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reduce reliance on any one provider, to maintain competitive pressure and to create ¬‚exi-
bility. This approach works particularly well for project work that can easily be reallo-
cated. It can reduce country risk if the providers are in different locations. It can also
provide a disaster-recovery alternative.
Using multiple providers also has its disadvantages. Multiple providers means double
or triple the governance, management and coordination. Use of multiple providers also
complicates determining who is responsible when defects are detected. It may also result
in less favorable contract terms and higher prices than a company might receive if it is
willing to pool all of its business with one provider.

Choosing the right partner: ¬nancial stability and location
The ¬nancial ability of an offshore provider to perform its obligations is a critical con-
sideration, particularly if you will depend on a single provider for a critical service.
You must evaluate the risks associated with a provider and consider a few questions:
Who will be the contracting party? Where are they based? Are they thinly capitalized?
Do they have substantial assets and revenues? How much risk is your company willing
to take in contracting with a provider who might not be well capitalized, or who may
not have the performance record of some of the other providers?
Where a provider is thinly capitalized, a customer may require a guarantee, letter of
credit or other type of security for performance and payments. Alternatively, the con-
tract should be structured to minimize payment and performance risks, and the pricing
should re¬‚ect the degree of risk that the customer is taking.
In addition to the ¬nancial capability of the provider, the location of the provider™s
assets and business may determine where and how you ultimately enforce your agree-
ment. The ability to enforce contract terms varies from country to country. You should
consider which party is the best partner for your company based in part on the degree
of risk that you and your company are willing to accept for the offshore project.
Consider the following scenarios:
— Onshore provider with offshore capabilities. FirstCo is based in the UK, and desires

to offshore certain software development services. FirstCo has operations in
Europe, but does not have a signi¬cant presence in India or Asia. FirstCo would like
to choose a provider that has substantial operations in India. FirstCo is concerned
about the risks of contracting directly with an Indian-based provider. FirstCo would
rather contract with an established UK service provider, SoftCo, who has offshore
capabilities. SoftCo has a well-established presence in the UK, and has suf¬cient
assets against which SoftCo may rely should things under the contract go wrong.
FirstCo will require in its contract that SoftCo will do everything necessary to
ensure that its offshore af¬liates and subcontractors will comply with the contract.
FirstCo will require that all contract disputes be handled in the UK under UK law.
123 Offshore legal issues

Offshore provider with onshore capabilities. SecondCo is a multinational company

with operations and locations around the world, and headquarters in the US.
SecondCo has manufacturing facilities in India and China, but no established
operations that would support software development services. SecondCo currently
completes software development through two major centers around the world: one
in the US, and other in Europe. SecondCo wants to relocate some of its software
development into two centers, one based in China and the other in India.
SecondCo is comfortable with contracting with providers in India and China
directly because SecondCo already operates there. SecondCo signs an agreement
with an Indian-based provider of services who has substantial operations in the
US, India, and China. The agreement is governed by US law, and most major
issues will be resolved in accordance with US law and in US courts. SecondCo
knows that if legal issues arise, it will enforce its agreement ¬rst in the US, but it
may need to resort to enforcement in India and possibly in China with the provider.
SecondCo has the resources and the contacts to take those actions, if necessary.
SecondCo is comfortable taking this increased risk. As with FirstCo, SecondCo has
performed due diligence on the provider to know that the provider has suf¬cient
assets and operations in the US, India, and China, such that SecondCo may enforce
its contract rights ¬rst in the US, but also in India or China, if necessary. SecondCo
may also consider international arbitration to resolve disputes.
— Offshore provider, a new entrant. ThirdCo is a US company that has some

international presence, but not as extensive as SecondCo. ThirdCo wants to
offshore software development services to India. ThirdCo has identi¬ed an Indian
service provider, CodeWell. CodeWell has performed well in a pilot program.
CodeWell is a subsidiary of a large manufacturing and engineering company based
in India whose primary business is construction. CodeWell is a relatively new
entrant to the IT services market, and CodeWell only accounts for about 3% of the
parent company™s combined revenues. ThirdCo is nervous about contracting with
CodeWell because CodeWell has relatively few assets. CodeWell™s parent company
is a much larger company with substantial assets. ThirdCo will require that
CodeWell™s parent give a guarantee of the ¬nancial and performance obligations of
CodeWell under the agreement. In this way, ThirdCo is assured that a larger and
more substantial company is standing behind the new entrant™s obligations.
ThirdCo will use international arbitration to enforce the guarantee. The arbitration
will occur in a neutral country, which is fair to both parties.
In addition to choosing the right party, there are contract provisions that may be use-
ful in protecting against a ¬nancially challenged provider. Make sure your contract gives
you ownership in important assets: that is, in the case of software, including source
code. Where you will not own the source code, and are using software developed
under license from the provider, you should require that the provider™s source code be
placed in escrow, and that you have a current license grant permitting you to access and
124 Managerial competency

use that code. Consider negotiating a right to terminate after a drop in the provider™s
credit rating, or after the provider suffers a material adverse event. Require the provider
to deliver regular ¬nancial statements, certi¬ed by its chief ¬nancial of¬cer.
You should structure payment terms, such that services are received, or milestones
are met before you are required to pay. You should not allow the provider to assign
your agreement to a different party without your approval. Require the provider to
carry insurance and to name you as a loss payee or additional insured. Finally, include
clear clauses that require the provider to return your con¬dential information, owned
materials, and other proprietary items at any time upon your request.
All of the clauses above together will not prevent you from suffering business disrup-
tion and loss, if your provider suffers ¬nancial trouble. But they can lessen the blow.

Key service agreement terms

Some contract terms common to outsourcing deals take on unique importance in off-
shoring. The contract terms in this section address the key risks and key disadvantages
discussed in earlier sections of this chapter regarding, contracting for offshore services.
These contract terms apply to more than a traditional offshore outsourcing agreement.
They would also apply to the end user of services in a joint venture or BOT arrange-
ment. In a joint venture or BOT situation, there is usually a service agreement that cov-
ers the details of the service that the end user requires. The service agreement is
separate from the corporate “deal” documents that establish and govern the joint ven-
ture or BOT organization. In fact, it is important for the customer to document the serv-
ices to be provided by the joint venture entity or the provider in a BOT model in the
same manner that the customer would if the customer simply hired a provider of serv-
ices without the joint venture or BOT part of the deal.

Rights to approve personnel and subcontractors
The customer should have a contractual right to approve of all key provider personnel
and contractors, and to remove them for non-performance. These rights to approve are
important for several reasons:
— The customer retains a level of control over who performs the services.

— The customer may need to approve of subcontractors for legal reasons, where

certain functions cannot be further subcontracted or moved to different countries
(e.g. an offshore provider could not further subcontract services to a country that is
subject to current embargo restriction).
— The fact that much of the work is being performed by provider personnel in distant

locations presents a unique contract and quality management challenge. The
125 Offshore legal issues

remoteness of offshore services adds to the importance of the project management
team and onsite staff, all of which need to remain subject to the customer™s
reasonable approval.
In contrast to domestic outsourcing, in offshoring very few customer employees transfer to
the provider. This creates a risk of discontinuity and a potential loss of institutional knowl-
edge. To guard against knowledge loss, the contract should address the mix of onsite,
onshore, and offshore staff, including: de¬ning the required quali¬cations and experience
of support personnel; de¬ning the required staf¬ng levels; describing the provider™s reten-
tion strategies for any of the customer™s existing staff who will be retained through a tran-
sition period; and de¬ning the processes for ensuring effective knowledge transfer.

Rights to dispute charges
An outsourcing customer should negotiate for the right to dispute charges in good
faith, and to withhold payment of those charges until the issues are resolved. In light of
the enforcement issues that may exist in offshore outsourcing arrangements discussed
earlier in this chapter, this right is terribly important to protect the customer. While this
remedy is not a favorite with providers, there are a few measures that providers may
request in the contract to reduce the chance that a customer will unfairly withhold pay-
ment. A provider may request that payment disputes go through an expedited dispute
resolution process, so that the provider is not waiting endlessly for payment. The provider
may also require that disputed payments be held in escrow by a third party until the dis-
pute is resolved. Holding money in escrow deprives the customer of use of the funds
while the dispute is pending. An escrow protects the provider and encourages the cus-
tomer to dispute charges only when the customer has a good faith dispute.

Termination rights and unwinding
Unlike other commercial contracts, outsourcing arrangements typically permit the cus-
tomer to terminate for various reasons, but do not permit the same termination rights to the
provider. These customer rights might include: termination for provider non-performance;
termination for provider change of control; termination for certain service level failures;
and other similar rights. The customer may also be able to terminate without cause, usu-
ally with some prior notice and in many cases with payment of a termination charge. The
provider may only have the right to terminate for repeated non-payment by the customer.
Outsourcing agreements can protect customers, using extensive provisions regard-
ing what happens upon termination. The unwinding provisions take on even greater
importance given the complexity of distance and the dif¬culty of knowledge transfer
from provider personnel back to the customer or the customer™s new provider. Usually
the customer is entitled to termination assistance or unwinding services from the provider,
in addition to other termination rights.
126 Managerial competency

The customer may seek rights to hire dedicated onsite employees and contractors of
the provider, and potentially to hire some offshore employees as well, to preserve
knowledge. If hiring employees is not possible, then it is important for the customer to
have a long termination assistance period to enable knowledge transfer. In addition,
customers may have the right to purchase dedicated equipment from the provider,
although the customer needs to consider whether decommissioning and transport costs
make this right less attractive when the equipment is in an offshore location.
Another important right, upon termination, is to require the provider to assign to the
customer any dedicated third-party agreements and licenses. The customer may want
to specify certain terms of the dedicated agreements that the provider enters because
the customer may want to take assignment of these agreements after termination.
The agreement should also specify that the provider should deliver all work in
progress, and return the customer™s con¬dential information.
Finally, there may be software tools and other proprietary materials owned by the
provider, and used by the provider to provide the services. The agreement should specify
that the provider will license those proprietary items to the customer upon request. This
is especially important in offshore deals where many providers have special code cre-
ation tools, compilers and other items that they use to provide the services, but they do
not commercially license to other parties.

Right to use third parties or in-source
One of the more important ways for a customer to retain ¬‚exibility and control is the
right of the customer to re-bid the services to a third party or to perform the services
internally. This can be the best method for ensuring that the customer is obtaining a
competitive price for the service. The mere prospect that this right could be exercised
can be an important reminder to the provider of the need to remain competitive in the
cost and quality of its services.

Price protections
Pricing for offshore deals varies from ¬xed price engagements to time and materials
work priced against a negotiated rate card. Fixed price engagements tend to be used when
the project requirements are well de¬ned, and most of the variables are known. For multi-
year offshore agreements, where work is done over time (such as in a large application
maintenance and development deal), the prices for the services are often determined
according to a rate card. When the customer™s costs to receive services are not ¬xed, it
is important to include price protections in the agreement. There is no perfect price
protection mechanism. Outsourcing customers should look for a variety of provisions
that together work to deliver a market-priced deal.
127 Offshore legal issues

First, customers should look for the agreement to provide “all inclusive” pricing.
Some offshore providers charge additional money for use of certain tools and software.
Aside from the base charges for services, it is also important to agree on who will pay
the incidentals such as travel, lodging and communications. Many customers accus-
tomed to onshore services forget the additional expense created when offshore profes-
sionals travel to the onshore site. Similarly, the parties must decide who will pay for the
network security and data communications that will be required for the offshore site to
communicate with the onshore facilities.
Second, customers should expect to pay for rate increases in the labor portion of the
charge for services. The rates are often subject to increases according to some eco-
nomic adjustment factor, such as a cost of labor adjustment (COLA), or a consumer
price index (CPI). The agreement should reference the right index for these escalations.
For example, for a rate card that covers providing software development resources in
both Hungary and India, the rate card™s escalations factors should be de¬ned by the
best index available for each country. Customers may want to cap the maximum amount
of these increases, and equally split any increases that exceed the cap.
Finally, we come to the special case where the volume of business is large, typically
in a multi-year agreement. Here, the customer has committed to providing large vol-
umes of business to the provider, or the volume of business makes the customer heavily
dependent upon the provider™s services. In such a case the customer should consider
including benchmarking rights. In an agreement that includes benchmarking, a quali-
¬ed third party analyzes the provider™s price, service levels, service quality and other
factors as compared to similar providers™ prices and services. If the provider™s prices are
determined to be high, the customer may have the right to reduce the services, require
a price reduction for future services, or terminate the agreement. Benchmarking for off-
shore services should be done according to geography, service type, and skill set. For
example, a benchmarking that examines the rates for SAP-quali¬ed developers in
India from top tier providers will be more accurate than a benchmarking that compares
the rates for all software developers in the US, Europe, and India.

Service Level Agreement (SLA)
There are a number of direct and indirect measures of service quality that may be
appropriate to include in the contract. They include ¬nancial levels and performance
milestones for provider compliance. They also include statements regarding compli-
ance with recognized industry standards, such as Capability Maturity Model (CMM)
and International Standards Organization (ISO) certi¬cations.
Service levels are perhaps the most important and widely recognized measure of
service quality. De¬ning service levels is critical because service levels represent the
objective standard used to measure the provider™s performance. The SLA assigns to
the customer rights and remedies if the provider fails to achieve speci¬ed performance
128 Managerial competency

levels. Some critical SLA terms and principals are described below. Another detailed
discussion of this important element of offshore outsourcing is found in Chapter 7, in
the Governance section.

What is measured?
Service levels are de¬ned ways of measuring a provider™s performance. A service level
is a measure of the quality, speed, availability, capacity, reliability, user-friendliness, time-
liness, conformity, ef¬ciency, or effectiveness of services. For example, an availability
service level for a computer system might be the percentage of the relevant time when
the computer system is capable of performing a speci¬c task. Service levels for a soft-
ware development project might include measuring whether the project is done on time,
within budget and within a tolerance for defects and errors.
A good service level is designed to align the incentives of the provider and the cus-
tomer. For example, a ¬xed price contract may incent a provider to cut costs (and qual-
ity) in order to increase pro¬ts. The SLA for a ¬xed-price contract should focus on
quality and timeliness.

How is it measured?
The parties must de¬ne the service level with precision. For example, is a computer
system “available” if its central processing unit (CPU) is working? Or do the databases
and telecommunications systems also need to be working? Does it need to be “available”
to the end user, who may not be able to access that computer system because of a local
area network failure? Is it “available” when the operating system is working, even if the
application program has failed?
For each service level, you need a process for measuring provider™s performance.
For example, you could measure a computer system™s availability in several different
ways: by installing a resident monitoring program within that computer system, through
periodic polling by another computer system, by user complaints about downtime or
use of a monthly user satisfaction survey asking about perceptions of downtime. The
measurement process will affect the results.
You also need to consider the measurement period over which you will measure the
service level. Typically, the measurement period will be a month or quarter. Longer meas-
urement periods give the provider more opportunity to make up for bad performance.
Shorter measurement periods give the provider a “fresh start” more often. Longer meas-
urement periods mean that more is at stake during any one measurement period. The
measurement period may exclude excused “downtime” due to scheduled maintenance,
acts of war or terror, or other events beyond the provider™s reasonable control.

SLA reporting
The SLA should require the provider to make performance reports on a timely basis for
each measurement period. The SLA should de¬ne precisely what information will
129 Offshore legal issues

appear on the reports: such as exception reports for missed service levels and trend
reports for key service levels. The SLA might also require the provider to conduct a
root-cause analysis of service level failures and report the results to the customer.

SLA credits and performance incentives
A “service level credit” is a credit that the provider grants to the customer after a service
level failure. The provider may be required to write a check to the customer or the cus-
tomer may simply have the right to apply the credit to future service. Either way, it
reduces the price of the services and the provider™s pro¬t margin.
As an example, an SLA might call for service level credits for any of 10 service lev-
els. For each of those 10 service levels, the SLA might indicate a number of “credits” to
be granted upon a failure, with each “credit” being a small percentage of the customer™s
total bill for the measurement period. The total service level credits for a measurement
period might be capped at, say, 10% or 15% of the total monthly bill.
Service level credits are an incentive system. Customers often retain the right to revise
the service level credit structure so that they can re-align the incentives as their priorities
change. One important question is whether the service level credits are the customer™s sole
remedy for a breach or merely one of the customer™s remedies. The contract should clearly
state whether the credits are the sole remedy or are in addition to other contract remedies.

Dispute resolution
Disputes are inevitable. In outsourcing arrangements, particularly offshore outsourcing
arrangements, it is critical that the parties have a process in the agreement for quickly han-
dling the many disputes that could arise. This process may include informal discussions
between the primary contacts at the customer and the provider, followed by escalations
to more senior members of each organization after certain periods of time. If such esca-
lations do not resolve the issue, other more formal actions may be taken, such as binding
or non-binding mediation, arbitration, or bringing a claim in the applicable court or tribu-
nal. These formal actions should only be used after informal processes have failed. The
parties should not dash off to court every time they have a disagreement. Unlike games,
where there is often a winner and a loser, successful outsourcing relationships acknowl-
edge the need for mutual bene¬t of the provider and customer. This mutual bene¬t
requires that the parties cooperate, and when appropriate, compromise. Formal dispute
proceedings, while useful and necessary at times, do not necessarily facilitate cooperation
and compromise. The parties should recognize that use of formal dispute resolution may
signal the end of the relationship.
7 Managing the offshore transition
Erran Carmel and Erik Beulen*

This chapter covers the management processes and structures that lead to successful
transitioning of IT work offshore. These are lengthy, subtle, and dif¬cult processes that
require close managerial attention. We cover three key transition topics in this chapter,
and each one of these topics can be read by itself and does not require linear-style read-
ing. The topics are augmented with case studies and examples. The three topics are:
— Knowledge transfer. The process of successfully transferring speci¬c types of

knowledge and experience into the minds of all those collaborating on the work
across many kilometers.
— Change management. Overcoming the inertia and resistance within the

organization to a dif¬cult change.
— Governance. Establishing structures, roles, responsibilities, and written agreements

to ensure that control, coordination, and relationships are all functioning smoothly
between the client and the provider in offshore outsourcing.

Knowledge transfer

How would you transfer the knowledge of eating at a restaurant to someone
who never has? You don™t really know about it unless you go there yourself. You
can have someone to tell you about it. You can order takeout from a restaurant.
You can buy a cookbook from a restaurant. But, to really understand how it
works and feels and tastes, you have to go to one.1
Knowledge transfer deals with moving speci¬c kinds of knowledge and experience
into the minds of the people collaborating on the software work.2 Some of the knowl-
edge transfer is from home location to offshore location; some of it goes the other way.
Knowledge transfer is one of the principal reasons for failures in the ¬rst few years of
offshoring, regardless of whether one is dealing with offshoring by outsourcing or off-
shoring inside the ¬rm. Executives, intoxicated by offshore euphoria, demand a quick
payback, leading their subordinates and their providers to take short-cuts. These short-cuts
often prove to be expensive.3

* Beulen is at Atos Origin and af¬liated with Tilburg University, The Netherlands.
131 Managing the offshore transition

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