Features: January 28th, 2011

ByJohn Enstone*

Deficit reduction measures are producing slimmer budgets. In the struggle to preserve frontline services public bodies are searching for ways to do the same with less. Outsourcing is one avenue to explore. Costs can be reduced, but that is not always the result. The author sets out the pros and cons of outsourcing.

One of the benefits of helping people outsource services for more than twenty years is the ability to offer some “home truths” – otherwise known as cutting through the hype – about how to make this very useful opportunity work for you.

• Outsourcings, executed properly, can and do generate very substantial cost savings and efficiency improvements for customers in both the public and private sectors.

• Outsourcings are complicated, however, in ways that customers may not have encountered before.

• Small and first time customers typically need to learn the hard lessons of those who have gone before.

• Clarity of purpose, an eye to detail, realism and the resolve to strike a fair deal are fundamental.

• Outsourcing is quite different from most commercial relationships: the deliverables are often hard to define with precision, the customer and supplier will be joined at the hip for the life of the project, staff and assets may need to be transferred to the supplier and changing suppliers part way through a project can be very challenging indeed.

• Be ready and able to deal constructively with the inevitable shortcomings on both sides as the project advances.

• Outsourcings fail for many reasons, and the causes can be laid at the feet of customers as well as suppliers. Frequently, it’s a combination of the two.

• Seek specialised help early – backtracking from an error is expensive at best and often fatal to a project, even if try to correct it.

While this brief piece is written primarily for customers, the success factors and cautionary lessons below should help suppliers as well.

Health warning

Typically, the customer is under pressure to deliver cost savings or performance improvements quickly. Suppliers are generally receptive to this and able to meet these requirements – within limits. In the final analysis, cost savings and performance improvements can realistically be achieved only within the boundaries of what is possible. Otherwise there is a substantially increased risk that something will go badly wrong. In the current economic environment, suppliers may be willing to “take their chances” by agreeing to something that they aren’t sure they can deliver, or by accepting a low price with the knowledge that they have not built in any margin for the unexpected.

Thinking with precision

There are few instances in which the saying “you only get what you pay for” is more apt. Being careful with the specification and sophisticated in reviewing and evaluating the suppliers’ proposals can be very helpful in ensuring that you will be protected.

But what does being “careful with the specification” actually mean in practice? Think of it this way: the more precisely the service can be described, the more likely the customer will be content with the result. There’s little point in providing a summary of the services or not addressing all the material combinations and permutations that can arise in service provision, unless the customer is looking for ways to spend money on lawyers. For no matter how detailed the specification, the supplier will examine it to see how little it needs to do to comply and so keep the costs down. At most, the supplier will seek to resolve only those ambiguities that cannot be made to work in its favour. It is up to the customer, therefore, to make sure that the specification is complete.

Customers and suppliers often have their own standard contracts. Few customers, however, have a standard contract that will fit an outsourcing arrangement. Suppliers’ contracts, on the other hand, are typically one-sided and afford them a good deal more latitude (read, excuses for poor performance) than the customer should accept.

Out of fairness and balance, it is important to consider how suppliers think. By way of example, at a recent outsourcing seminar I asked the audience about their experiences with projects that had gone wrong. Initially only the customers spoke up. The gist of their message was that the suppliers “saw them coming”. And so it could be today, with the financial changes that Westminster has wrought in local and other government areas and the resulting urgency to find solutions. There’s no doubt that suppliers will offer more than they can deliver, and for less money, if they think they can get away with it.

As the criticisms of suppliers were running out of steam, however, a supplier waded in with one, particularly well-reasoned point: outsourcing delivers real value but is not a panacea, and customers who do not understand this are a threat from which suppliers wish to protect themselves.

Need for a meeting of minds

So how should customers and suppliers find the middle ground where the former are satisfied that they are not going to be short-changed and the latter able to protect themselves from questionable claims of poor performance? In addition to care with the specification and savings expectations referred to earlier, customers must be absolutely focused on achieving the realistic performance objectives they have set, and suppliers on committing to do what they have agreed to do, including accepting that they pay compensation if they fail. Experience suggests that the party that blinks first will never regain the ground lost.

Several helpful provisions come immediately to mind if the project, and the contract that governs it, are going to be treated as a commercial success. The first is the ability to make changes to a project as new requirements and limitations arise. Customers sometimes see better or different services and want to add them to the contract, with or without removing some of the services already agreed. This can be an expensive exercise as suppliers, over and above the cost and other challenges of cutting back on the commitments made downstream to provide the agreed services, may charge a premium. And if the customer is effectively a “captive audience”, doing so will be commercially attractive. So contracts should contain cost protections.

Arrangements need to be in place for when the supplier’s performance deteriorates or ceases, and when the contract expires, is terminated for cause or some other factor intervenes. Often the customer will need to have an uninterrupted supply of the outsourced services. And bear in mind that the people and assets required to perform the services have usually been transferred (“TUPE’d” in the case of people) to the supplier. Accordingly, transition arrangements and their funding should be agreed at the start and, in many circumstances, so should the customer’s right to step in and at the supplier’s cost fill a gap in performance, if only temporarily.

If you have concluded that outsourcing is not business as usual, you are right. It doesn’t matter whether the issues are commercial or legal, better deals are done if the advice customers obtain is based on proven expertise. There are a number of suitably qualified advisors in the market. Failing to retain one – customers rarely find the requisite skills in house – is false economy. Among other things, an outsourcing contract is sufficiently complicated that the specifications, the commercial arrangements and the legal terms must be fully integrated. So one last tip: if your lawyer says “I’ll leave the schedules and the commercials to you,” think about finding another lawyer.

*John Enstone, a businessman turned lawyer, heads the London outsourcing practice of Faegre & Benson LLP.