What is Outsourcing?
Attitudes to Outsourcing
Key Business Priorities
In recent years Irish companies have shown increased interest in outsourcing business functions to third parties, particularly in the IT sector. The market appears to be growing: it is estimated that the total market for outsourcing in Ireland could be worth in excess of €500 million annually. This update explains the concept, identifies some of the legal issues and describes the key priorities for any business seeking to outsource IT services.
At its simplest, outsourcing consists of a company sourcing, from an external service provider, services that it previously provided itself either as an integral part of, or to support aspects of, its core business. A more complex outsourcing might involve the transfer by one company to another of employees, land, buildings and other assets (eg, hardware and software, the benefit of contracts or licences, and other know-how) previously used or owned by the first company in providing the service to itself (or another member of its group), with the second company then providing the service back to the first company at an agreed cost. A variation of this theme could involve the establishment by the two companies of a joint venture company which will provide the relevant services to the first company, as well as to any other businesses seeking to outsource similar services.
Where the outsourcing involves companies outsourcing certain business processes (eg, accounting, human resources, supply chain management, payroll or other services), these are often referred to as 'business process outsourcings', to distinguish them from 'functionality outsourcings' under which the outsourced service provider will provide an entire function previously provided in-house by a company (eg, the provision of IT services). In many cases the commercial and legal issues to which these different forms of outsourcing will give rise are similar.
A recent survey(1) maintains that while there is a high level of awareness of outsourcing among companies in Ireland, there is a low take-up and a low awareness of what can be achieved. It suggests that because of their high profile and Irish government focus on data centres, many Irish companies associate outsourcing exclusively with web-hosting facilities. The survey finds little evidence of an outsourcing culture among many Irish companies. This contrasts with organizations in other major European countries such as the United Kingdom, Germany and France. One of the most important findings of this survey is that outsourcing in Ireland is often considered as an IT tactic rather than integral to an overall business strategy.
In some cases companies may be seeking to improve unsatisfactory standards of service by outsourcing the service to a third party with a proven track record in providing better levels of, and with the resources and determination to continuously improve, service delivery.
Development of 'core' business
Another rationale for outsourcing IT services may be that the company wishes to concentrate on its core business activities and is seeking an outsourcing partner to provide non-core or 'back office' services, preferably on the basis of a fixed-price contract delivering significant cost savings.
In addition to the obvious benefits which can be obtained from a fixed-price service contract, a company may obtain other benefits from IT outsourcing. For example, where employees move to the outsourced service provider as part of the transfer by that company of a distinct business, that service provider will usually be responsible for all their terms and conditions of employment, including remuneration and pension obligations. The company seeking to outsource may also be seeking to achieve a significant reduction in the amount of management time spent in the supervision and operation of various aspects of the outsourced service.
The service contract will be the key document governing the business relationship between the parties. It will identify areas where risks will be shared, where other risks will be allocated as between the parties, and the types of remedies which will be available in the event of a failure to perform. The service levels should be clearly defined and measurable, and the customer should ensure that it has adequate remedies to ensure protection against persistent failure to achieve service levels as well as catastrophic failures. There must also be adequate provision for 'change control' mechanisms to deal with changes in service levels and the costs of these changes, as well as an 'exit plan' to facilitate the handing over of the service at the end of the contract term. However, it is also necessary to get the right balance in the contract – if it is too one-sided in favour of the customer, the service provider will not be sufficiently incentivized to provide an adequate service.
Acquired rights for employees
To the extent that a business is transferring from one company to another, the employees in that business will as a general rule have the right to transfer their employment to the new service provider. This right is enshrined in EU law and the relevant EU directive was implemented in Ireland by the European Communities (Safeguarding of Employee Rights on Transfer of Undertakings) Regulations 1980 and 2000. The key issues are to determine whether a business transfer is taking place and which employees will actually transfer. It will then be necessary to negotiate appropriate contractual protections for both parties (eg, in relation to any employment-related claims brought by transferring staff arising before and after the transfer).
In the case of certain outsourcings (eg, in the field of telecommunications), the service provider may require a licence from the Commission for Communications Regulation. Other regulatory issues may be relevant in other types of outsourcing, for example in the banking sector.
Tax planning/third-party consents
Where assets are being transferred it is necessary to consider the tax implications, as stamp duty at rates of up to 9% may be chargeable on certain asset transfers. Tax planning opportunities should be considered as well as the question of whether there is a need to obtain the consent of any third parties to the transfer.
End of the contract
In drafting the service contract the customer and its advisers must also look forward to the end of the contract term, and ensure that there is adequate legal protection for the customer when the time comes to renegotiate the contract and/or invite tenders by potential new service providers.
Will it work?
IT outsourcing is a major procurement exercise, and ideally should involve a market test, competition, shortlist, selection of preferred supplier and contract evaluation. Fundamentally, however, any business considering outsourcing should be concerned to ensure that it will actually achieve real cost savings and an increase in service levels and standards. While outsourcing is a simple concept, it may prove surprisingly difficult for a company seeking to outsource IT services to establish what service levels it actually requires at a minimum, how it wants those services to be improved, and how much it is prepared to pay for them. As any outsourcing will involve a form of partnership between the company seeking to outsource and the outsourced service provider, which will continue for many years, it is vital that these basic requirements are established at the outset. If necessary, specialist consultancy advice should be sought to assist the customer in getting the right answers to these questions. Failure to do so could result in adverse financial and business consequences, with the customer subject to the possibility of being tied to a contract for five to 10 years (or even longer) while facing the prospect of increasing costs and static service levels.
Getting the team right
Another key priority is to select the right service provider with real expertise in information technology, a proven track record, and an effective management team who can work together with their opposite numbers to establish the levels of services to be provided and the basis upon which these are to be paid for. The selection by the customer of an experienced team to assist with the contract negotiations and the achievement of the core business objectives is also critical to the success of any outsourcing.
For further information on this topic please contact David Sanfey, Jack O'Farrell or Mark Ward at A & L Goodbody by telephone (+353 1 649 2000) or by fax (+353 1 649 2649) or by email ([email protected]).
(1) “Irish Business Attitudes to Outsourcing”, by Lansdowne Market Research on behalf of Cap Gemini Ernst & Young.