How will your deal weather a downturn?

What will happen to outsourcing if budgets are trimmed and belts tightened? A careful look at key aspects of existing contracts would not go amiss, suggests lawyer Margaret Harvey.

Economic forecasts by consultancy Capital Economics suggest the UK is set for a worse downturn than the US. Whatever the merit of that prediction, there is little doubt the UK is entering a period of economic uncertainty.

So businesses are battening down the hatches and examining processes to see where they can cut spending to protect margins. Outsourcing will be under particular scrutiny.

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The consensus is outsourcing will not be affected by the downturn, because more executives will use it to reduce costs. A recent Gartner report showed cost is still the primary reason for outsourcing.

Yet if a serious recession hits, companies might scale back outsourcing. If a company's market share is hit, their need for outsourced services may be reduced. In this situation, some companies might opt to bring services back in-house.

Outsourcing has changed significantly over the past few years and so have contracts. Gone are the megalithic outsourcing deals where organisations used one supplier for the whole range of IT and business services.

End-user organisations now know not to outsource problems and realise they need to retain significant control in-house. They often now use multiple suppliers to fulfil different aspects of the outsourcing.

The credit crunch means a greater focus on cost. Organisations will be assessing how to get the most from suppliers. So how can organisations ensure they contract properly for outsourcing in these tighter economic times?

Don't rush

If organisations are panicked by an impending recession, they might rush into an outsourcing contract for a quick-fix solution.

In their eagerness, they might spend less time on due diligence for example. But the preparatory stages of outsourcing are crucial in structuring the right contract.

Once the contract has been signed, organisations need to keep it front of mind. Constant referral is vital to understand the outsourcing objectives and how the contract can help to achieve them, as well as the applicable contractual duties and the contractual standards. The contract is a roadmap and following it will help outsourcing deals be more successful.

Liability caps

The current economic climate increases the importance of contractual issues such as liability caps. The liability cap is a safeguard in all outsourcing contracts to guarantee the end user compensation if the supplier doesn't deliver.

Liability caps are often contentious - take the ongoing EDS and Sky case as an example. But if the supplier and the end user approach the issue cautiously, the supplier will be less inclined to promise more than it can deliver and will be able to manage its client's expectations more carefully.

When resources are tight, it is important that end-user organisations have a clear and realistic view on what can or can't be achieved.

Scope creep

Suppliers and customers often cite 'scope creep' as one of their biggest problems in an outsourcing arrangement - this arises when one party asserts that the parameters of the project have changed once the outsourcing is already underway.

Customers can get annoyed when suppliers fail to respond to changing requirements. But these changes may not be within the scope of the original contract.

If a contract is particularly focused on cost reduction, the supplier's obligations will be structured within tight parameters. It is important the supplier and the end user know what these are. If changes then need to be negotiated, the contract has to be flexible enough to cope with this.

Exit strategies

Exits are particularly important in the current economic climate. Organisations must have the technical and legal means to recover outsourced services from a service provider, either to take them back in-house or to pass them to an alternative provider.

The need to retake control of the services could arise on an early contract termination or on the expiry of the original term of the outsourcing contract. In either case, the contract must specify how the services and the underlying assets will be transferred from the service provider to its successor or the customer.

It will be interesting to see how outsourcing arrangements pan out under an economic slow-down. The focus will now swing firmly back to costs and whether organisations are formalising new outsourcing contracts, or renegotiating existing ones, they need to bear this in mind.

Whatever the economic outcome - whether it's belt-tightening or a full-blown recession - organisations need to have a contract that prepares them for any eventuality.

Margaret Harvey is a partner in the technology and outsourcing group at law firm Addleshaw Goddard.