Without doubt

13 Jun 2007

More and more entities including public authorities are considering the benefits of transferring responsibility to expert suppliers for non-core business processes and functions in order to find new efficiencies, to reduce costs and to increase shareholder value.

In addition to outsourcing IT functions such arrangements can cover call centres, transaction processing, HR and payroll, accounting, treasury and finance, administration, claims management, supply chain, procurement, purchasing and logistics support.

Outsourcings and managed services contracts, whether they occur in the public or private sector, share many characteristics – in particular the need from the customer’s perspective to form a robust but flexible contractual relationship that mitigates the inherent risks of transferring responsibility of a particular service or function to a third party.

Some of these risks together with ways of mitigating them are discussed below.

The heart of a successful outsourcing or managed services contract is a clear definition of who does what for whom and for how much. In other words, there needs to be a clear service description, a clear statement of customer and supplier responsibilities and a clear delineation between the two. For the customer the process of defining the precise scope of the services and what elements of the services (if any) to retain in-house is essential and should involve careful examination and selection.

Public authorities will have the added complication of needing to ensure that any such procurement complies with applicable public procurement law and government guidelines and that such laws and guidelines are strictly adhered to.

Sharing risk and responsibility

A central part of the value of any outsourcing is transferring the risk and responsibility for the services to expert suppliers. In practice it is not possible to transfer all risk, and the use of external suppliers inevitably introduces new risks, such as cost increases, poor service performance and the related potential for reputational loss.

Customers will require contractual protections to manage these risks, and suppliers will want to ensure they do not take on risks inherent in the services themselves, without being adequately compensated, such as material changes in law or developments in the customer’s business that might impact on service delivery. It is important to balance these conflicting views in the contract by affording protection for the customer without unduly fettering the supplier.

One of the key commercial issues for the customer is ensuring ongoing price competitiveness and value for money. Benchmarking and other forms of market testing, indexation and gain-sharing are common, although there is no one-size-fits-all solution. Long-term arrangements are likely to yield more attractive pricing, but with a greater need over time for changes to be made to the service description, service levels and technology platform.

So, outsourcing or managed services contracts will be subject to change and alteration. Customers typically seek to ensure that the contract caters for change in a way that seeks to automate the process of agreeing and implementing change and controls the cost of changes made. A public authority should include a change procedure to deal with changes that are within the scope of the original procurement and be mindful that changes outside such scope may involve a re-tendering process, as the law generally does not allow an authority to depart from the parameters mapped out in the original procurement.

Service levels and credits

It is important that the service level and service credit regime is properly designed so that it incentivises good performance rather than institutionalises poor performance. Service credits are not a perfect solution to non-performance and they have to be engineered with care in conjunction with other mechanisms (such as reporting requirements and escalation) designed to identify and mitigate poor performance.

One factor that is consistently absent in failed outsourcings is a proper management and governance structure. The issue of corporate governance needs to be addressed in the contract: a jointly appointed management committee, an independent chair, a dispute-resolution mechanism, an escalation procedure, joint participation in continuous improvement and other classic signatures of good corporate governance should be designed for the deal.


Employees currently engaged in providing the services to be outsourced may have rights under the European Communities (Protection of Employees on Transfer of Undertakings) Regulations 2003 (as amended). Pursuant to these regulations, such employees may have the right to transfer to the new supplier on their current terms and conditions of employment and on the basis that their service is treated as continuous from the date of the employees’ start with the first employer. The regulations also impose obligations on both the transferor entity and the transferee to inform and, if required, to consult with the affected employees’ representatives within a period of no less than 30 days prior to the transfer.

An early assessment should be undertaken as to which employees are within the scope of the transfer, the terms and conditions of their employment, the costs associated with those employees including pensions and other benefits and whether there are any industrial relations implications arising from the proposed transfer.

How the services are migrated back to the customer or another supplier at the end of the arrangement is critical in all outsourcing transactions. Post-termination assistance, use of intellectual property rights and assets, recruitment of staff, and return of data and records will all need to be addressed. The supplier will be concerned to cover the cost of its investment and to retain control of its valuable intellectual property rights. In practice this gives rise to a series of issues that need to be carefully examined: Should the exit provisions simply mirror the terms of the initial transfer to the supplier? What should happen to the employees on termination? How will intellectual property and the customer’s data be dealt with?

As major outsourcings or managed services arrangements differ considerably in both size and complexity from simple procurements of services or out-tasking of responsibilities, the development of a bespoke contract is of key importance and should be seen as a strategic opportunity to reflect in detail the customer’s unique requirements and policies and to put a ‘best foot’ forward for any negotiations.

By John O’Connor, a partner in the information technology law group at Matheson Ormsby Prentice