an outsourcing trilogy - mcguirewoods...jan 19, 2004 · who does baselining and outsourcing every...

©2003 Gordon & Glickson LLCAll Rights Reserved

AN OUTSOURCING TRILOGY The JUF High Tech Division,

Lunch and Learn Series Chicago, Illinois January 19, 2004

Gordon & Glickson LLC 444 North Michigan Avenue

Suite 3600 Chicago, Illinois 0611-3903

Tel: (312) 321-1700 Fax: (312) 321-9324

[email protected] www.ggtech.com

This article and the accompanying presentation are intended to alert the reader to some of the legal issues discussed herein. The impact of the law for each particular situation depends on a variety of factors, therefore, we strongly recommend you engage legal counsel to assess and help minimize your legal liability based on the particular requirements of your institution. Like any article and presentation, these are not meant to be used as a substitute for legal counsel.

Gordon & Glickson

Click on any blue link to send mail or reach our home page. Click on any table of contents entry to reach that point in the article.

©2003 Gordon & Glickson LLCAll Rights Reserved

TABLE OF CONTENTS

INTRODUCTION .............................................................................................................. 3 ARTICLE I - PLANNING TO OUTSOURCE .................................................................. 4

INTERNAL ANALYSIS ................................................................................................ 4 THE REQUEST FOR PROPOSAL................................................................................ 5 THE OUTSOURCING AGREEMENT (TERMS AND CONDITIONS) ..................... 5

ARTICLE II - CONTROLLING THE OUTSOURCING NEGOTIATION PROCESS ... 8 THE METHODOLOGY................................................................................................. 8 REQUEST FOR PROPOSALS ...................................................................................... 8 VENDOR “FORM” CONTRACTS ............................................................................. 10

ARTICLE III - PLANNING FOR THE END GAME – DISENTANGLEMENT.......... 12 PROBLEMS AND RISKS OF DISENTANGLEMENT............................................. 12 DISENTANGLEMENT PROVISIONS....................................................................... 13 DEALING WITH RISKS OF FINANCIAL FAILURE .............................................. 14

- 3 - ©2003 Gordon & Glickson LLCAll Rights Reserved

INTRODUCTION

There has been a recent flurry of news reports regarding the new focus by major vendors of Information Technology Outsourcing services on middle-market customers. In January, 2003, CNET News reported that IBM was in the process of hiring 500 software sales and support personnel to focus on companies with 100 to 1,000 employees. At the same time, others have predicted a continuing hot market for providing information technology outsourcing services to mid-sized companies and others. With this in mind, we present this series of articles on the subject of outsourcing.

Article I, “Planning to Outsource” details a number of critical items that should be addressed and analyzed in connection with a decision to outsource.

Article II, “Controlling the Outsourcing Negotiation Process,” is a discussion of the methodology we have developed to be used by customers to control the negotiation process for the benefit of both the vendor and the customer, and a brief discussion of the negotiability of vendors’ “Form” agreements.

Article III, “Planning for the end game” discusses steps to take in planning an outsourcing to address what to do when outsourcing goes bad and the customer either wishes to take the outsourced function back in-house, or contract with a more satisfactory vendor.


ARTICLE I - PLANNING TO OUTSOURCE

Preparation for outsourcing outsource should begin with the fundamental premise: information technology outsourcing is neither intrinsically good, nor bad.

People who are in favor of outsourcing tend to be either customers who have had a good experience, or vendors or others (like consultants and lawyers) who stand to profit from the transaction. People who are against outsourcing tend to be either customers who have had a bad experience, or the customer’s information technology (“IT”) human resources who may not wish to be employed by the vendor, rather than the customer.

So, outsourcing is good for the customer if it works, and bad for the customer if it

does not. Therefore, a customer should not move forward with an IT outsourcing initiative if it cannot anticipate either (a) better service levels for the same price, or (b) the same service levels for a better price, or (c) both. If you, as the customer, cannot be reasonably certain that outsourcing will be successful for your enterprise, you should not do it.

How do you determine whether outsourcing will benefit you? First, you must

perform a detailed internal analysis, and if your analysis leads you to the conclusion that a particular vendor will be able and willing to perform an IT outsourcing that will benefit you, you should write a good contract, one that requires the vendor to do what you want it to do, and that makes the vendor legally accountable to you if it fails to perform.

INTERNAL ANALYSIS Your internal analysis should consist, at the minimum, of the following:

Determine the precise scope of the function or process that you are currently performing yourself, or you are having performed by a vendor; Identify all resources, whether technological or human, that are currently being utilized in the performance of the function or process; Determine the service levels at which the function or process is currently performing, measured in every category that could be useful to you in deciding how well the function or process is being performed; and Determine the real cost of your performing the function or process yourself (or the real cost of utilizing your present vendor). The analysis of true cost must take into account all costs, direct or indirect, incurred in connection with the function or process. When you have successfully performed this analysis you will have created what is

referred to in the vendor’s world as a “Baseline.” This baseline is a starting point for determining whether outsourcing should be considered. If a vendor can perform the same function and do it better than the baseline, or do it cheaper than the baseline, or do it both better and cheaper, then outsourcing should be strongly considered.


THE REQUEST FOR PROPOSAL

Once you have established your baseline and formulated your threshold requirements for a successful outsourcing, you are ready to move on to prepare and issue your request for proposals (“RFP”). The RFP should be the result and culmination of all of your baselining efforts and should clearly set forth the ways in which you want the vendors to do better than the baseline, or at least provide the framework for them to propose to do so.

Please be warned that it is virtually impossible to prepare an appropriate RFP before you have fully baselined the IT outsourcing project. In fact, next time you hear a story about unexpected cost increases from an unhappy customer, please remember that you are probably talking to someone who failed to baseline the project well enough and soon enough. It is critical that the RFP be properly done. An independent IT consultant, who does baselining and outsourcing every day, working in conjunction with an experienced IT lawyer, can be an incredibly valuable resource in this process. The key element of the RFP is the scoping of the project and disclosure of both human and other resources currently used in performing the process or functions proposed to be outsourced.

The scope statement should be drawn with enough precision that it can be used, verbatim, as the Statement of Work for the outsourcing agreement. Best practices call for the inclusion in the RFP of the outsourcing agreement that you intend to use.

The resources disclosure should include all resources currently used to perform the process or function, including infrastructure, operating systems, network architecture, and the like, as well as all human resources and their functions and responsibilities. The resources disclosure should be sufficient to prevent vendors from asking for clarification, or later claiming they have to alter their bids because they were misled by the RFP.

THE OUTSOURCING AGREEMENT (TERMS AND CONDITIONS)

Set forth below are highlights of some of the terms and conditions that can have the biggest impact on the degree of accountability that you can expect from your vendor.

Scope. No matter how well-crafted your scope provisions, from the customer’s perspective any good outsourcing agreement needs some version of the following clause: “This statement of scope shall not be construed as the complete statement of every single job, task, function, or process to be performed by vendor. ‘Scope’ also includes all tasks and functions reasonably inferred from, or reasonably incident to, or necessary for, the performance of those tasks and functions listed in outsourcing agreement, and all other tasks and functions currently being performed by customer in connection with such tasks and functions.” Vendors hate this clause with a passion, but it is essential if you wish to avoid being charged extra unanticipated fees for “scope creep.”


Price. With proper scope and resources disclosure, experienced vendors should be able to reduce price to a predictable monthly or annual cost range, except for applications development. In this regard, we are not referring to applications maintenance and routine development activities involving minor modifications and upgrades, but rather major development work. Development work is traditionally done on a time-and-materials basis and should only be considered after the vendor has proved itself with regard to basic operational services.

Assumptions. “Assumptions” are a vendor’s euphemism for excuses. Although the term seems innocent, if the vendor insists on its own language, the customer will likely have no claim or other recourse agains t the vendor if any assumptions do not prove accurate. Beware of assumptions.

Provisions for Disentanglement. The disentanglement provisions of an outsourcing agreement are the essential equivalent of a prenuptial agreement. They are addressed in detail in Article III of this series. From the customer’s perspective, moving an IT outsourcing from one vendor to another should not have any adverse impact for the customer and should not impose additional fees. This takes careful drafting and negotiation because each vendor will wish to minimize its own duties and risks, and three-party transactions are by their nature complicated. Nevertheless, the time to tackle this issue is at the beginning of the deal when the vendor is still anxious to please.

Key Personnel. Vendors will try to tell you that personnel used by them in performing the outsourced functions or process are none of your business; and they will add that you are at risk of being deemed a co-employer if you obtain any rights as to personnel. It would be wise to ignore this advice and get as much control over the assignment of personnel to your account as your legal counsel will allow. Successful outsourcing is heavily dependent on both the skills, and continuity, of key personnel, and the ability to exclude bad apples.

Limitation of Liability Clause, and Exceptions. This area is extremely important, and covers major substantive issues and drafting challenges. A couple of observations: (i) do not settle on a cap on liabilities that is so small that a vendor may consider buying himself out of the outsourcing agreement by simply paying a settlement equal to the cap. Also, make sure that you have exceptions to the cap, especially a non-suspension of services clause.

Consequential and Incidental Damages Clause, and Exceptions. This is closely related to the limitation of liabilities clause and is a limitation on the types, rather than the amounts, of liability for which a vendor can be held responsible. Make sure you are entitled to at least “Costs of Cover” (some courts consider cover to be an incidental or consequential damages), and get the same exceptions that you get for the dollar caps on liability. “Costs of Cover” means the amount necessary to pay for a replacement service.

Right of Set-off- Right to Withhold Disputed Payments. Make sure you are allowed to withhold the disputed portion of any invoice and are allowed to set-off your damage claims against the vendor’s invoices. You may have to agree to put


some of the withheld payments in escrow, but this provision is absolutely critical to your being able to maintain a reasonable amount of negotiating leverage in the event of a dispute.

Non-Suspension of Services Clause. The non-suspension clause and the right to withhold disputed payments go hand- in-hand. The key is that you cannot have an outsourcing agreement that permits the vendor to terminate its services if it either does not like the deal it agreed to, or it does not agree with your opinion that it is performing badly. As indicated above, never put yourself in a position where the vendor would be tempted to buy its way out of the outsourcing agreement because the limitation of liability cap is sufficiently low.

Don’t Overreach. Perhaps most important of all, never do such a good job of negotiating that the vendor cannot make a reasonable profit and will wish to seek any way available to terminate the outsourcing agreement.


ARTICLE II - CONTROLLING THE OUTSOURCING

NEGOTIATION PROCESS

Because managing the legal aspects of the outsourcing of information technology services has been a core component of our practice for over 20 years, we have developed a methodology for negotiating information technology outsourcing agreements that has proved extremely successful for a wide range of clients. Many consider this methodology to constitute a “best practice” in establishing an efficient negotiation process, either in a single vendor or multiple vendor competition setting, while simultaneously limiting the risks to which a customer is exposed in the outsourcing agreement.

THE METHODOLOGY The key to avoiding lengthy negotiations is to create a structured timeline and procedure for conducting negotiations, that may not be deviated from by either party. Following the guidelines set forth below will help you shorten the length of negotiations, enhance your leverage, and negotiate better business terms for the outsourcing transaction.

Prepare a detailed and well thought out RFPs describing your technical requirements;

Prepare a complete and comprehensive outsourcing agreement, including exhibits, to distribute to vendors prior to negotiations;

Require all vendors to respond to the outsourcing agreement in a structured issue paper format to reflect the actual language changes to the outsourcing agreement requested by the vendor;

Limit the time for negotiations by number of days, and hours per day; and

Stick to the established procedures.

REQUEST FOR PROPOSALS If the best outcome is to be achieved, your legal counsel must be involved in the process from the beginning, even with the RFP and exhibits, because the description of services should be in wording that can be used verbatim as the Statement of Work exhibit to the outsourcing agreement. Outsourcing negotiations are often protracted because confusion arises around the types and levels of services that the customer expects the vendor to provide. That is why “Baselining,” a subject addressed in Article I of this series, is so important.

You may not be able to accurately scope all of the functions or processes that you wish to have the vendor provide if you have not performed those functions or processes before, or had another vendor perform them. In these cases you may wish to ask the vendor to include a Statement of Work for those services in its response to the RFP. If you have problems with the vendors’ proposed solution for the new services, you will have the opportunity, within the negotiation process, to discuss those problems and to require the vendor to submit a revised proposal fo r those services.


The outsourcing agreement should contain all of the documents that you will need to complete the outsourcing transaction, including the terms and conditions, the Statement of Work, and the format, if not the specific pricing provisions, of the Pricing Schedule. We also recommend that the outsourcing agreement start from a reasonable middle-of-the-road position to encourage shortened negotiations and a positive negotiation experience for all of the parties. It is difficult to negotiate an outsourcing transaction in a tight timeframe unless the document that you are starting from is one that both sides feel is relatively fair and evenhanded. It should be noted that preparing the outsourcing agreement prior to negotiations will enable you to clearly articulate and protect your position, and to prevent time-consuming exchanges with the vendor relating to the drafting of a Statement of Work or other exhibits.

Negotiation Procedures.

The negotiation procedures included in the RFP should describe the process you will use to select a vendor, and the negotiation schedule you will follow throughout the process. We recommend that you competitively bid and negotiate any outsourcing project that you choose to undertake, because it will provide you with the opportunity to get the best deal on the best possible terms, and it is a manageable task if you use the process we have described.

Issue Papers

The exact language changes that each vendor wishes to make to a particular paragraph or provision of the outsourcing agreement, and the reason for the requested change, should be set forth in each vendor’s issue paper. Using this process will be beneficial in both a single-vendor and a multiple-vendor setting. In a single-vendor situation, this makes each change to the contract much more visible, creating a disincentive to the vendor and its lawyer who won’t, at least to some degree, want to appear picayune or difficult. It also discourages the vendor’s lawyer from “tinkering” with the contract and thereby dragging out the negotiation process. In a competitive bid situation, the issue paper process will motivate each vendor to minimize its requested changes in order to remain competitive with the other vendors.

You should develop a schedule for the negotiations, including the total number of days of negotiation that each vendor will be allocated, the number of rounds of negotiations that will be conducted, the number of days in each round of negotiations, and the specific hours during those days when you will negotiate with the vendors. Each vendor should be treated equally, so it is important to strictly adhere to the negotiation schedule – start on time, end on time, and make no exceptions to that process. If you can, scheduling negotiations with the various vendors consecutively will allow you to use the same negotiation team for all vendors. (This will result in a significant saving in time and costs, as well as gains in knowledge-management.)

The first round of negotiations should be an opportunity for you to discuss an attempt to reach agreement on the issue papers. It is unlikely that you will be able to resolve all items raised in the issue papers during the first round, but if you have extra time, you may wish to discuss other documents or information provided by the vendor as part of its response to the RFP (e.g., press for information). You may also choose to allow the


vendor to submit additional issue papers prior to round two of the negotiations for discussion during the second round. In addition, you should discuss any exhibits to the outsourcing agreement that the vendor was asked to prepare, and negotiate the terms of those documents. By the end of the final round of negotiations you and each vendor should have concluded your discussions and agreed to take one of three positions on the changes proposed in each issue paper:

agreed (as the issue paper may have been modified during the course of negotiations);

incorporated into the outsourcing agreement without agreement (either in the original form or as modified by the vendor); or

withdrawn by the vendor.

Your negotiation guidelines should specify the default position you will take if you and the vendor fail to agree on taking one of the three positions listed above with respect to any issue paper. The most reasonable position would be to incorporate the vendor’s last version of the issuer paper (as it may have been modified during negotiations) into the outsourcing agreement, without agreement.

Another technique that is often successful is to consider giving the vendor additional time following the completion of negotiations to submit its final proposal on those exhibits that are prepared solely by the vendor, such as the final pricing proposal.

After the final round of negotiations you should incorporate all of the issuer papers and exhibits into the outsourcing agreement to create a complete set of file documents, and the vendor should be given a certain number of days to review these documents and raise any issues relating to how you incorporated the agreed-upon changes. The negotiation procedures should also specify the process you will use to ensure that you and the vendor agree on the incorporated changes. The complete set of final documents as agreed to by the vendor will be considered the vendor’s best and final offer for your evaluation in selecting the winning vendor, and should be executed by the vendor prior to submission to you.

Enforcing the foregoing guidelines strictly will prevent vendors from transforming the negotiations into a typical prolonged outsourcing negotiation and will allow you to control the process to the advantage of all. Many of our clients have concluded that, if the foregoing methodology is used, entering into an outsourcing arrangement is neithe r as risky nor as time-consuming as anticipated.

VENDOR “FORM” CONTRACTS No matter what function or process is being outsourced, it is almost certain that the “Form” agreement presented by the vendor will be relatively one-sided and, occasionally, overbearingly one-sided. It is worthy of note that it is both our experience, and the experience of others in the IT legal community, that these need not be difficult negotiations, provided the vendor understands that you are aware that its “Form” agreement is overreaching. The reason some vendors continue to lead with overreaching agreements is that there still are many customers who will sign them without comment or objection.


You should seek to negotiate all vendors’ “Form” agreements. We believe that you will find that those negotiations need not be especially expensive, time consuming, nor difficult, but simply an opportunity to reach a balanced agreement between the parties.

ARTICLE III - PLANNING FOR THE END GAME – DISENTANGLEMENT

Whether information technology outsourcing is done at the vendor’s premises, or at the customer’s premises, and regardless of whether any facilities or personnel of the customer are transferred to the vendor at the time the outsourcing agreement is entered into, the least familiar, and perhaps the least understood, aspect of outsourcing transactions is that the outsourcing agreement cannot just be allowed to expire in the manner of more conventional service agreements. When the customer and vendor finally exhaust their ability, or desire, to continue their association, the customer will normally have to recommence an information technology processing operation, or hire a different vendor to provide one. Because most IT outsourcing operations are relatively “custom,” it would be extremely difficult and costly for the customer to replace those operations upon the expiration of the outsourcing agreement. Accordingly, the customer should require very detailed obligations from the vendor with respect to the re-transition of the outsourced functions, either back to the customer or to a new vendor. Particularly where a data processing facility has been taken over by a vendor, the process of identifying, tracking, and then reconveying the data center facility and operations is likely to become increasingly complex with the passage of time. Also, because improvements are likely to have been made during the term of the outsourcing agreement, the facility and applications may be worth more at the end of the outsourcing agreement than they were at the beginning. The term “Disentanglement” seems an appropriate one to convey the sense that both the vendor and the customer are likely to become very much entangled over the course of the outsourcing agreement, and they both need a mechanism to disassociate and terminate.

PROBLEMS AND RISKS OF DISENTANGLEMENT Disentanglement exposes some special problems and risks:

Identifying the Data Center Properties. If data center properties have been transferred in connection with the outsourcing, the identification of these properties will be a moving target because the properties are in a state of continuing change and the precise date for the conveying of them will be unknown. Provision must be made to ensure that all information needed to operate the facility is adequately safeguarded and ultimately made available to the customer. Facilitating the Transfer of the Operation. The outsourcing agreement should contain provisions relating to facilitating the transfer of the operation back to the customer, or a new vendor, and establishing a mechanism to determine the price at which the facility would be conveyed to the customer. Minimizing the Risks and Adverse Consequences of Business Failure by the Vendor. While there are no fully satisfactory solutions, we discuss below a number of alternatives in dealing with risks of financial failure.

DISENTANGLEMENT PROVISIONS

Because failure to address disentanglement issues would probably favor the vendor rather than the customer, the bias in the following suggestions may be seen as pro-customer, but the intent here is to illuminate the issues.

Specify the time or events when disentanglement will occur (e.g., a material default by the vendor, change of ownership or control of the vendor, in the event the vendor experiences financial difficulties, or at the end of a trial period).

Specify the mechanics of how the disentanglement is precipitated, who is permitted to elect to Disentangle, how is notice given, when is the closing, and the like.

Specify the elements of the transaction. This may include reacquisition of real and personal property as well as the reemployment of employees and the reestablishment of employee benefits.

Specify the allocation of duties among the vendor, the successor-vendor, and the customer during the disentanglement period.

Specify the allocation of disentanglement costs among the parties. Vendors typically prefer to impose a separate charge, on a time-and-materials basis, for the performance of disentanglement duties. In the alternative, they may propose to re-allocate dedicated personnel, and either reduce or abandon service level requirements. Customers may wish to require the vendor to absorb these costs, even though vendors will claim that this forces them to bid-up the prices for their regular services.

Specify the prices (or at least, the formula for establishing the prices) at which resources can be re-acquired by the customer. This factor may be extremely difficult to establish if the facility has changed a great deal.

In all circumstances, provide for the preservation of the integrity of the data center. In this regard, it is extremely helpful to provide for a mechanism for keeping a current record of the data center properties and of all information needed to operate the facilities. The outsourcing agreement should also require that all licenses or leases provide for consent, in advance, to their re-conveyance to the customer upon disentanglement. The customer should always have access to all technical documentation and source code regarding new software, and the customer should seek to have the exclusive ownership of all new developments created by the vendor that involve the data center. In addition, the vendor should be required to properly maintain the physical property and to establish and maintain disaster protection and recovery capabilities.

DEALING WITH RISKS OF FINANCIAL FAILURE

One of the most difficult issues in disentanglement is the risk that the vendor will sustain a bankruptcy and the customer will be unable to reclaim the data center. The risk of financial failure is an unavoidable risk at some levels and must be evaluated as

part of the business decision to outsource to a particular vendor. The worst nightmare is that the data center properties will be kept from the customer and liquidated as an asset of the estate of the vendor in connection with a bankruptcy, requiring the customer to await the process of the bankruptcy court and eventually enter a bidding contest in order to reclaim its data center. We have encountered a number of ways to address this risk:

One is to obtain a lien on the data center properties and thereby seek to be able to reclaim them through foreclosure in the event of a financial failure by the vendor.

A second is to isolate the data center operation from the risks of the remainder of vendor’s business by requiring the vendor to create a single purpose subsidiary, the sole activity of which will be the acquisition and operation of the data center. If the vendor is willing, there are several reasons why the single-purpose subsidiary may be a good idea for the customer. The principal purpose of this structure is to isolate the data center in an entity that is likely to survive and be profitable if kept separate from the vendor’s other businesses. Such a structure raises complex additional legal and financial issues on which advice would have to be obtained. The additional complexity makes this solution unusual.

Other solutions involve structuring of the outsourcing agreement so that title to the facilities is not transferred to the vendor.

Keep in mind that once in bankruptcy, the vendor will have the right to assume or reject the outsourcing agreement depending on its assessment of the value of the outsourcing agreement to it. The vendor will also have the right to assume and assign your contract to another supplier, even where the contract prohibits assignment. Moreover, if a vendor does not want to make a quick decision on assumption or rejections, it may well be allowed to delay that decision until the end of the bankruptcy case, which could be a very long time. During this time you may not be able to terminate the outsourcing agreement or otherwise enforce some of its provisions. Bankruptcy court approval would be required in this period to terminate, a potentially difficult and expensive process. Accordingly, pre-planning is the key to dealing with the financial risk of the vendor going bankrupt. In this regard, you should obtain financial covenants and current financial information that will give you an early notice of financial trouble so that you can act before the bankruptcy filing. Indeed, crafting an outsourcing agreement where the customer retains ownership and control of all software, data, equipment, deliverables and any work in process, as well as the right to use vendor-owned items, may prove very important. In addition, notwithstanding bankruptcy law, your outsourcing agreement should prohibit the assignment of the outsourcing agreement or the delegation of the vendor’s responsibilities, without your express written approval.

• • • Legal services to the information technology market • • • • • • Legal services to the information technology market • • •

© 2003 Gordon & Glickson LLC. All Rights Reserved.

IT Outsourcing AgreementsPlanning for a Successful Transaction

Gordon & Glickson LLC444 N. Michigan Ave.

Suite 3600Chicago, IL 60611

312-321-1700 www.ggtech.com



The JUF High Tech Division, Lunch and Learn Series

Chicago, IllinoisJanuary 19, 2004



This presentation is intended to alert the reader to some of the legal issues discussed herein. The impact of the law for each particular situation depends on a variety of factors, therefore, we strongly recommend you engage legal counsel to assess and help minimize your legal liability based on the particular requirements of your institution. Like any presentation, this is not meant to be used as a substitute for legal counsel.



Agenda/Outline• Speaker background• Outsourcing marketplace• Planning to outsource• Negotiation process• Planning for the end game• Questions



Who is GGTech?

GeneralRepresentation

IT Industry

M&A and Corporate Finance

E-Commerce Domestic & International Commercial

IntellectualProperty

Litigation & Disputes



Practice Mix

64%

22%

14%

Special Counsel

General Representation

Litigation & Disputes



Global Experience

Israel

North America

Europe

South AfricaVenezuela

Australia



What is Outsourcing?

Definition: An arrangement in which one company performs services for another company that could also be or have usually been performed in-house.

Outsourcing transactions can range from large contracts where a company like IBM manages another company’s IT services to the practice of hiring contractors and temporary office workers on an individual basis.



Original Reasons for Outsourcing

40%

32%

20%

19%

Lower I.T. Costsand CapitalExpensesLack of InternalStaff

Improve Quality

Faster Time-to-Market

Source: CIO.com



Actual Benefits Gained29%

25%

21%

15%

14%

12%

9%

7%

Improve Quality

Lower I.T. Costs

Faster Time-to-MarketReduced Staff

Stronger BusinessContinuityImproved Security

Lowered CapitalExpendituresOther

Source: CIO.com



Functions Outsourced to Date39%

29%27%27%27%27%

25%22%22%

18%15%

8%

Web Hosting

Ntwk/Comm

I.T. Infra

Help Desk

Data Center

Applications

Bus. Process

PCs

ERP

I.T. Security

CRM

Other

Source: CIO.com



Part 1: Planning to Outsource

• Three key elements– Technical preparation: Baseline– Commercial preparation: Procurement best

practices (the RFP)– Legal preparation: the Outsourcing Agreement



Do Your Homework!!• Create a “Baseline”

– Determine scope of function as you currently perform it

– Identify all resources currently being used

– Determine current service levels– Determine actual current cost



Use Your “Baseline”

• Baseline sets threshold for what a vendor must do to “make things better”

• Baseline sets framework for the written RFP document

• Baseline sets a starting point for the scope of the vendor’s services



Procurement Best Practices

• Assemble a complete team• Conduct internal preparation• Utilize an RFP process• Allow adequate time/keep the process

moving forward• Solicit multiple vendors



The Outsourcing Team

• Technical management

• Technical operations• Finance/procurement• Human resources• Legal• Executive sponsorship



The RFP

• Accurate and complete– Clear picture to the vendor– Allow a clear picture of the vendor

• Reflects homework done and team assembled– Technical detail– Financial expectations– Legal terms– Process expectations



The Outsourcing Agreement3 ‘C’s

• Critical core features– Price– Scope– Service levels

• Comprehensive coverage

• Customized to fit specific needs



The Outsourcing Agreement• Scope • Fees • Service Levels• Asset/personnel

transfers• Key Personnel• Reporting and

management

• Warranties & Indemnities

• Default• Disentanglement• Limits of liability• Disputes/Root-Cause

Analysis



Define Scope of Engagement• Define scope in a “Statement of Work”?Clearly define deliverables (including software

and systems)?Include “Responsibility Matrix” (identifying

specific responsibilities of both vendor and customer)?Describe transition from old vendor (or in-

house) to new vendor?Describe transfer of resources

(Assets/Personnel)



“Catch All” Provision• In order to avoid extra unanticipated fees for

“scope creep”, the SOW should include a clause similar to the following:– “this scope statement shall not be construed as the

complete statement of every single job, task, function, or process to be performed by Vendor. ‘Scope’ also includes all tasks and functions reasonably inferred from, or reasonably incidental to, or necessary for the performance of, those listed in this Exhibit, and all other tasks and functions currently being performed by Vendor’s [XYZ] department.”



Service Levels & Credits• Core feature of outsourcing agreements• Need to be specific and measurable• Types of SLAs:

– System Availability Requirements– Support Response Time Requirements– Ad hoc SLAs – Detailed Function Requirements

• SLAs are meaningless without associated financial consequences, such as payment credits



Warranties

• Investigation Warranty• Services Warranty• Documentation Warranty• Deliverables Warranty• Intellectual Property Warranty• Authority and Approval Warranty• No Pending Litigation Warranty• No Misrepresentations Warranty



Disputes/Root-Cause Analysis• Root-Cause Analysis

– Vendor acts no matter the cause– Parties perform post resolution root-cause

analysis; vendor is reimbursed if not at fault

• Right to Set-off/Right to Withhold Disputed Amounts

• No Suspension of Services clause



Part 2: Negotiation Process



Why Use a Formal Negotiation Process?

• Leverage• Speed• Control• Resources• Cost



Negotiation Guidelines

• Schedule– Number of: hours, days, rounds of negotiations– Concurrent vs. consecutive negotiations– Set it in stone

• Detailed process steps• The importance of personality

– Buying into the process



Process Steps

• Issue papers– Redlines of requested changes– Limitations on submission of new issue papers– Incentive system

• Timeframe for resolution• Issue paper resolution – agreed, withdrawn,

incorporated without agreement– Default position



Round by Round Guidelines• Round one of negotiations

– General discussions– Issue paper resolution

• Process for making changes

• Round two of negotiations– Issue paper resolution– Discussion of vendor-

provided items– New issue papers?

• The end of the final round of negotiations



Ending the Negotiations

• After the Negotiations– Final proposal from vendor– Incorporation of issue papers– Review process

• Best and Final Offer– Right of response in single vendor situation?



Key Considerations• Single vendor transaction

– Leverage– Ability to start over

• Private sector transactions– Leverage across vendors

• Sticking to the process• Public sector additional considerations

– Fair and equal treatment– Disclosure rules



Part 3: Plan for the End Game

• Disentanglement• Financial failure of the vendor



Plan for Disentanglement• What is Disentanglement?

– A post contract transitional phase in which the outsourced function is restored

• Specific Obligations:?Full cooperation; No adverse impact?License to proprietary technology?Provision of data and documentation?Transfer of assets, leases, licenses,

and other contracts?Hiring of employees



Details of Disentanglement Clause

• Specify– Time or events when it will occur – Mechanics of how the it is precipitated– Elements of the transaction– Allocation of duties among the vendor, the successor-vendor, and

the customer during the disentanglement period– Allocation of costs among the parties– Prices (or at least, the formula for establishing the prices) at which

resources can be re-acquired by the customer• In all circumstances, provide for the preservation of the

integrity of the data center



Financial Failure of Vendor

• There are a number of ways to address this risk:– Obtain a lien on the data center properties– Isolate the data center operation from the risks of the remainder of

vendor’s business by requiring the vendor to create a single purpose subsidiary

– Structure the outsourcing agreement so that title to the facilities is not transferred to the vendor

• Once in bankruptcy, the vendor will have the right to assume or reject the outsourcing agreement depending on its assessment of its value



Conclusion

• Preparation• Planning• Process

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