26Th Annual Institution on Computer & Internet Law

From PLI’s Course Handbook

Information Technology Law Institute 2008: New Directions: Social Networks, Blogs, Privacy, Mash-Ups, Virtual Worlds and Open Source

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outsourcing challenges: crisis management and avoidance

Kenneth A. Adler

Thelen Reid Brown Raysman & Steiner LLP

NY #1226964 v1

Biographical Information

Program Title: Information Technology Law Institute 2008

Name: Kenneth A. Adler

Position or Title: Partner, Chair of Outsourcing Group

Firm or Place of Business: Thelen Reid Brown Raysman &
Steiner LLP

Address: 875 Third Avenue, New York, NY 10022

Phone: (212) 603-2410

Fax: (212) 603-2001

E-Mail:

Primary Areas of Practice: Outsourcing, Technology, Media& Communications, Intellectual Property, Privacy and Data Security

Law School: The George Washington University Law
School,1986

Work History:

Mr. Adler is a partner of Thelen and Chair of the Outsourcing Group, where he practices out of the New York office, specializing in outsourcing and technology transactions, strategy and dispute resolution/remediation.

Speaking Engagements

Mr. Adler is a frequent speaker on outsourcing issues, including at significant industry conferences provided by The Outsourcing Institute, Sourcing Interests Group and the Gartner Outsourcing Summit.

Table of Contents

Outsourcing Challenges:......

Crisis Management and Avoidance......

Introduction......

Why Outsourcing Relationships Fail......

Resolution Strategy......

Expert Assistance and Assessment......

Carefully Review the Agreement......

Prepare a Detailed Outline......

Creating a Corrective Plan......

Revisiting the Payment Schedule......

Avoiding Extreme Measures......

Other Alternatives......

Change Management......

Conclusion......

Outsourcing Challenges:

Crisis Management and Avoidance

Kenneth A. Adler

Introduction

With many information technology outsourcing relationships maturing, having reached the end of a long-term arrangement with fees paid reaching tens of millions of dollars, customers and suppliers face a difficult road in the event their relationship goes awry. The bottom line question for both parties: How to navigate through the problems, realign the interests of the parties and realize value from the relationship.

Companies enter into outsourcing arrangements for a variety of reasons, including cost-savings, operational efficiency, and perhaps most importantly, to better focus on the core objectives of their businesses. From a business point of view, once the outsourcing agreement is signed, the two companies become intertwined. But as the relationship evolves, turnover in operations and management can occur over time and a detachment in relations may develop where the supplier finds it more difficult to keep the customer happy and the customer may feel that the subtleties of its business culture or environment are being ignored. Additionally, a long-term outsourcing agreement may not be equipped to deal with changes in circumstances, such as mergers, expansion or divestitures. In the end, mismatched expectations are perhaps the biggest cause of the negative spiral that sometimes ends in an outsourcing relationship failure.

Why Outsourcing Relationships Fail

There are a number of reasons why an outsourcing relationship may fail, some forces external to the parties, others caused by the parties themselves. An assessment of common factors in failed relationships can assist to avoid them in the first place, and how to navigate their occurrence.

The significant recent changes in the economy means that nearly any entity can be the target of an acquisition or divestiture. Regardless of the health of an outsourcing relationship, a new parent entity may elect to bring certain functions back in-house, add services to its own pre-existing outsourcing relationship, or realize efficiencies by engaging one of its other subsidiaries instead of an outsourcer. Careful review of the underlying outsourcing agreement is necessary to determine whether the new parent is entitled to assign the contract or have it apply to affiliates, as well as the circumstances under which it can terminate. At the initial negotiation phase, many customers may elect to forgo more favorable pricing that comes with a long-term contract in favor of more flexibility with a shorter contract term.

Another external cause of a failed outsourcing relationship is a change in personnel. Departure of a project leader from either the customer or supplier side can mean the loss of the driving force accounting for success. These departures may occur due to normal attrition, or the redistribution of staff. Once an outsourcing relationship is underway, the parties may be inclined to promote top performers or shift their key staff to new projects/new clients that require attention. The loss of key players may turn a project with great potential into a neglected drain on resources. A way to curb the negative effects of inevitable departures is to properly staff the arrangement such that key personnel can do on-the-job training of their potential replacements. Consistent, reliable communication will help seasoned professionals bring new staff up to speed. The parties can also try to protect against this risk contractually by requiring key individuals to remain staffed on the project for an agreed upon period of time.

Changes in the technology landscape can also impair an outsourcing relationship. A customer, locked in to a long-term supplier contract, may never manage to get ahead of the curve of technological advancements. If parties are not satisfied with the technology infrastructure, or disagree about the path to follow regarding innovations, the parties will drift. To address significant IT innovations, the parties must remain in sync on how to make adjustments to the arrangement if they are to maintain a productive relationship.

Internal forces can also significantly affect outsourcing relationships. Over the course of a long contract term, the nature of the customer’s business may change. The efficiencies that initially brought the customer to the negotiating table may no longer be present if their core business or focus has changed and the outsourcing relationship has not been realigned. The corporate cultures of the parties may clash. Customer and supplier may even have created a relationship doomed from the start if based on faulty assumptions or misaligned goals. For example, if a shift occurs in the customer’s business, or across all users in the customer’s industry, which requires different technology, staffing or solutions, the assumptions underlying the benefits of the outsourcing arrangement may no longer hold true.

An obvious but common basis for failed outsourcing is a failure of attention by the parties. A customer may have its eyes on the horizon of its own business marketing and development, and may not maintain interest in the outsourcing project once in motion. Some customers lack discipline with respect to project management or time sensitivity of required tasks. The customer’s executive management may be distant, creating a communication and knowledge gap between the decision makers and the staff that interacts with the outsourcer. On the supplier side, there may be a failure to properly invest company personnel or resources in a customer’s project. A supplier may also be focusing on the next deal, moving staff and resources away from established outsourcing arrangements.

Regardless of how the parties get there, a failing outsourcing relationship bears tell-tale signs. Service performance, service level or savings objectives are missed. Communication or responsiveness declines. Customer satisfaction falls. Unresolved disputes or technology failures accumulate. At some point, the writing is on the wall -- the outsourcing transaction is failing.

Resolution Strategy

When faced with the undeniable reality that trouble is brewing, both parties should take prompt action to maintain a positive working relationship instead of immediately running to court or considering termination of the agreement. This will require efforts and compromises on behalf of both parties. Most suppliers and customers, if approached, will respond to genuine complaints, but parties will be best served by following the Three P’s: preparation, planning, and patience.

Expert Assistance and Assessment

The “Preparation” step requires parties to assess the status of the service and performance, as well as the outsourcing relationship itself. First, key management personnel who will be involved in negotiations should seek expert assistance (e.g., in-house IT staff or independent technical consultants) to clarify current system and service problems and applicable industry standards. Next, management should analyze the problem and define the issues. Sometimes, management will not grasp the extent of the problem until complaints have been documented. Only after an internal evaluation, which consists of consultation with IT staff and information gathering from departmental meetings, can management discern significant issues. For instance, sometimes the frustration over a failing system or service can be isolated to fixable problems; other times, a closer look will reveal multiple failures that require more significant remediation.

Carefully Review the Agreement

After prioritizing the issues, the dissatisfied customer or supplier should study the outsourcing agreement. In many instances, the parties may not have been looked at the agreement terms since the contract began. This review will help determine whether the current complaints and issues are addressed or fall within the scope of the agreement. Once a party’s needs are defined, senior management can meet with IT advisers and legal counsel to gain a clear understanding of the issues (both technical and contractual) and formulate a solid negotiating stance about how the failing relationship and services can be salvaged.

A well-drafted outsourcing contract should include a dispute escalation process as part of its governance procedures to ensure that neither party will press the termination button before there has been an opportunity for both sides to sit down and rationally discuss the situation. If the dispute must be escalated from the operational level to the management level, it is also likely to rise above any tensions that understandably arise between the operational teams on both sides.

Prepare a Detailed Outline

At this point, key management executives, along with IT experts and legal counsel, should draft a detailed demand, outlining the current complaints and specific IT issues and present a proposal for corrective action. The demand should describe not only the current problems, but reference any performance promises or corrective action assurances made by the other side during the course of the relationship. This demand serves several purposes. It puts the supplier or customer, as the case may be, on notice about the current limitations of the supplier’s solution or troubles in the outsourcing relationship. The demand also demonstrates seriousness and professionalism, since the sender has clearly spent considerable time evaluating the problems and proposing solutions, and now desires prompt attention of the other side and remediation of the issues. Further, a detailed demand indicates a desire to move forward to a resolution, sending a much different message than a terse letter from counsel claiming the other party has breached the agreement.

The more time put into defining the issues and preparing a well-reasoned demand, the easier it will be to engage the other party. Instead of a haphazard approach, often reduced to unproductive back-and-forth arguments and finger pointing, a structured negotiating approach generally leads to productive communication that works toward amicable resolution.

Creating a Corrective Plan

The “Planning” stage provides a party the opportunity to propose targeted solutions developed from the preparation they have done. One effective tool that the parties may use to resolve their dispute is a “corrective plan.” Basically, a corrective plan is a written agreement that is tailored toward the specific items identified in the demand document. The plan lays out a course of action that the parties need to take, generally over the near-term (e.g., 30-90 days), to resolve the outstanding problems. For mutual trust and comfort, often the plan will contain explicit language that there is no admission of wrongdoing on either side.

Depending on various factors, such as the nature and severity of the dispute or the length of the remaining contract term, the plan can be a modification to the original agreement, a restated agreement, or an entirely separate document. For example, if the original contract is not due to expire for several years, the parties may wish to use the corrective plan to modify the existing agreement. If, however, the original contract is due to expire within a year or two, the parties may prefer the corrective plan to be a free-standing document, allowing the original agreement to expire and, at its expiration, decide whether to continue the relationship. There is no required form for a corrective plan, but the plan should be the result of mutual discussion and agreement on the actions of the parties and/or modifications to the outsourcing agreement that will bring about change to correct the failures in the relationship.

Revisiting the Payment Schedule

On the financial side, the parties may renegotiate the payment schedule of the original agreement, providing for reduced, increased or the same payments for services. Further, the plan may provide for performance milestones for the supplier, to which payments due or additional payments should be tied. The parties may also elect an alternative payment structure to better align the objectives of the parties.

Avoiding Extreme Measures

“Patience” can truly assist to move a troubled outsourcing relationship in the right direction. A corrective plan is far more productive than one party unilaterally taking extreme measures to try to force the other side to the bargaining table. If, for example, a dissatisfied customer suddenly stops paying the supplier, this could result in unwanted and perhaps even devastating consequences for both parties. First, if dealing with a small to medium-sized suppliers, if a single large customer stops paying, the supplier’s financial health could be jeopardized. Second, without timely payments (or partial payments), even during a service crisis, the supplier has little incentive to work towards resolving outstanding problems. Finally, the underlying agreement may have terms that specifically address payment obligations during the course of a dispute between the parties. While many customers believe they will force a resolution by withholding funds, in the end, extreme measures may backfire, particularly when a supplier can no longer pay its employees and the customer is left without any trained personnel to perform “business critical” services. The same situation also may result if the supplier is dissatisfied with the customer’s behavior and reduces the level and quality of service. Regardless of who is at fault, extreme actions should be avoided, given the potential for the harmful business and financial implications they can have on the parties.

The re-negotiation of an outsourcing relationship is an opportunity to truly align the objectives of the parties in a manner that had previously been absent, or to address changed circumstances from when the agreement was originally agreed upon. With this second chance, it may make sense to involve the services of relationship management consultants or experienced counsel, especially on unwieldy or complex engagements. The parties should encourage free and open discussions with all cards on the table. This may be facilitated with off the record conversations. These re-negotiations, if successful, can translate to a customer agreeing to trade claimed damages for the supplier’s refocused or modified services. The process may involve a re-scoping of the engagement (including both the supplier’s and customer’s responsibilities and obligations), a re-pricing of the supplier’s services and a rebound period where new client and supplier representatives seek renewed trust and team building.

Other Alternatives

If senior management cannot agree on a feasible corrective plan after serious efforts from both sides have been made, the parties may decide to terminate their business relationship. Again, the outsourcing contract needs to be consulted to determine the specific rights of the parties. Termination clauses may have different termination rights and criteria for each party. For instance, while each party may have termination rights for “cause”, the specifics of the termination right and timing of termination may differ. Additionally, many outsourcing agreements include a termination for convenience clause, which essentially is a buy-out provision that allows a party to walk away from the agreement without cause, by paying a pre-determined convenience termination payment. Different termination rights may be subject to different timetables, with more egregious conduct enabling more rapid termination. The guide for each party will be the termination clauses, hopefully drafted without ambiguity. Of course, having a termination right and enjoying such right requires careful attention to, and compliance with, the specific notice provisions of the agreement. What may appear as the ministerial task of giving notice of termination can be a bona fide basis for the other party to reject the claimed termination.