Outsourcing: Economic thaw will expose the cracks in rushed deals

Services contracts struck hurriedly in the downturn could start unravelling next year...

In the current economic climate, cost-cutting organisations have been outsourcing in haste. But what happens to these deals when things are on the up, asks lawyer Kit Burden.

The downturn has left few industries or sectors unscathed by losses and declines in business and confidence. The outsourcing sector is no exception. Established global firms announced flat or dropping profits. Even the previously unbroken growth of the Indian service providers has hit the buffers.

But activity has picked up noticeably in recent months, with some deals being done at a pace that might previously have raised eyebrows. So what is likely to happen next?

To answer that question, we might start by looking at how an ideal outsourcing procurement process might be conducted - at least from the perspective of the negotiating team.

Flexibility and bargaining power
In such a theoretical scenario, the customer would have a desire to outsource, but not an absolute need to do so, to maintain flexibility and bargaining power. The time permitted for the process would be generous and would include contingency to avoid cutting corners and to allow time to probe potential risks arising from due diligence.

Legal, technical and commercial advisers would have been engaged early in the process to add best value before too much detail has been agreed.

Finally costs, while always an important factor, would probably not be the primary or sole driver for the project. In other words, the project might include additional advantages such as flexibility, access to improved technology, or transformational activities.

So how does this scenario match with what has happened in practice? While there are obviously notable exceptions, our experience in the market over the past 12 to 18 months can be summarised by the following observations:

  • Outsourcing projects have been approached with no plan B. Organisations have had an absolute need to outsource, rather than a strong interest in doing so.
  • Projects have been undertaken in shortened timescales and on occasion even at breakneck speed.
  • Projects have been short-staffed in internal resource and external advisers.
  • Projects have been driven overwhelmingly by a desire to remove costs from balance sheets.

In contractual terms, these characteristics have manifested themselves in different ways. Some customers have insisted on tougher or more onerous contract terms and have tried to force suppliers into making earlier concessions.

Customers have adopted this stance partially to avoid lengthy and costly negotiation processes but also because they feared the foreshortened processes will give rise to more "unknown unknowns" - to quote Donald Rumsfeld - and hence more risk. They would like to pass on this risk to the service providers.

Service providers have themselves been under pressure to win new business, and so have perhaps been more amenable to take on such contract risks, in conjunction with squeezed margins and less fulsome due diligence processes.

What happens when bad deals collapse?
What can one imagine as being the outcome of this? To adapt an old axiom, one suspects that anyone who has contracted in haste may well come to repent at leisure. Bad deals, including bad contracts, have a nasty tendency to unravel and to require, at best, renegotiation and at worst, to collapse into acrimonious dispute.

So 2011 may well be the year when the focus shifts. At the moment organisations may be renegotiating contracts to squeeze out more cost benefits and to outsource whatever isn't nailed to the ground.

But next year, the baton may pass to our legal colleagues in the litigation and dispute resolution teams. So expect to see the creation of a wave of new outsourcing-related case law.

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