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Recent media reports about J.P. Morgan’s pending $5 billion outsourcing deal with IBM raised an important question: Has the time come to consider again large-scale outsourcing as a strategy to reduce costs and focus on core competencies? This is actually something of a trick question because despite the reports, businesses have never stopped outsourcing. Granted, system outsourcing deals, where a company turns an entire data center over to a vendor (like the J.P. Morgan deal), are few. But other forms of outsourcing, such as handing over discrete functions (payroll, benefits and accounting), or sending application maintenance overseas to a vendor, have been driving tremendous activity lately. Yet even with all the activity and experience managers have with outsourcing, 20 percent of 700 technology professionals surveyed by InformationWeekreport that their outsourcing deals have not met their expectations. [See Gareiss, "Analyzing the Outsourcers," InformationWeek, Nov. 18, 2002 at 30.] This is a shocking statistic, especially since outsourcing strategies are often sold to senior management as a potential solution for reducing high tech costs and increasing system service levels. This should not be the case if a business has access to experienced legal counsel and focuses on some fundamental rules in negotiating and managing an outsourcing relationship. If your law firm or any of your clients are considering an outsourcing deal, following these 10 rules will offer greater potential for a successful outcome. Rule 1: Understand the landscape. Before considering outsourcing it helps to know exactly what it is. The most widely used are system outsourcing, (also called “glass house” or IT outsourcing), business process outsourcing (BPO), and application development and maintenance outsourcing (AD/M). Each has its own peculiar issues. System outsourcing means a third party assumes management of an entire data center — and a lot of control is being trusted to that vendor. BPO involves a vendor handling only certain discrete functions so the risk is limited to that particular business function. And AD/M could mean the company’s entire legacy software system is put in the hands of developers never seen and potentially thousands of miles away. Before engaging a vendor, it is critical that the business team discuss the risks and its willingness to accept them, while developing a detailed plan. Hiring an outsourcing vendor without a business plan is like driving a car without a chosen destination. Rule 2: Engage the team. Build the right team for the deal and make sure all the members are committed for the long haul. The most common mistake is for a company to begin with a technology executive, a finance executive and a project manager, with outside counsel hired weeks later — too often after the financial components are locked in and contracts are under negotiation. The ideal way is to hire an outside consultant to manage the deal. As a neutral third party, the consultant will not have inter-departmental political agendas. The second step is to engage outside counsel as soon as possible. An experienced lawyer can address a lot of important issues and questions early on. But most important is that the right executives start with — and remain engaged in — the process. Schedule regular meetings to discuss progress and decisions. Make sure senior management has already blessed the deal to prevent political battles that may erupt as a manager’s department is turned over to a vendor. Have representatives from the end-user community involved as well. They are ultimately the “customers,” and their satisfaction is critical to touting the deal’s success. Rule 3: Evaluate vendor options. The industry has no shortage of outsourcing vendors; the issue is picking the right one. That choice will be a function of the size of the deal, the functions outsourced and the goal of the business plan. Bigger does not always mean better. Some smaller vendors are stronger and more focused in some industries, which can make transition much smoother. Others may be able to offer lower hourly rates with off-shore personnel, though that may impact the quality and control of the services. One option is to solicit information from a half-dozen vendors on their service abilities. A request for information will outline what the company is trying to accomplish and how the vendor can fulfill the needs. These requests, however, open the gates to a sales feeding frenzy, and drafting a request is often a lengthy process. Using a consultant or outside counsel for drafting one can be an effective way to anonymously begin the evaluation process. Rule 4: Never “sole source” a deal. Sole sourcing means going to a single, large vendor for a proposal and then never looking at the competition. A vendor that starts in a sole-source situation will put tremendous pressure on a customer to close the deal quickly. Resist the urge to make a fast deal on the basis of price. Tantamount to success is getting the right vendor with the right skills. When a vendor relationship fails, executives never ask whether the price was right. Start with no more than six proposals and then negotiate actively with two vendors on scope and price. Be up front and let each vendor know (a) it is a two-horse race (disclosing the competitor is optional but chances are the vendors will find out) and (b) the final decision will be made by a certain date. Rule 5: Scope, scope, scope. Once the two vendors have been chosen, the company team should document the scope of the transaction. The scope encompasses exactly what functions, technology, services and people the vendor will take over. This is where contributions from operations, technology and the user community is critical. Those groups must document all the activities, reports, cross-function communication and service levels they perform and anticipate receiving from the vendor. Rule 6: Don’t talk price too early. During the dealmaking, it is not unusual for a vendor to provide a range for the cost of the outsourcing engagement. But neither the vendor nor the customer should treat the price as fixed until each has a full understanding of the scope of the deal. To fix the price any sooner will set false expectations and lead to disappointment. In fact, the best vendors will resist giving a price for as long as possible to ensure proper due diligence of the cost infrastructure the vendor will have to bear. The vendor may ask early on what the proposed “budget” for the engagement is, much like a car salesman asking how much a customer is willing to pay per month. The price can then be adjusted to fit the budget. And the company should have a budget, having analyzed what it costs to perform the functions under consideration for outsourcing. However, the budget and internal costs should be kept within the company. Rule 7: Document the deal. Many businesses view the phase where contracts are exchanged as the beginning of the “contract negotiations” — or simply lawyers dealing with the legal issues. This is a gross misconception. In reality, there is no difference between “legal” issues and “business” issues. A contract is evidence of the deal the parties struck and the lawyers’ role is to put that deal into clear language that future business people (and potentially a judge and jury) will understand. Often, it is only when the parties try to put into words what they have agreed to that they discover how many issues remain unresolved. Rule 8: Execute a transition plan. Moving the outsourced responsibilities from the company to the vendor, particularly in system outsourcing, is tricky. At some point the company will “cut over” from its technology environment to the vendor’s systems. This will require careful planning, with contingencies built in for failure, and close management of the vendor to ensure success. The first evidence of the vendor’s ability to perform will be how well it takes ownership of the business functions in transition. A failure on the vendor’s part will also be viewed by management as a failure by the project manager, whether that is valid or not. The project manager must, therefore, discuss the plan’s execution in detail with the vendor and find out about any contingencies in the vendor’s ability to perform and alert the user community and executive management that there is a chance of a problem arising. Stage the cutover with a testing period and then production during a period of low-demand, such as a weekend. Rule 9: Measure success. After a vendor has been handling the workload for an agreed-to period, the company should measure how the vendor’s performance is tracking against the goals. If the vendor is performing well, the vendor and management should both be told and complimented. If the vendor is not meeting the goals, the company should not hesitate to exercise its rights to penalties and remedies for failure to meet performance standards. The most successful outsourcing deals are ones that are closely managed, kept on schedule and enforced according to their terms. The parties are free to waive penalties if the circumstances warrant, but the company must be careful not to let its generosity seem like a lack of concern for the success of the deal. Rule 10: Prepare for the job’s end. All good deals must come to an end; the issue is whether the relationship ends according to plan or because of a change in plans. The company must negotiate for terms that not only outline what will happen at the agreed-to expiration date for the agreement, but also for an early termination. For expiration after a period of years, assuming the company does not want to renew (which it should have the option to do), the company will need contractual commitments from the vendor to transfer all the operations, data, people and technology back to the company or to a new vendor. Transition services clauses typically call for a period during which the vendor will continue to provide services on a month-to-month basis at the current prices until the company has those services running elsewhere. The vendor should also have committed to keeping the data and files in an open format (as opposed to a vendor proprietary system) that is easy to move to another database application. In addition to its remedies for breach, the company should always have the right to terminate an agreement for the company’s convenience. Ideally, this will occur without cost, but the vendor may have some investments or expenses it will need to recover before termination. Be careful of large termination penalties. Costs for early termination should be outlined in advance and subject to audit. John Dieffenbach is a senior associate in the technology, intellectual property and outsourcing group at Kaye Scholer (www.kayescholer.com), where he focuses on outsourcing, system integration and licensing transactions and litigation.

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