Offshore outsourcing contracts should focus on value, not price

Price is no longer the most critical issue to address in an offshore outsourcing relationship. Offshore outsourcing contracts should focus on value, not price.

Offshore outsourcing contracts should not focus on price - this is the worst and most common mistake CIOs make in IT negotiations, according to experts. Ironically, that focus usually leads to higher costs and unacceptable service levels.

"Negotiate on price, and price alone, and you'll start the relationship with a resentful vendor who will pinch

pennies at your expense," says Jim Geisman, president of MarketShare Inc., a consulting firm in Wayland, Mass.

The fact that price has been the top negotiating point in many offshoring outsourcing contracts is not surprising. In the late 1990s, offshore IT development and infrastructure outsourcing services began price wars with U.S. vendors. Today, pricing advantages still exist, but CIOs who negotiate well-rounded contracts end up paying less in the long run, experts say.

Consultant Greg Blount agrees. "About 25% of my work is redoing deals done incorrectly from day one, contracts that put price above value, service levels delivered and risk assignment," says Blount, project director at outsourcing consultancy TPI Inc. in The Woodlands, Texas.

Internal requirements and deliverables

Too many CIOs choose offshore outsourcing vendors the way they'd choose a restaurant: They gather a bunch of candidates and decide what they can offload by choosing from vendors' menus of services.

This outside-in approach puts the horse before the cart, according to consultant Dean Lane, who advises CIOs to look within before shopping outside. A former corporate CIO, Lane is now CEO of Varitrak Systems Inc., /a>a Los Angeles-based compliance consulting firm.

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Before beginning offshore outsourcing contract negotiations, a company should conduct an internal process and requirements audit and chart its business model, in terms of business management tasks, processes and their values. This preparation equips the CIO with the most important information needed in a contract negation: knowing exactly what functions should be outsourced.

Internal preparation will shorten negotiations tremendously, says Vivek Asija, CIO at McGuire Real Estate in San Francisco. "The functional scope of the work and its value relating to dollars is the main arguing point between the customer and the provider," he says. Asija's outsourcing experience includes a contract with Mumbai, India-based Tata Consultancy Services Ltd. (TCS) to design, develop and implement new enterprise-wide software for McGuire.

Also part of planning for offshoring outsourcing is determining the duration of the contract. There's no one contract length that's optimal for everyone, our sources say. For one thing, length of contract depends on what the company is outsourcing. In software development, Asija says, timelines vary greatly, and companies may have in-house developers who can update or maintain an application once it has been developed. In infrastructure management, however, longer contracts of two to five years are common.

Besides defining functions to be outsourced, CIOs must define and financially valuate measurable deliverables.

"The vendor will say, 'If we hit these measurables, you will pay us this much,'" Asija says. "If you don't know the monetary value to your company of having those service levels met, then how can you determine if the pricing is a good value?"

Beyond basic service-level agreements, good contracts include detailed requirements for security, financial responsibilities for mishaps, communication and even employee turnover.

Security

Get granular with security details, Asija advises. For example, some CIOs require that only workers with clearance for their project/systems will be allowed access; that no one from other departments of the outsourcing companies can get in physically or electronically. It's common to require clean rooms, so that employees with access can not bring pens or Universal Serial Bus keys to copy data off computers.

Security and service-level agreements should also cover the vendor's staffing. Loss of intellectual property and security information and service slowdowns can result from turnover. Include provisions in contracts addressing what happens when key members of the team depart, Asija advises

A good contract also spells out who's financially responsible for the risks involved in offshore outsourcing, whether those risks come from turnover, acts of God, war, hackers and so on. A good indicator of the quality and reliability of service is how much financial responsibility a supplier will contractually accept, Blount says.

Communication

Without open and real-time lines of communication, offshore outsourcing is incredibly risky.

Contracts should require regular face-to-face meetings with a vendor at the client's headquarters. Besides regularly scheduled e-mail reports, Lane also suggests requiring daily telephone meeting and video conferences at given intervals.

Real-time documentation is a must for Asija. "If I cut off the relationship, I must have captured the knowledge," he says.

Regarding time differences, be sure to include contractual provisions about scheduling and coordination of communications, particularly during holiday and vacation periods. In many cases, Lane says, time differences pose productivity advantages, as it's like having a team working a second shift.

Failures and exit clauses

When the going gets tough in offshoring relationships, tough failure provisions in contracts can save relationships and money.

Even a carefully crafted contract will not prevent disputes. So create a dispute resolution process that works for both the supplier and client. "Otherwise, you end up with a very negative relationship," Blount says.

Exit clauses are a top priority. Many people focus on gaining pricing advantages by committing to long-term contracts of five to 10 years. Yet, Lane says, "the length of the contract is not as important as the exit clause." Always include provisions enabling your company to exit the contract at any time by providing 60- or 90-days notice.

Agree on penalties for vendors' failures. "Generally, stipulate that failure to deliver on deliverables and on time will put a penalty against the amount of money paid," Asija says.

Being sure that your company is financially protected from failures is the best price negotiation you can do, our sources say. "Then offshore vendors won't fail, because they want to get paid their full price," Asija says.

Maxine Kincora is a technology writer in Berkeley, Calif. She can be reached at mckincora@msn.com.

This was first published in April 2006

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