In the current world order where national boundaries are blurring, real-time connectivity across borders is a reality and reducing costs is a necessity for survival, businesses have outsourced various functions typically serviced internally, engaging external third-party providers to cut costs, meet demand, improve quality and provide customers with enhanced service offerings.
IT outsourcing probably began with skill-specific jobs related to software development and gradually developed into a spectrum of diverse services from low-end data entry and back-office support to high-end development and research including legacy applications maintenance, applications development, Enterprise Resource Planning (ERP) support, financial and legal services (research and documentation). Also, services like data warehousing and embedded software development are being outsourced.
Not only has there been an increase in outsourcing in general, but also outsourcing to offshore countries such as India, which offers cheaper labour costs as well as a skilled workforce.
Once the decision to outsource has been made, it is critical that the customer seeking to avail itself of offshore services, considers and adopts the correct contract for the project.
Typically the three different routes commonly adopted to structure an outsourcing venture are by way of establishing: (1) a captive entity, namely setting up a wholly owned subsidiary; (2) entering into a joint venture with a third-party; or (3) contracting with a third-party supplier. The decision to opt for a particular structure must be based on a careful consideration of the operational risk and regulatory compliance involved, the tax liabilities and indeed local grants and financial incentives the entity will attract, as well as related issues such as cost, commitment, efficiency of output and control of administrative and management responsibilities. Several other parameters such as customer control and confidence, liability, flexibility, speed, local knowledge and the culture of the organisations involved also have a bearing on the ultimate structure adopted.
This contract and its counterpart (Contract 41) deal with the contractual arrangements in outsourcing to an independent third-party (option 3 above).
Third-party supplier outsourcing contracts
Multinational giants such as Microsoft, Cisco Systems, Nortel Networks, Lucent Technologies, Apple Computer, McCain Foods and Monsanto all outsource various elements of their businesses and all have more than one outsourcing partner.
A typical third-party outsource provider/contractor could either be based onshore or offshore, although offshore has become more popular since one of the main reasons for outsourcing is cost related and offshore locations such as India have lower labour costs than the EU, US, Australia or Japan—to use as an example the jurisdictions covered by this book.
In any third-party contractual structure, the outsourcing client contracts with an external service provider to carry out a specific set of business processes. Unlike creating a wholly owned subsidiary or joint venture for performance of the outsource work (specified in options 1 and 2 above), there is no investment or equity/capital participation by the outsourcing client in the business run by the external service provider.
In outsourcing transactions, careful consideration must also be given to the actual parties to the contract. Requisite due diligence must be undertaken to ensure that the contracting party is indeed capable of carrying out the obligations of the outsourcing arrangement and have sufficient assets in case enforcement proceedings against the company are necessitated owing to non-performance.
A third-party contracting arrangement is quicker to execute and takes minimal lead time. The contractor/service provider generally has pre-existing infrastructure and personnel, which can be engaged upon completion of a due diligence exercise and execution of formal agreements. The lead time in operating through this means is also short as there are no formalities, such as setting up a subsidiary or incorporation of a separate company required for commencing the operations as well as cutting down set up costs.
In addition, the outsourcing client is saving the time and expense associated with scaling up the services or making alterations to cater for the changing requirements of the company.
Issues for consideration
The outsourcing client in a third-party arrangement cannot exercise supervisory control on either the employees or the management of the provider/contractor; hence it is often difficult to enforce and obtain best practices which are followed by the client’s own company. Besides, where proprietary technology, confidential information and processing of a company’s trade secrets are involved, outsourcing to an independent service provider/contractor may have its risks, so strict provisions relating to confidentiality and non-disclosure are essential.
This contract is drafted for the benefit of the outsourcing client/customer.