers. The price an outsourcer must expect to pay for the long term contractual right to provide the outsourced function is that the outsourcer be measured on its performance and held accountable by the customer. If this discipline is not built into the BPO contract, the customer is at substantial risk that, over time, performance will begin to degrade and the customer will find itself locked into a long term contract with no recourse.
Generally, a customer will hope that much of this accountability is assumed willingly by a proactive outsourcer who wants to be measured to demonstrate success and who wants to communicate regularly with the customer to find ways to identify and fix problems, improve performance and share in increased profitability or cost savings. Of course, the customer must be willing to view the relationship in this manner as well. Not all customers understand the importance of ensuring that their BPO provider view their account as a profitable account and one in which the outsourcer wants to invest extraordinary time and money in the interest of a long term relationship. The true test of this kind of ‘win-win’ relationship is that the parties are willing to take the time to identify areas ripe for improvement and to negotiate a contractual basis for offering the outsourcer a share of the upside as an incentive to achieve that improvement.
The Risk of Lost Business Process Knowledge
BPO customers worry a great deal about forever losing key personnel who have gained experience and knowledge unique to the customer’s business. This is another area in which BPO arrangements may vary substantially from an IT outsourcing arrangement. Personnel responsible for critical business processes may have gained substantial expertise in dealing with unique requirements of a company’s other internal users, customers or suppliers and they may have had direct contact with these constituencies for many years. This is less of a concern across the board in IT outsourcing situations.
Therefore, in BPO negotiations, customers analyze very carefully where these pockets of unique business knowledge reside among the personnel being outsourced. The customer will want to negotiate contractual provisions for some assurance that it will have the ability to re-employ these individuals upon expiration or termination of the contract. Restrictions on the outsourcer’s ability to transfer these personnel to other outsourcer accounts may also be negotiated.
These negotiations can often be difficult as the outsourcer attempts to protect its investment in these employees as well and to ensure that it can continue to service new accounts even after the customer is no longer contracting with the outsourcer. Usually, the parties will find common ground and reach an agreement that provides some protection to both, especially if the negotiations focus on areas where the customer may be particularly vulnerable and the personnel tend to be substantially dedicated to the customer’s account and not shared among a number of the outsourcer’s accounts.
The key to this area of negotiation again is one of fairness and balance, recognizing the legitimate concerns of each party. What is inappropriate for an effective BPO contract, however, is either party’s attempt to negotiate rights involving outsourced personnel that can be used later in the contract term solely on a ‘leverage’ basis to gain more favorable terms, such as an extended contract term from the customer or arbitrary pricing concessions from the outsourcer.
Bill Deckelman is a shareholder with Munsch Hardt Kopf Harr & Dinan, P.C., a law firm specializing in outsourcing, with offices in Dallas and Austin, Texas.
Lessons from the Outsourcing Primer on Negotiating Service Contracts
- BPO contracts present some unique challenges but, as with all outsourcing contracts, the key success ingredients are clarity, fairness and balance.
- Parties looking to enter into a BPO relationship should not sign a canned form BPO contract. The process for due diligence and negotiating service contracts itself is key to allowing the parties to thoroughly understand their respective responsibilities and identify areas for continuous improvement and reward sharing with the outsourcer.
- In BPO contracts the parties should address the customer’s concern of loss of control and increased legal risks by first negotiating clear definition of the responsibilities assumed by the outsourcer and the authority retained by the customer, then negotiating sharing and limits of liability appropriate to the deal structure.
- A Service Level Agreement is necessary and appropriate in a BPO contract as a mechanism to ensure fair accountability of the outsourcer’s performance during the contract term.
- BPO contracts should include provisions to address the legitimate concerns of both customers and outsourcers with respect to rights to hire, retain and restrict transfer of key personnel with specialized knowledge of a customer’s critical business functions.