Outsourcing Transactions

Companies considering entering into an outsourcing agreement will be confronted with a host of complex issues typical for these types of arrangements. Some of these issues will include defining the products and services that the vendor will provide and the service levels upon which they will be provided, limiting your company’s and the vendor’s liability, complying with regulatory requirements (including Sarbanes-Oxley and privacy requirements), and ensuring an orderly transition to a new vendor (or to your company) on termination of the arrangement.

Lord, Bissell & Brook LLP can provide insights into various alternatives to address these issues based on our experience in numerous outsourcing agreements.

Outsourcing Basics

What is Outsourcing?

Outsourcing occurs when a company engages one or more vendors to provide to the company services that the company once provided to itself. For example, in the financial services sector, outsourcing occurs when an insurance company pays a vendor to perform various aspects of the insurance company’s back office administrative processes (e.g., receiving and processing applications, underwriting in accordance with rules provided by the insurance company, performing billing and collections functions or operating call centers).

Types of Outsourcing

There are essentially two broad categories of outsourcing:

Business Process Outsourcing (BPO). In BPO outsourcing, the vendor performs for the company business processes or administrative functions that the company once performed for itself. These processes may include billing and collection, payroll or benefit plan administration, claims processing, and inventory management. In regulated industries such as the financial services and insurance industries, the outsourced business processes may be regulated processes, such as processing applications for insurance.
Information Technology Outsourcing (ITO). In ITO outsourcing, the vendor provides to the company services relating to some or all information technology functions, such as operating and maintaining computer hardware, executing software, managing networks, hosting application systems or developing and maintaining software. Like BPO transactions, ITO transactions often have regulatory aspects, such as privacy issues. (For more detailed information on IT Transactions, please refer to the Business Technology Group practice, “IT Transactions.”)

Benefits of Outsourcing

Companies can obtain numerous benefits by entering into outsourcing relationships. The number and magnitude of those benefits can be increased if the outsourcing agreement is well structured and reflects the knowledge of attorneys and consultants who have experience with other outsourcing relationships. Some of the potential benefits are as follows:

Prompt access to new technologies. Companies can more easily stay current with technology trends at lower costs by taking advantage of the vendor’s technological expertise and ability to leverage scale.
Scalability. Companies can more quickly: increase or decrease processing capacity in response to business developments by using processing capacity provided by the vendor.
Access to better technology expertise. Companies can shift responsibility for managing technology to a vendor whose core competency is technology management.
Variable cost structure. Companies can convert their fixed costs to variable costs and avoid paying for resources that the company does not actually use.
Lower labor costs. Companies can reduce labor costs by having work done offshore.

Risks of Outsourcing

Balanced against the benefits are risks inherent in poorly structured outsourcing agreements. These risks can include:

Limited vendor accountability. Limits on the vendor’s liability and other contractual terms can decrease the vendor’s accountability for its breaches and expose the company to losses for which the vendor is not financially responsible.
Loss of control. By transferring control of processes and IT functions to the vendor, the company may lose the ability to mandate or influence the manner in which those processes and IT functions are performed or provided and the manner in which corrective actions are implemented.
Loss of negotiating leverage. Unless the outsourcing agreement is well structured and unambiguous about the responsibilities of the company and the vendor, the company may lose significant bargaining leverage after entering into the outsourcing agreement because the company’s obligations to pay are usually clear, but the scope of the vendor’s obligations can be uncertain.
Loss of ability to change vendors. After the vendor has performed business processes or IT functions for a company for a material period of time, bringing the processing and functions back in-house or transferring the processing and functions to another vendor at the end of the relationship can be difficult unless the outsourcing agreement protects the customer’s ability to implement such a transfer.

Companies that have outsourced successfully have found ways to assess and mitigate these and other risks of outsourcing. One of the most powerful tools that companies can use to mitigate these risks is to use an outsourcing agreement that reflects the knowledge base of attorneys and consultants who have experience with other outsourcing relationships.