Strategic Use of Outsourcing Arrangements: Current Outsourcing Challenges

Richard Austin (DWW)Richard Corley (Goodmans)

Peter Miscevich (Bell)

The Eighteenth Annual Canadian IT Law Association Conference

Montreal - October 20-21, 2014

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Outsourcing: Not a New Concept

“Specialization on the basis of one’s relative strengths (i.e. sustainable competitive advantage) leads to higher productivity and more value creation”

Adam Smith, The Wealth of Nations

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Quotations: From the Trenches

• “After all, how hard can it really be?”

• “My job is to get the signed contract. Your job is to deliver it.”

• “It has to be signed today if we’re to get it into this quarter.”

• “If I’d known the contract said that, I never would have agreed to do that change order for that price.”

• “Who’s the idiot who agreed to that?”

• “There’s no way I can deliver what you have committed us to in the time we have to do it/for the price you have negotiated.”

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Broad Outsourcing Trends

• 80% of major enterprises intend to increase their use of outsourcing

“2013 State of Outsourcing” KPMG

• 25% of outsourcing deals fail within two years and 50% fail over the initial term

• Outsourcing transactions and relationships are becoming more complex and challenging

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IT Outsourcing Trends for 2014

• Hybrid offshoring heats up

• An increase in insourcing

• Service integration comes home

• The Cloud gets grounded

• Contracts compel inter-provider cooperation

• Big deals get smaller… Small deals get bigger

• Governance gets harder

Seven of the top ten IT outsourcing trends identified by Stephanie Overby of CIO.com, January 17, 2014

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Implications for Outsourcing Strategy

• Greater:diversity and complexity in delivery options, models, venues and

service providersdiversity in business goals and objectives complexity in the governance and management of multiple

outsourcings focus on flexibility, adaptability and business agility

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Topics for Discussion

1. Cyber-Security

2. Service Disaggregation

3. The Changing face of Contract Management

4. Business Process Outsourcing

5. Multi-sourcing

6. Transition In and Transition Out/Termination Services

7. Audit Rights

8. Use of the Cloud

9. Pricing Controls and Principles

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Cybersecurity2003 “Not everyone needs or will pay for, military strength security.”

2006 Winners / TJ Maxx data breach (45.6 million credit and debit cards / 18 months)

2008 Heartland Payment Systems (100 million credit and debit cards / U.S. $140 million)

2013 Mandiant allegations of cyber attacks by People’s Liberation Army Unit 61398 (Comment Crew)

“Bad outsourcing decisions cause 63% of data breaches” according to the 2013 Trustwave Global Security Report

OSFI, Cyber Security Self-assessment Guidance, October 28, 2013

Target data breach (110 million accounts)

2014 eBay (145 million customers)

Home Depot (56 million accounts / 5 months)

JPMorgan Chase (76 million households, 7 million accounts / 1 month)

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Service DisaggregationDefinition: the use of different service providers to deliver services previously provided by a single service provider under a multi-tower outsourcing agreement

An Implication of Ubiquitous High-Speed Data Communication

Cloud, service as software (SAS)Application service provider (ASP) Infrastructure as service (IAS)Virtualization of desktop / server / applications

ConsequencesResponsibility for interfaces is increasingly criticalFacilitates multi-sourcing

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The Changing Face of Contract Management

“Gee we didn't realize we had/could to do that in contract...”

Passive/reactive CM is becoming a thing of the pastProactive CM is essential to meet/enforce obligations The “business relationship” is not CMRigorous governance requirements demand better CMpoor CM eats into the economics of the deal

“It is a contract after all so I guess we have to read it...” “Playbooks” are critical for Day 2 business teamsDraft provisions like you had to manage the contract

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Business Process OutsourcingBPO VERSUS ITO: DIFFERENCES AND DEVELOPMENTS

Percentage of outsourcing deals that are BPO deals is smaller in Canada (than in U.S. or Europe)

Different supplier market structure in BPO (large number of niche vendors by service category)

Longer sales cycle for BPO transactions BPO transactions are highly customized

BPO deals generally can be more complex (scope definition, transition issues, difficult personal information issues, automation of manual processes, service levels)

Customer business processes may be poorly defined (risk assessment and mitigation are complex)

Pricing reflects unique customer requirements (less leverage) and that labour arbitrage may be significant component of any cost savings

Supplier focus on administering (not making) policy and on not providing legal advice about the Customer’s business

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Multi-Sourcing (Multi-Vendor Contracts)

Definition: can refer to:Use of different vendors to perform adjacent services, each having

the capacity to perform some or all of the services of the others; facilitate a competitive procurement and ongoing flexibility

Use of multiple vendors to provide the same types of service; facilitate competition on an ongoing basis (for large customers)

IssuesClarifying scope of responsibilityGovernance challenges Impacts of terminationCost-benefit analysis Integration – customer as integrator of last resort

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Transition / Termination Services

“Sure we’ll help you when you want to move to our competitor...”

Back in the day motherhood statements ruledCustomers held hostage and terrified of switching suppliersSuppliers motivated to keep customers in the dark

“After you write our RFP so we can replace you, we’d like 24 months of transition services...”

Customer expectations and demands are highSuppliers wary of sharing “secret sauce” with competitorsNegotiated outcomes are complete and detailed

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Audits and Certifications• The evolving Outsourcing industry:

Maturing transactions, customers and suppliers Increasing emphasis on privacy and securityWell-publicized breakdowns of internal controlsStrengthening governance requirements

• Increased emphasis on audits and certifications:More extensive rights for customer audits/investigations Increased regulatory requirements:

• OSFI B-10 Guideline Outsourcing of Business Activities, Functions and Processes, s. 7.2.1 h)• OSFI Memorandum “New technology-based outsourcing arrangements”, February 29, 2012

• Third Party Audits:CPA Canada, Auditing and Assurance Standards Board, Canadian

Standard on Assurance Engagements, Reporting on Controls at a Service Organization (CSAE 3416)

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Use of Cloud Computing

Definition: the practice of using a network of remote servers hosted on the Internet to store, manage, and process data

Range of OptionsNo charge, consumer / mass-market applications (e.g. Hotmail)Enterprise scale, private cloud implementations

IssuesSecurity and control of dataDisconnect between (low) cost and (high) riskProperly define requirements (need for due diligence)Security and access for discovery / litigationCompliance with regulatory requirements

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Pricing Controls and Principles

“We’ll have the Benchmarking, Most Favoured Customer, Pricing Principles and Termination for Convenience without fee...”

Many tools for customer to ensure fair pricingDoes anyone other than the benchmarkers like benchmarking? “Apples to apples” comparison critical for suppliersAre any two complex agreements “substantially similar”? What’s fair pricing for changes to services?Capex recovery vs. termination for convenience

Strategic Use of Outsourcing Arrangements:Current Outsourcing Challenges

Richard Austin (DWW)Richard Corley (Goodmans)

Peter Miscevich (Bell)

The Eighteenth Annual Canadian IT Law Association Conference

Montreal - October 20-21, 2014