Key Issues in Outsourcing William G. Roche Ellen G. Ray April 20, 2004 12:30 1:30 p.m. EDT If you have not downloaded the program materials, please do so now at www.kslaw.com/e-lunch/handout
To connect to the audio part of the program please call: 1-888-291-5971 A customer service representative will connect you to the seminar. For technical assistance at any time during the presentation, please call: 1-888-865-7469 Speaker Biographies William G. Roche broche@kslaw.com 404-572-4936 Bill Roche joined King & Spalding in 1983 and became a partner in 1991. He is a member of the firm s Private Equity and Intellectual Property Practice Groups in Atlanta. Mr. Roche received his law degree from Stanford University in 1983, graduated with highest honors and was a member of the Order of the Coif. He has represented clients in connection with a variety of transactions involving intellectual property and technology based assets and services, including information technology (IT) outsourcing transactions. He also advises clients in connection with the acquisition, development, marketing and protection of intellectual property and technology assets through merger and acquisition transactions, development agreements, licensing, joint ventures, strategic alliances and other arrangements. Mr. Roche s practice is focused primarily on the computer software and telecommunications industries.
Speaker Biographies Ellen G. Ray eray@kslaw.com 404-572-2885 Ellen G. Ray has been elected partner on King & Spalding's Private Equity Practice Group. She has extensive experience in technology and business process outsourcing transactions, licensing transactions and the formation of strategic alliances. The types of licensing transactions include traditional software licenses, together with maintenance and support, content licenses and ASP agreements. Before joining King & Spalding, Ms. Ray served as Acting General Counsel for HBO & Company. Prior to that, Ms. Ray was the Associate General Counsel for Dun & Bradstreet Software Services, Inc. She is admitted to the Alabama Bar and the State Bar of Georgia and to practice before the United States Supreme Court and the Eleventh Circuit Court of Appeals. She is also a member of the Intellectual Property Law Section of the American Bar Association, the Computer Law Section of the Georgia Bar and the Atlanta Bar Association. Key Issues in Outsourcing William G. Roche Ellen G. Ray April 20, 2004 12:30 1:30 p.m. EDT 1
Agenda Introduction Overview/Basic Concepts Success Factors/Current Trends Outsourcing Process: From RFP to Ts and Cs Contractual Considerations Offshore Considerations Managing the Relationship Legislative Update 2 7 7 Overview Some estimates indicate that the global market for business process outsourcing will increase from $123 billion in 2001 to $178 billion in 2005. What companies are finding is that they initiate outsourcing for cost, stick with it for quality, then commit to it as they realize it helps them focus on their core competence and remain close to their best customers. Source: Business Process Outsourcing : Cost, Productivity, and Competition; The Outsourcing Center (2003) 3 8 8
What is Outsourcing? Outsourcing is the assumption by a third-party of one or more business or technology functions of the customer, typically under a long-term agreement and often involving the transfer of assets and/or personnel to the vendor. Operation of a call center or the human resources/benefits administration function may be the basis of an outsourcing Focus on traditional third-party outsourcing arrangements; issues vary in co-sourcing arrangements. Co-sourcing allows the vendor to manage the process or function while the customer retains and uses its own resources (typically people) to perform the actual services 4 9 9 Types of Outsourcing Information Technology/Process Outsourcing Application Development & Maintenance (ADM) Data Center Management (DCM) Training/Support Help Desk Business Process Outsourcing Customer Care Centers Human Resources Finance/Accounting Manufacturing Procurement Asset or Property Management 5 10 10
Current Trends in Outsourcing Outsourcing transactions are increasingly complex More time in the BPO arena Customers may retain multiple vendors Requires sophisticated analysis and apportionment of obligations and associated risks; coordination amongst multiple vendors Customer sophistication is increasing Vendor selection/management Service level expectations Economic expectations 6 11 11 Objectives of Outsourcing Reduce and control operating costs Improved efficiencies Transfer of employees Use of offshore resources Generate cash through transfer of assets to vendor Improve focus on core business Free internal resources for other purposes (e.g. strategic planning) Obtain resources that are not available internally Gain access to world-class capabilities Receive same or improved level of service as was provided internally 7 12 12
Top Factors for Successful Outsourcing Understanding company goals and objectives Creating a strategic vision and plan Involving senior executives and obtaining support Selecting the right vendor Structuring the contract properly Customer and Vendor objectives are aligned Using outside expertise to evaluate and structure relationships Developing an exit strategy Actively managing the relationship(s) Paying careful attention to personnel issues Verifying near-term financial/operational justifications Accounting for inevitable change Source: Survey of Current and Potential Outsourcing End-Users; The Outsourcing Institute Membership 8 13 13 Typical Outsourcing Process Determine Objectives RFP Process Vendor Selection Vendor Management $ Organize the Effort Outsourcing Assessment Gathering of Data for RFP Prepare RFP Distribute RFP Vendor Process Management Proposal Evaluation & Vendor Selection Term Sheet Agreement Negotiation Transition Post- Outsourcing Contract Management Total Average Cost: $20K-$500K+ Total Average Time: 2-8 months Time 9 14 14
RFP Process Develop bid criteria Include bidding rules/process Diligence By the customer By the vendor Selection of potential vendors Bid comparison/scoring Use of internal/external procurement expertise 10 15 15 Process Drivers Customer driven process Involves multiple resources Internal Human Resources Finance/tax MIS/IT Legal Real Estate External Consultants Legal 11 16 16
Top 10 Factors in Vendor Selection Commitment to quality Price References/reputation Flexible contract terms (e.g., length, scalability, accommodating other changes) Scope/depth of resources Additional value-added capability Cultural match Existing relationship Location Retention of personnel Source: Survey of Current and Potential Outsourcing End-Users; The Outsourcing Institute Membership 12 17 17 Contractual Considerations Scope of Services Established by the Statement of Work ( SOW ) Must be clearly defined in order for pricing to be determined Flexibility to change the SOW is important to account for organic/inorganic change Vendors desire a narrow and crisp SOW (e.g., Vendor only provides services expressly listed in the SOW ) Customers desire a broad SOW that includes everything that the affected employees performed prior to outsourcing (e.g., Vendor provides all IT services unless expressly excluded ) Sweeps clause 13 18 18
Contractual Considerations Fees Designated fees for in-scope services Fees can be based on: Unit pricing (e.g., FTE, per call, equipment units, MIPS, etc.) Time and materials Fixed fees Cost plus Combination of methods Need flexibility for additional/reduced services Often fees and service levels are benchmarked against industry standards 14 19 19 Contractual Considerations Adjustments to Fees Adjustments are more likely with longer term agreements Adjustments are typically tied to an inflation index Selection of index may be more complex outside of the U.S. Which party bears the risk? One party takes all of the risk Fees are adjusted annually based on index Each party shares the risk Fees are adjusted if change is in excess of an agreed percentage Adjustment is capped Share impact if actual change exceeds cap 15 20 20
Contractual Considerations Currency Risk Change in the value of one currency relative to another Agreement should address allocation of currency risk One party bears the risk Customer and vendor share the risk 16 21 21 Contractual Considerations Service Levels Enables customer to incent good performance and measure continuous improvement Quantified performance standards/levels of service to be provided by the vendor Customer and vendor need to determine existing levels of performance and desired levels of performance Fair and objective standards by which the delivery of service is measured need to be established (e.g., response times, fix time/task completion, availability, and throughput) Consequences of failures and successes should be clearly defined Performance credits are credits the customer receives for missed service levels Credit earnbacks allow the vendor to earn back previous credits as performance improves 17 22 22
Contractual Considerations Handling Change Change in the scope of Services is inevitable Highly likely that the pricing mechanism will change during the term Include a comprehensive Change Process Include a process to add New Services Include a Governance Process 18 23 23 Contractual Considerations Software and Other Intellectual Property ( IP ) Agreement will need to address appropriate cross-licenses Licenses by the customer to vendor for purposes of performing services Licenses by the vendor to customer for receiving services Consider whether consents are necessary in connection with third-party software Agreement to address ownership of newly developed software Agreement to address customer s rights during and after the term Agreement to address vendor s rights to customer s IP after the term Commercialization rights 19 24 24
Contractual Considerations Term and Termination Term - trend is towards longer terms (5-7 years) with renewal options; if the parties cannot agree on the renewal terms and conditions, original term is usually extendable for a defined period (e.g., 12 months) Termination For convenience - by the customer, but usually subject to payment of termination for convenience fees For cause - customers want to limit vendor s right to terminate for cause, solely for customer s failure to pay For changes in control of vendor or customer For failure to meet critical service levels - in some cases, customer may terminate immediately with no cure period 20 25 25 Contractual Considerations Consequences of Termination Termination for convenience carries a premium - Vendor has invested in start-up costs that will be recouped over the entire term; thus, termination for convenience fees decline over the term Continuing rights and obligations typically without regard to the reason for termination Termination assistance - ensures no material disruption to the customer s operations Vendor is obligated to help transition back to customer or to customer s new vendor May involve additional charges due to out-of-scope services Continued IP rights - customer may retain rights to use certain of vendor s IP on a going-forward basis 21 26 26
Contractual Considerations Employees and Vendor Personnel Vendor typically hires a significant portion of customer s employees providing the function prior to the outsourcing Knowledge transfer - Vendor determines who to hire Employees not transitioned are terminated at customer s expense Key employees - Vendor may agree to retain core customer personnel for a certain time period Vendor personnel Typically there are restrictions on key vendor personnel - approval rights prior to assigning or transferring; dedicated full-time to customer s account Restrictions on hiring personnel of the other party - typically waived for customer at termination for certain personnel 22 27 27 Contractual Considerations Liability Direct Damages Typically capped at a defined amount - based on fees paid during a defined time period or may be a specific dollar amount each year of the term Exclusions Consequential damages are typically excluded Exceptions Indemnities are usually excluded from the cap on direct damages and exclusion for consequential damages Certain breaches may be excluded from the cap or exclusions 23 28 28
Contractual Considerations Other Contractual Provisions Security Data protection Physical security Warranties Indemnities Confidentiality Data ownership and security/safety and security procedures Dispute resolution - arbitration/mediation Assignment Audit rights SAS 70 24 29 29 Offshore Considerations What is Offshore? Onshore Near Shore Trend is toward increased off-shore services Call Centers Help Desk Product Development Benefits Low cost labor Low cost communications Multiple languages supported 25 30 30
Offshore Considerations Challenges Political backlash Cultural issues Risks Geo-political Legal Intellectual Property Privacy Security Customer backlash Impact on customers of poor execution 26 31 31 Managing the Relationship Develop and maintain communication and decision making procedures Each party appoints a relationship manager Acts as the internal advocate Facilitates internal communication Collects input from all affected business units Engage in joint strategic planning Alignment of long term goals 27 32 32
Managing the Relationship Assess performance against metrics Document issues in a timely manner Diagnose problems Jointly develop solutions Implement solutions designed to avoid recurrence of problems Coordinate interaction between multiple suppliers Establish and maintain communication protocols 28 33 33 Legislative Update Federal Consolidated Appropriations Act of 2004 (Public Law No. 108 199), effective 9/1/03, provides in part: (e) An activity or function of an executive agency that is converted to contractor performance under Office of Management and Budget Circular A-76 may not be performed by the contractor at a location outside the United States except to the extent that such activity or function was previously performed by Federal Government employees outside the United States. 29 34 34
Pending Federal Legislation Amendment to Immigration and Nationality Act (HR 2154) To prevent an employer from placing a nonimmigrant who is an intra company transferee with another employer Amendment to Immigration and Nationality Act (HR 2688) To repeal H1-B visas (temporary/specialty worker) and related authorities L-1 Nonimmigrant Reform Act (HR 2702) To amend the Immigration and Nationality Act to revise L-1 nonimmigrant visa (intra-company transfers) provisions USA Jobs Protection Act of 2003 (HR 2849; S 1452) To amend the immigration and Nationality Act with respect to the H- 1B and L-1 visa programs to prevent unintended United States job losses, to increase the monitoring and enforcement authority of the Secretary of Labor over such programs, and for other purposes 30 35 35 Pending Federal Legislation Jobs for America Act of 2004 (S 2090) Limits offshore performance of contracts for the procurement of goods and services; limits use of funds appropriated for financial assistance to a State by requiring certification that funds will not be used for goods or services performed outside of the United States 31 36 36
State Legislation Details vary from state to state Legislation has been introduced in at least 12 states At least 10 states are currently considering introducing legislation Common themes Ban award of procurement contracts by the state for services rendered from a site outside the United States (CO) Require that service contracts with state be performed by U.S. citizens or individuals authorized to work in the United States (IN) State agency regulation of call centers and place restrictions on overseas call centers (AR,NJ) Require disclosure of city, state or country where call center rep is calling from (NC) 32 37 37