Best Practices for Effective Outsourcing Contracts

Due to the strategic nature of the outsourcing initiative, it’s critical that you select the right outsourcing vendor and set up the partnership in such a way that both parties benefit from the relationship. Structuring the contract with the outsourcing vendor is a critical process in establishing the outsourcing relationship.

The current contract structuring process typically takes a significant amount of time and also frequently results in expensive legal consulting bills.

This article provides a basic framework and process to follow in structuring your outsourcing contracts.

Benefits of Well-defined Outsourcing Contracts

A well-defined outsourcing contract helps in:

  • Clearly articulating the success criteria to the stakeholders in both the client and the vendor teams.
  • Defining some of the high level metrics used to measure the vendor performance.
  • Defining the project requirements in terms of people, process, security, technology and business continuity.
  • Defining the incentives and penalties based on vendor performance.
  • Handling the unpredictable scenarios without causing undue frustration on either side.
  • Pursuing structured growth of the partnership.

Framework for Structuring Contracts

We’ve assisted multiple clients in negotiating and structuring contracts. Over the course of our experiences, we’ve developed a framework to assist organizations with their contract structuring. The framework shown above forms the basis for the contract structuring process between the vendor and the client.

In each step of contract negotiations, both parties should make sure that the contract serves the purpose of their short-term and long-term goals. This will ensure that there are sufficient incentives for both parties to guarantee the success of the outsourcing relationship.

Contract Structuring Framework

It’s important to clearly define the requirements for the projects in terms of people, infrastructure, security, business continuity and processes.

  • People-related requirements include the skill set of resources, size of the team, duration of ramp up, etc.
    Infrastructure requirements include hardware, software and network details.
  • Process-related requirements include resource induction process, status reporting, delivery knowledge transfer, quality process etc.
  • Security requirements include physical, personnel and network security.
  • Business continuity requirements include planning for physical theft, data theft, virus attacks and natural and man-made disasters.
  • The service levels for the outsourcing relationship and the corresponding incentives and bonus clauses should be clearly defined. This will help the vendor to internally measure and manage the outsourcing projects as well.
  • The governance of the contract in terms of termination clauses, contract breach and governing clauses should be clearly defined.

Once these areas are covered, then the client should discuss commercial terms. The client should also expect to be flexible in the reduction or increase of scope for the clauses defined above based on the flexibility shown by the vendor during the pricing negotiations.

The Process for Structuring Contracts

The contract structuring process should be defined so that the time spent on it is minimized and the team can start the relationship initiation process (though not the actual service delivery) before the final contract is signed.

One of the best practices commonly followed by companies is to discuss all the operational terms and sign a non-binding term sheet. The project initiation process can start as soon as the term sheet is finalized.

The term sheet is then passed on to the legal departments of both companies to develop acceptable language for both parties.

This process also makes sure that the delays in the project due to any legal discussions are reduced and that the legal resources are used effectively.

To reduce the cost of contract structuring, companies can leverage in-house legal council to draft the contract based on the term sheet. Also, vendor contract templates can be modified to incorporate the term sheet details, and outside legal support can be used only for the final validation of the contract.

Final Words of Advice

Clients should leverage the process and framework defined in this article to negotiate and structure a win-win contract with the service providers you’ll be working with.

It often helps to get third-party consultants to help in defining and negotiating the contract terms. This will minimize the risks involved in structuring the outsourcing relationship and set it up for success. It also enables the stakeholders to focus on planning the outsourcing project requirements, goals, transition and management.

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