By Gordon & Glickson LLC

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 ” (SEE BELOW)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.

 

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 against 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 legalcounsel 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 forwhich 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.

Gordon & Glickson LLC, an internationally recognized law firm based in Chicago , has focused exclusively on providing legal and strategic consulting services to the technology marketplace for over twenty-five years. The firm provides corporate, commercial, litigation and finance counsel for its entrepreneurial technology clients, and serves worldwide as strategic and technology counsel for both private and public sector clients. For more information please contact Philip P. McGuigan at 312.321.7659 or at ppmcguigan@ggtech.com.