What to look for in an outsourcing contract

Are you OK with your SLA? When it comes to outsourcing, there aren't many rockier foundations than a badly drawn up contract. Ben King speaks to a couple of experts about getting them right…

An outsourcing deal is meant to simplify your IT. You bundle up your systems, give them to someone else and sit back (or 'focus on your core competences', as management gurus would put it) while someone else puts in the long hours in the server room on your behalf.

Of course, it's not like that. Outsourcing is complex and can easily go wrong. It could be the most crucial deal your company signs in a decade – so it pays to make sure it is done properly.

"You're effectively transferring part of your company to different ownership, so it's every bit as complex as a divestment or spin-out," says Stuart Payne, director at outsourcing specialists Morgan Chambers. "In fact it's more complex, as you are still expecting to receive vital business services from the part of the business that you're placing in someone else's hands."

It's something that a frightening number of companies have got wrong and are continuing to get wrong. Analyst house Gartner warns that 50 per cent of all outsourced IT projects will fail in 2003, largely due to poor communication between external service providers and their clients. And the key to avoiding becoming a part of that particular ugly statistic lies to a large extent with drawing up the right contract before starting.

The first thing to straighten up is price. User organisations generally choose outsourcing to save money. Tread carefully here. Be tough but don't aim to nail your supplier to the floor. You'll only be getting what you pay for.

"If either party feels they're not getting a good deal, then the contract will suffer," says Morgan Chambers' Payne. "You're ultimately looking to save money by outsourcing but if the supplier isn't making money on the deal they won't have an incentive to keep it running."

In fact, says Duncan Aitchison, until recently head of global outsourcing with Cap Gemini Ernst & Young and now European chief of outsourcing advisory firm TPI, simple cost savings aren't necessarily the main reason for outsourcing. "It's often more about control and visibility of cost – or the flexibility to scale up or down."

Once the price is right, an outsourcing contract should specify exactly who has responsibility for what. This also means reliable procedures for resolving the disputes and disagreements that will occur.

The people in the company who will be responsible for making the deal work need to have continued input into the deal as it comes together. However smart the management team is, they won't be able to get a handle on the day-to-day details of the transaction, and that's where the deal will stand or fall.

Aitchison says: "The deals that are done by the executive handshake alone tend to be poorly defined. You have to understand what you want, define what you want and then get the market to give it to you."

Service level agreements (SLAs) referring to business goals rather than arbitrary technical metrics should be specified – but they should be enforced more by incentives and bonuses than penalties.

It might be simpler to penalise an outsourced provider every time they slip below the specified threshold for the uptime of an application - and it would certainly give them an incentive to keep that application online - but it's better to make them concentrate on delivering those benefits that the project is meant to deliver. That could translate to cutting the cost of a helpdesk operation or improved efficiency, for example.

Though penalties have their place, a contract that hits a supplier with crippling fines when things start to go wrong isn't going to improve the working relationship. Bonuses tend to be much more motivating.

"There's no such thing as a win-lose outsourcing deal," says Morgan Chambers' Payne. "It has to be win-win or there's no win for anyone. The suppliers are in it to make money, after all – so it's better to have a deal where they share in the upside."

As with everything in life, don't jump into something you can't get out of. Like a good Hollywood marriage, an outsourcing contract should specify who gets what if the two partners decide they can no longer stand each other's company, down to the last pair of gold cufflinks.

Even if you don't end up as one of the unlucky 50 per cent of companies who suffer from an unsuccessful outsourcing deal, it's just as important to negotiate an exit strategy. Make sure you know where the 'out' door is, even though you may hope never to use it.

And even if the contract goes well, you won't be in a very strong negotiating position when you come to extend it if your supplier knows it would be messy and cripplingly expensive for you to go elsewhere.

A contract should specify in detail the terms of an exit, including compensation for jilted suppliers and a detailed specification of who gets what if the contract is terminated or not renewed.

This obviously applies to staff and staff-related costs but also to fixed assets and intellectual property as well. If you're paying someone to code applications on your behalf, make sure you own the code they produce and don't end up having to buy it off someone who wrote it on your time.

"The goal is to balance flexibility and control," adds Payne. "Build a contract that remains relevant in a fast-moving world but make sure it guarantees you the benefits that drove you to choose outsourcing in the first place."

And if you're on the verge of putting pen to paper, consider this parting piece of advice from TPI's Aitchison, who believes one of the keys to a good contract is to leave enough time to draw it up properly.

"From first assessing the problem and building the business case, to drawing up a shortlist of suppliers, to concluding the negotiations, the usual range is between 6-9 months. Some people try to do it faster but there's a lot of stuff to be sorted out. You need to leave time to deal with it properly."

For more stories and advice about outsourcing, see our special report at www.silicon.com/outsourcing.