Offshore Outsourcing. A Practical Guide

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1 APRIL 2004 Offshore Outsourcing A Practical Guide In brief 1 Introduction 2 Scoping the services 3 Selecting the service provider 4 Contractual issues 5 Conclusion 6 Contacts

2 OFFSHORE OUTSOURCING: A PRACTICAL GUIDE 1 Introduction The global demand for outsourcing shows no sign of abating. With many businesses finding they can slash their operational costs by up to 40% or more, it is not surprising that the key business question is not will you outsource? but what is your outsourcing strategy? Businesses that have the most to gain are service intensive with low profit margins, such as those in the travel industry. Increasingly, companies are looking to outsource operations offshore to other countries. The lion s share of offshore outsourcing continues to go to India. With a large pool of educated, English-speaking graduates, many UK-based businesses find that they can gain significant cost savings with no reduction in quality. India also offers a range of tax breaks which makes it even more attractive as an outsourcing location. Analysts Gartner predict that by % of outsourced services will be offshore; India s market share will be 57% generating US$13.8 billion for the country. Many businesses have not yet taken advantage of the offshore revolution. Often, this is because they are uncertain how to deal with the legal and commercial risks involved. This guide gives an introduction to developing an offshore outsourcing strategy and how to manage the attendant risks to deliver real cost savings.

3 FIELD FISHER WATERHOUSE 2 Scoping the services The first step is to carry out a business-wide scoping exercise to identify: those services which are most amenable to outsourcing the cost savings and other possible benefits that the business wishes to achieve Many businesses find the use of specialist outsourcing consultants useful, although this is not always necessary. Once the prospective services have been scoped, the resources required to support those services should also be investigated. This is important to identify what assets (if any) or other resources need to be transferred to the service provider, or to identify those assets that the service provider must provide. For call centre operations, one example of this may be specialist customer management software. Travel businesses may also need to ensure that a service provider has a licence to use any travel specific software such as Sabre or Galileo. In most offshore outsourcings, relatively few generic resources will need to be transferred, as the customer usually looks towards the service provider to provide its own cheaper labour, premises and equipment. 3 Selecting the service provider Request for Information (RFI) and Tender process The customer should conduct a formal RFI and Tender process to identify those service providers that will best match its business expectations. Before issuing the RFI and Tender documentation, the customer should seek the appropriate legal, tax, audit and human resources advice for input into the tender documentation. Role of the contract or term sheet The RFI and Tender should be accompanied by either a contract or, at the very least, a term sheet setting out the customer s key contractual requirements. The contract and/or term sheet should be drafted by a lawyer in consultation with the business so it can fully reflect the specific requirements and concerns. The customer is then in control of the business terms on which it will be contracting and has a document tailored to meet its specific risk points. Contracting on the standard terms offered by service providers generally offers poor value for money. The standard terms of most service providers are heavily weighted in their own favour and provide poor protection for customers. Given that most outsourcing contracts are between five and ten years in length, this is often a case of marry in haste, repent at leisure. Who will you be contracting with? It is vital to identify the legal entity with which your business will be contracting. Some Indian service providers establish UK companies expressly for this purpose. However, such companies may be little more than shell companies, existing solely to market the Indian service provider in the UK. The risk in contracting with a shell company is twofold: the customer has no direct means of enforcing any contractual obligations against the actual service provider the shell company may not have sufficient assets or insurance to meet any claims These risks can be mitigated by taking a parent company guarantee or other form of protection such as a performance bond. However, most companies will wish to contract directly with the Indian service provider itself, either on its own or in a tri-partite contract including both the UK-based shell company and the Indian service provider. Travel businesses should be aware that not all Indian service providers are home-grown. Several international service providers have operations in India and provide another option that first time offshore outsourcers may find particularly attractive.

4 OFFSHORE OUTSOURCING: A PRACTICAL GUIDE 4 Contractual issues Contracting structure The contracting structure will depend on the commercial objective of the outsourcing transaction. Where assets are to be transferred, an asset transfer agreement will be required as well as a services agreement. If the outsourcing is an international project, then the parties may choose to have a master services agreement with descending individual asset transfer contracts and service level agreements. The parties may also wish to implement a transitional arrangement (either in the form of a separate agreement or, more usually, as part of the services agreement itself), to set out the terms on which the services will be transitioned to the service provider. Yet another option is for the parties to set up a joint venture company. This arrangement is in vogue as it reflects the current business trend for long-term, strategic partnering. Some of the perceived benefits of a joint venture company are profit share and control (by the customer holding the shares in the joint venture company) and, in certain instances, tax breaks under Indian law. However, customers should be careful when negotiating such an arrangement to make sure the service provider does not use the joint venture structure to water down service level, termination and other key contractual provisions. Managing performance how to ensure the contract delivers One of the most common complaints from customers where an offshore outsourcing has not worked out is that performance did not live up to the customer s expectations. It is therefore vital that the contractual documentation clearly sets out: the services to be provided the required service levels for those services the contractual performance incentive measures for ensuring that the service levels are met Whilst these should be ensured for all outsourcings, they are particularly important for offshore outsourcings. Distance, language and cultural differences may result in differing expectations between the customer and the service provider, leading to the customer feeling it isn t getting the performance it had expected. Clear contract provisions will help to minimise possible misunderstandings. Service level measurement and reporting provisions should also be built into the contract to allow the customer to monitor and assess performance against the required service levels. Where services may change over time, the contract should be designed to be flexible. This may involve the use of change management provisions and/or a call-off structure for agreeing scope of any discrete project services requested during the contract term. Managing costs how to ensure the contract delivers cost savings The contract should also be designed so that the pricing mechanism incentivises performance and cost savings. Some customers like to use a fixed price methodology. However, many offshore outsourcings are not suited to this, for example where the outsourcing is for a long term (in excess of five years) and the scope of the service is complex and/or subject to change. One innovative price mechanism often seen in outsourcings is target-based pricing with the use of open book accounts. This involves the parties agreeing and setting the target price for the services (identifying a given margin for the service provider). If the total cost of the services plus margin achieved by the service provider is lower than the target price, the cost saving is shared with the customer in agreed percentages. This is particularly useful where a customer is looking to incentivise cost reduction. In addition to pricing, the contract should also contain a range of other incentives for performance which may include: liquidated damages service credit regimes performance bonuses assessed against a balanced scorecard reserving customer rights to benchmark costs against those of other service providers Managing the relationship how to ensure distance is not a problem Building a strong contract management structure is critical to the success of offshore outsourcings. The objective of the structure is to address any issues as early as possible and to avoid issues developing into disputes.

5 FIELD FISHER WATERHOUSE This may involve providing in the contract for contract managers, escalation procedures and, ultimately, dispute resolution procedures. The contract should also expressly state the governing law and identify the courts which will have jurisdiction in the event of any dispute; usually the customer should require its own law to govern and its own courts to have jurisdiction over the contract. Time and effort in getting these provisions right at the start of the offshore outsourcing will reap dividends over the long term. Force majeure and business continuity All contracts should address force majeure. However, given recent tensions in the Asia, this is even more critical for offshore outsourcings. Customers should always ensure they have a right to terminate in the event of force majeure such as acts of God, terrorist attacks and other events outside the control of the parties. Depending on how business critical the services are, they may also wish to provide, as part of any business continuity arrangements, for the services to be delivered back in-house or at another offshore location in the event of force majeure. Employment matters In most offshore outsourcings, few, if any, personnel will be transferred to the service provider. However, where this is the case (for example, with any senior managers who may be transferred to the service provider), advice should be sought on whether the Transfer of Undertakings Regulations 1981 apply. These regulations aim to safeguard employees rights in the event of the transfer of an undertaking and may apply where services are contracted out. Where the outsourcing may lead to redundancies, customers should also seek employment law advice on this issue before any announcement is made to the employees. Data protection Businesses should be aware of the Data Protection Act 1998 (the Act) where it plans to transfer any personal data to an Indian service provider. Personal data means simply all data that relates to a living individual who can be identified from that data. This type of transfer is common where an outsourcing involves matters such as payroll or customer database management. In brief, the Act prohibits the transfer of personal data from the UK to a country outside the European Economic Area unless that country ensures an adequate level of protection for the rights of individuals whose personal data is being processed. The Indian Government has announced that it is working on implementing data protection law because, at present, the country does not have the required level of protection. This, though, is not an absolute obstacle to outsourcing data to India. There are a number of exceptions to the UK s data transfer prohibition. The position regarding data is complex. Legal advice should be sought on the aforementioned exceptions and on generally ensuring that the outsourced services comply with the Act. Managing exit guarding against service provider lock-in The contract documentation should always expressly address what will happen when the contract comes to an end. This may be because the contract simply expires without being renewed, or because the customer has terminated it due to poor performance. There should be a detailed exit plan. This is vital to ensure a smooth handover of services, either back to the customer or to another service provider. The contract should also contain other monitoring provisions (including, for example, the maintenance of an asset register) so that the customer is kept up to speed on the services and how they are delivered. The exit plan will also need to provide for know-how transfer at the end of the contract. These are necessary to prevent the risk of the customer becoming locked in to the service provider if it has lost the ability to perform the services itself.

6 OFFSHORE OUTSOURCING: A PRACTICAL GUIDE 5 Conclusion Offshore outsourcing offers a tremendous opportunity to travel businesses looking to cut baseline costs. However, it does involve more risk than outsourcing services to a UK service provider. Prevention is better than cure. Thorough research, legal advice and contractual documentation can manage those risks and lay a firm foundation for a mutually advantageous business relationship. 6 Contacts For further information, please contact: Michael Chissick Partner and Head of Technology Law Group t: +44 (20) e: michael.chissick@ffw.com Belinda Winward Senior Solicitor, Technology Law Group t: +44 (20) e: belinda.winward@ffw.com This publication is not a substitute for detailed advice on specific transactions and should not be taken as providing legal advice on any of the topics discussed. Copyright Field Fisher Waterhouse All rights reserved Field Fisher Waterhouse 35 Vine Street, London EC3N 2AA t: f: