What is outsourcing?
Outsourcing is an arrangement under which an organisation contracts with a service provider to perform services that the organisation currently performs in-house. The service provider provides those services instead, using their own personnel.
Outsourcing has become increasingly popular over recent years, as challenging economic climates have forced organisations to cut costs and make efficiencies. The main advantage of outsourcing, therefore, is that it allows a specialist service provider to provide services at a higher standard and in a more cost-efficient way to an organisation than it could achieve itself.
The basics of outsourcing terms
Whilst operational risk is passed by the organisation to the service provider, strategic risk is not. So the outsourcing contract and its terms are key to managing risks such as property damage, data loss, unforeseen charges or fees, liability to the public and staff, poor performance by the service provider and employment liabilities. Ensuring that a robust contract is in place between the organisation outsourcing the services and the service provider being engaged to provide them is, therefore, vital.
A guide to the key issues to cover
The cornerstone of any outsourcing agreement is to ensure that the services being outsourced are detailed clearly. This is usually achieved in a services schedule which should contain a description of each specific element of the services. Often, pre-contractual exchanges between the parties will consist of key documents (such as a Request for Proposal (RFP) and the service provider’s response) which can be incorporated into the schedules, or their content used as a basis to describe the services being outsourced.
Service levels and service credits
Service levels are specific standards that the service provider must meet as it provides the services. Key performance indicators (KPIs) are often used to measure and determine whether standards have been met.
The outsourcing agreement should also provide for service credits. These are a refund mechanism which apply if the outsourced services are not supplied in accordance with defined service levels. Service credits should apply without prejudice to the organisation’s other rights or remedies under the outsourcing agreement, such as the rights to terminate the agreement.
As well as service credits, the organisation will also want to ensure the agreement allows for the implementation of correction or service improvement plans to remedy the root cause of any poor performance, and step-in rights which allow the organisation to temporarily replace the service provider.
As part of the outsourcing arrangement, the service provider may have access to the organisation’s premises or may be fulfilling its task as a representative of the organisation. Ensure, therefore, that the agreement provides the organisation with protection if the acts or omissions of the service provider cause loss or damage to property, to data or injury to people.
The organisation should ensure that the agreement contains appropriate indemnities in its favour and that the service provider has in place, and maintains, appropriate insurance cover (both public liability and employer’s liability) to cover any such risks and meet such indemnities. The organisation should also negotiate carefully any terms limiting or excluding the service provider’s liability for certain heads of loss, particularly where the services being outsourced are critical to an organisation’s business.
The outsourcing agreement should be clear on pricing and what the service provider will be paid for providing the outsourced services. Transparency is essential as one of the key reasons for outsourcing a particular function is to achieve savings as compared to keeping the function in-house. Transparency on pricing is critical for justifying the entire outsourcing operation. Consider, therefore, including a benchmarking mechanism under which the service provider’s charges are market tested on, say, an annual basis to ensure that they remain competitive.
Contract management, termination and exit
The outsourcing agreement will need to include a mechanism for management of the relationship and a clear escalation process for when problems arise, which supplement any service credit regimes, with the possibility of mediating if any internal escalation is unsuccessful.
The agreement will also need to include some form of exit plan which should address matters such as the continuation of the provision of the services for the duration of the notice period and any run-off period (including potential co-operation with the new service provider who will be providing the outsourced services), the return or transfer back of assets and equipment and the assignment to the organisation of any intellectual property rights that have arisen during the term of the agreement.
Before you embark on outsourcing, make sure you understand the legal issues behind it and the different ways it can work for you. Of course, the specific issues of concern will vary, depending on the nature of what is being outsourced.
For more information or advice on these issues, contact Richard Williams on 01905 744 865 or at [email protected]