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Outsourcing disputes: Is it time for a different approach?

Outsourcing disputes: Is it time for a different approach?

It is hardly surprising that issues and disputes commonly arise under IT outsourcing contracts. They are often complex, cover a wide range of services, and create a close relationship between suppliers and customers with different motivations and objectives.

In challenging times for the IT industry, it’s important for those involved in large outsourcing agreements – particularly complex multi-party deals – to ensure they understand each other’s objectives and commercial realities, not just the fine print of the contract.

Without that understanding, an outsourcing engagement can become problematic for everyone.

For the customer, the benefits of outsourcing include access to lower cost technology services, specialised capabilities, new technologies, and global practices that would be more difficult and certainly more expensive to obtain independently.

In return for those benefits, suppliers – unlikely to know with certainty what the costs will be over the contract – hope to deliver services profitably. They also hope that by implementing smarter technologies and processes, they can obtain operational efficiencies in the delivery of these services.

However, their often paper thin margins are likely to be squeezed further as the already competitive IT outsourcing market matures and other options (infrastructure as-a-service, and other cloud-based variants) become more acceptable to more organisations.

It is likely that more and more loss-making deals will be signed in the expectation either that things will improve given time, or that other, higher-margin services will be sold to the customer over the life of the engagement.

The contract negotiation is usually a difficult and prolonged process, for both parties. The proposed engagement is usually intended to be substantial and long term, and includes a large number of variables, obligations and inter-dependencies that need to be considered and documented.

The negotiation often becomes adversarial. The client invariably strives to obtain the best possible commercial and legal terms, knowing that the supplier is likely to be under considerable pressure to achieve its signing targets for the period.

Typically, the supplier is much more familiar with the technology and service delivery model than the customer; equally, the customer knows its business and processes much better than the supplier ever will. It is easy in that environment for some mistrust, battle-weariness and even outright cynicism to develop.

As a result, when the deal is eventually signed, and the parties are left with a heavily negotiated legal document that they hope will be a reliable framework for the years ahead, the relationship between the parties is likely to have deteriorated to some extent.

Against this backdrop, issues and disputes are likely to arise in every large outsourcing engagement. After all, every serious relationship has its ups and downs.

Commonly, there will be disagreement about the scope of the services provided under the contract. Significant scrutiny will be placed on the detail of the technical and financial responsibility documents contained within each Statement of Work, with contract managers and lawyers often hotly debating the meaning of now pivotal words and phrases.

In many cases, there are legitimate differences of opinion between the parties, and ones that can carry significant financial implications.

Service delivery and the contractual performance targets are often another common area for dispute. Whilst the fault for those issues can of course rest solely with the supplier, the situation will be much more difficult to untangle if the customer or one of its other vendors has done (or failed to do) something that may have contributed to the problem.

In many contracts, dissatisfied customers have the ability to take matters into their own hands by withholding payment. In most cases, those mechanisms are used to gain the supplier's attention or apply pressure in commercial discussions, but they can also be misused by customers, sometimes to devastating effect.

Disputes and engagement

Left unresolved, minor and major disputes can cause significant damage to the relationship, leading to long-term discord and discontent on both sides.

For the customer, discontent in the vendor management team can seep through to the rest of the organisation over time. It can result in a reluctance to engage the supplier for the kinds of higher margin projects that it may have come to rely upon to wring profit from the deal.

Left unchecked, it could also damage the supplier's prospects of winning an extension or longer term re-appointment at the end of the contract term.

For the supplier, disputes can dramatically reduce the profitability of the deal and may even impact the regional and global performance of its business. This is likely to have several unintended repercussions for the customer.

The supplier will undoubtedly look for ways to remove cost from its delivery of the services, perhaps at the expense of the quality and reliability of those services. In these cases, what may have started as an initiative led by the customer's vendor management team to reduce cost can soon impact the everyday user in customer's business, with negative consequences for all.

There is also an important human aspect that is often overlooked. Supplier personnel, especially those critical to the engagement, will often be remunerated according to the underlying financial performance of the account.

Strong performers are always in high demand and it may be difficult for a troubled account to hold on to them when it cannot afford to reward them for their hard work. It may also be difficult to persuade replacements of a similar calibre to join the account.

Dispute resolution

So how do organisations deal with all these variables in their outsourcing arrangements? Unfortunately, many deals do not cope well with the inevitable disagreements that will occur during the course of the engagement.

Typically, dispute resolution mechanisms in an IT outsourcing agreement do little more than require the parties to follow a convoluted series of escalation meetings before litigation (or arbitration) can be started.

Structured resolution processes like mediation, which could provide some real benefit, are rarely mandatory in outsourcing contracts and seldom used.

Litigation is often (rightly) seen as a 'nuclear option' - one that will destroy the relationship. In all but the most extreme cases, for example where termination has already occurred and disengagement has been completed, it may not be an appropriate option.

By its nature, IT litigation is distracting and expensive. It requires parties to deal with complex technical and evidential issues in a forum that is likely to be alien to them, turn over many hundreds of thousands of documents to the other side, and tie up important figures in the business for many months or even years.

Arbitration may promise a more flexible and confidential process, but is not favoured by many parties and, in any event, arbitral proceedings are likely to have the same negative impact on the relationship as court action.

Litigation of matters of this nature will also inevitably bring with it considerable uncertainty. What is certain, however, is that the litigation process itself is unlikely to be a quick or easy one.

Page 2: Stomach for the fight

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