One of the biggest points to decide on the outsourcing process is contract duration.

The received wisdom is often that shorter term contracts are better for customers as they keep the supplier honest and they give more flexibility to the customer in its sourcing strategy. In many cases, this makes good business sense and industry research shows a general trend in outsourcing over the last few years towards shorter duration contracts (five years is often the chosen duration).

However, this is not a black and white question and it can be an area where analysis is lacking. The decision on contract duration should be driven by a number of interlinked points including:

  • What sort of relationship is being created? If it is a relationship based on shared strategic goals and long-term investment, how long do you need to achieve those goals?
  • What timelines do you use to plan your business strategy? If your market is rapidly changing, do you need the ability to change suppliers? Do you simply need a right to re-negotiate terms in a contract?
  • Is the flexibility given by a short-term contract real or illusory? In reality are you tied in for a certain period due to, for example, a long transition or exit time or high barriers to entry for competitors?

How does this translate into contract drafting? Contracts of course allow for termination for "default" or insolvency event-based reasons. Short of one of those events occurring, the customer will either be committed to a fixed period across the scope of services or will have the right to terminate some or all of the services on notice. The latter is now quite normal in outsourcing but if the customer wants this flexibility it will have to pay termination payments to compensate the supplier for lost expenditure and even loss of profits.

Customers should consider a longer term contract (seven - ten years) to allow time to achieve strategic goals but with flexibility to terminate some or all of the services either at any time on notice or at given "break points" in return for the payment of early termination compensation to the supplier.