Legal Eye: Five steps to reduce outsourcing risk

Outsourcing relationships carry some inherent uncertainty but there are ways to minimise any potential damage to your business. Lawyer Kit Burden offers some advice.

This month's launch of the 2009 Black Book of Outsourcing: The Year of Outsourcing Dangerously by Douglas Brown and Scott Wilson has sparked much talk about the risks involved in outsourcing to offshore locations.

The report ranks locations based on potential offshore threats, such as civil unrest, but the impact the rankings will actually have on firms' outsourcing decisions is questionable.

In reality, there are very few instances of political or social upheaval having any impact on offshoring or outsourcing. One should also remember that major events are not isolated to offshore locations. The terrorist attacks on New York in September 2001 are an apt example of what can happen in an area perceived as a relatively 'risk-free' location.

While the threats identified by the report serve as a salutary reminder of what companies should consider before outsourcing their services, the sourcing decision itself has to be driven by fact, rather than pure perception.

With this is mind, the overarching truth is that the cost pressures for businesses, especially during the current economic downturn, are simply too acute to justify foregoing the cost advantages on offer. So long as the destinations in view pass muster at a basic level - as is the case with India -they will not be considered too risky and the outsourcing market will continue to develop. It would take a genuinely significant risk issue with a particular jurisdiction to overturn this.

To a certain extent, near-shore locations could end up looking more attractive in the reduction of perceived risk - but they will never offer the same level of cost advantages as offshore countries.

Of course, the smart approach is for companies to develop detailed due diligence and risk assessments on the ground. This will help reduce the potential risks of a particular location. Firms that solely rely on terms in outsourcing agreements and fail to adequately check that the actual situation of the location is reflected in the agreement, put themselves at an immediate disadvantage.

The contract between the two offshore business parties also needs to be specific and flexible to reduce the contractual threats, and it is imperative to maintain a high level of communication at all stages of the process.

So here are our five steps to reduce outsourcing risk:

1. Be realistic Remember that what the business wants, at the end of the day, is a service that works, at a price that is affordable. Setting unrealistic expectations or seeking to transfer too much risk and liability to the supplier ultimately increases the chance that they will fall short, and usually adds an element of contingency/risk premium to their pricing.

2. Do your due diligence Remember that this has both an inward and outward element. Companies need to fully assess the capabilities of the proposed suppliers, but at the same time confirm there is nothing within their own organisation which would act as a bar or a significant detriment to the proposed outsourcing programme.

3. Get the governance structure right A good, well-managed relationship can make a success of outsourcing, even if the underlying contract terms are poorly drafted or commercially unbalanced. A well structured contract can contribute to this by helping to set out clear, well organised governance and reporting provisions.

4. Try to anticipate change Change is a certainty in outsourcing relationships. In order to try to reduce the risk of potential disagreements and conflicts between the parties in this regard, ensure the contract sets down clear procedures for dealing with change - preferably in such a way as to make the consequences automatic rather than a matter for further negotiation.

5. Trust is transient At the end of the day, if things do go wrong, then any trust developed between the people involved in the original negotiations will likely be of little value in resolving the problems. At this point, there can be no substitute for comprehensive, well drafted contract terms.

Kit Burden is head of the technology, sourcing and commercial group at law firm DLA Piper.