Print Edition
August 2010 
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Outsourcing Arrangements In The Current Market |
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Muazzin Mehrban, May 2009 |
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Outsourcing is expected to continue rising as companies attempt to restructure operation and reduce costs. But successful outsourcing depends on an exhaustive process, and it is vital that companies undertake vigorous due diligence of any potential service providers before entering into a binding agreement. This need has been accentuated by scandals such as the one involving Satyam in India – a popular outsourcing destination – which means that the industry now needs to restore confidence in the market.
Despite the drop in confidence, the opportunity to reduce costs by outsourcing operations remains attractive to many companies, especially those in the retail, IT and financial services sectors. Companies view outsourcing not only as a way of reducing costs, but also as an important part of their long term growth. Clearly, there are numerous advantages to a strategy involving outsourcing. “The ability to obtain access to new technologies and methodologies without large up-front capital expenditures also continues to be a key driver,” notes Jason Haislmaier, a partner and co-chair of the IP, Technology & Media Group at Holme Roberts Owen LLP.
“As the current economic climate continues to provide companies with additional financial leverage over providers, the increased ability to actually lock in broader business benefits at these reduced costs will almost certainly play a role as well.” Indeed, cost is not the only consideration for a well-run business. Gaining a business advantage through discovering new innovations will remain a key driver for outsourcing, especially while the global crisis prevails.
A realistic approach
However, in order to successfully shift key business functions overseas, companies must fully understand their current objectives. An organisation must identify the individual performance standards that it hopes to maintain in outsourcing, as well as the corresponding risks. According to Dan Burge, a Partner and Head of Outsourcing at Denton Wilde Sapte LLP, there is no ‘one size fits all’ solution. “But there are common characteristics to an effective outsourcing strategy,” he points out. “Perhaps most importantly, there has to be a clear commercial vision which has been carefully modelled and championed at a senior executive level. Allied to this should be the creation of appropriate internal governance structures – with executive sponsors to ensure that issues can be swiftly identified and escalated and that there is a ‘root and branch’ fostering of the commercial vision throughout the relevant functions.” Ultimately, balance is the key to successful outsourcing. A company must remember to retain sufficient resources to oversee the relationship with the new provider while reducing their internal infrastructure elsewhere.
Unfortunately, this does not often occur, and it is clear that the majority of companies need to refine their approach to outsourcing. Andras Kohli Gurovits, a Partner at Niederer Kraft & Frey, believes companies should have parameters in place to measure the success of outsourcing companies. “Organisations should specify realistic strategic goals as well as realistic, specific benchmarks and short-term objectives against which the outsourcing provider shall be measured,” he says. This will allow companies to both correct mistakes and enhance positive practices. “The outsourcing customer has to ensure that it retains the ability or right to define the technologies, and the right to implement required or desirable changes over time,” adds Mr Gurovits. Also, an efficient strategy should include an efficient measurement of service qualities as well as an effective termination plan, allowing for a smooth transition back to the provider once the outsourcing process has finished.
In terms of selecting an outsourcer, companies should scrutinise potential targets individually to establish the best fit. Long term considerations, such as cultural fit, are as crucial as short term aims such as expertise and track record. “Key factors to investigate are a sound financial basis of the outsourcing provider, a sound track record demonstrating expertise and know-how of the outsourcing provider in the relevant areas, references from other customers in the same industries, interviews with and background checks of the designated key personnel of the provider that shall be allocated to the project, as well as thorough internal due diligence of the organisational function to be outsourced,” recommends Mr Gurovits.
The need for thorough due diligence has heightened recently, with companies keen to minimise risk levels across their operations. But Mr Burge warns there is a limit to how accurate and up-to-date records can be. “We are therefore increasingly seeing organisations supplement traditional methods of financial due diligence by adding mechanisms to outsourcing structures, which seek to mitigate counterparty solvency risk going forward. At the project level, it is prudent to undertake due diligence to understand how the supplier will be able to make a reasonable profit while still delivering the services to the required quality and timescales,” he says. This will provide a good indication of whether the supplier will be able to sustain the outsourced operations. If the supplier is unable to make a profitable return, it is likely that the quality of the service or the product will diminish as a result. To supplement this, client companies are advised to perform continuous diligence throughout the contract.
Experts have also agreed that businesses often underestimate the importance of risk management when outsourcing, despite the threat of disruption to services. To this end, Mr Haislmaier advises companies to take a multi-layered approach when structuring outsourcing contracts, so they can compensate for risk across multiple circumstances. “Contracts that rely only on the ability to terminate in the case of a service level failure or other breach are usually insufficient to avoid the disruption of service that can often accompany the breach.
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