One
of the major concerns about outsourcing is that there may be “no way back” –
but it can be done, in fact, decisions to continue a contract can be reversed
early, however the right to do so can come at a high price.
Q: So what can be done to avoid high losses?
The answer is to recognize up front that everything comes to an end sometime, and to plan accordingly at the contract stage.
Q: First things first, what is recommendable?
Firstly, a long term deal should be avoided and should not be agreed to – 5 years is usually about right. Because one it can’t be told what the needs will be in the future: the organization will change, as will the outsourcer, as will the business and technology environment in which everything operates. It always costs more to exit mid-term than at the end of the term. For most deals 5 years works as it tends to take a year or so to complete the transition and ending the service, then a year or so to get into steady state, so it is not until the third year that a considered view can be taken as in how the deal is going.
Q: How long will exiting a deal in a controlled way take?
Exiting in a controlled way, especially if an organisation want to consider moving to another supplier, will take around 18 months… so 5 years works. Any longer and the company could be trapped in a deal which no longer works for it, and have to pay for the privilege of getting out.
Q: And what if there is a want to terminate before the end of an outsourcing contract?
It should be made sure that the company has a right to terminate for convenience at any time, and that you have agreed the costs of doing this in advance. Outsourcing providers will resist this strongly, arguing that both need to be committed to the deal, which, of course, is true. But the fact is that requirements change, and one may need to terminate early.
Q: What kind of rights does a supplier have in these circumstances?
If you do terminate early and you have no contractual right to do so, the outsourcing provider will be able to claim for damages, including loss of future profits. So agree in advance what you think would be fair – generally we recommend the principle that the supplier should be “made whole” (i.e., they should be able to recover reasonable trailing costs and unrecovered investments), but they should not be paid loss of future profits on work they have not delivered.
Q: What else can be done to prevent a difficult exit?
Construct a matrix setting out all of the possible circumstances in which the outsourcing contract could be terminated, and all of the possible costs which could be incurred by either party. Then clearly agree who should pay for what under what circumstances. Consider from first principles which party should bear which risks and construct the contract accordingly. For example, if you have to terminate the outsourcing contract early, should the outsourcing provider recover their pre-contract costs of sale? You might think clearly not, but many outsourcing providers seek to recover such costs.
About Author:
Prabhakar Ranjan works with Systems Plus Pvt. Ltd. He is part of the consulting team that delivers Vendor Management Office projects. He can be contacted at prabhakar.r@spluspl.com
Q: So what can be done to avoid high losses?
The answer is to recognize up front that everything comes to an end sometime, and to plan accordingly at the contract stage.
Q: First things first, what is recommendable?
Firstly, a long term deal should be avoided and should not be agreed to – 5 years is usually about right. Because one it can’t be told what the needs will be in the future: the organization will change, as will the outsourcer, as will the business and technology environment in which everything operates. It always costs more to exit mid-term than at the end of the term. For most deals 5 years works as it tends to take a year or so to complete the transition and ending the service, then a year or so to get into steady state, so it is not until the third year that a considered view can be taken as in how the deal is going.
Q: How long will exiting a deal in a controlled way take?
Exiting in a controlled way, especially if an organisation want to consider moving to another supplier, will take around 18 months… so 5 years works. Any longer and the company could be trapped in a deal which no longer works for it, and have to pay for the privilege of getting out.
Q: And what if there is a want to terminate before the end of an outsourcing contract?
It should be made sure that the company has a right to terminate for convenience at any time, and that you have agreed the costs of doing this in advance. Outsourcing providers will resist this strongly, arguing that both need to be committed to the deal, which, of course, is true. But the fact is that requirements change, and one may need to terminate early.
Q: What kind of rights does a supplier have in these circumstances?
If you do terminate early and you have no contractual right to do so, the outsourcing provider will be able to claim for damages, including loss of future profits. So agree in advance what you think would be fair – generally we recommend the principle that the supplier should be “made whole” (i.e., they should be able to recover reasonable trailing costs and unrecovered investments), but they should not be paid loss of future profits on work they have not delivered.
Q: What else can be done to prevent a difficult exit?
Construct a matrix setting out all of the possible circumstances in which the outsourcing contract could be terminated, and all of the possible costs which could be incurred by either party. Then clearly agree who should pay for what under what circumstances. Consider from first principles which party should bear which risks and construct the contract accordingly. For example, if you have to terminate the outsourcing contract early, should the outsourcing provider recover their pre-contract costs of sale? You might think clearly not, but many outsourcing providers seek to recover such costs.
About Author:
Prabhakar Ranjan works with Systems Plus Pvt. Ltd. He is part of the consulting team that delivers Vendor Management Office projects. He can be contacted at prabhakar.r@spluspl.com
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