Outsourcing in Asia | SCMP

Outsourcing is increasingly popular again, and that's official. IDC has predicted that the Asia Pacific IT outsourcing marketplace will experience significant growth rates in the next few years, moving from US$4.7 billion in 2001 to nearly US$14 billion in 2006. It found that the key drivers for such an increase include: the increased acceptance of outsourcing as a business practice, organisations' desire to focus on their core business yet maintain a fully-reliable infrastructure; globalisation and competitive business environments and the use of increasingly complex applications.

These drivers are further spurred by the economic depression which has hit certain parts of Asia. However we expect Greater China's use of outsourcing to increase because it is most likely to make its impact on the global economy sooner rather than later by buying in expertise in key areas.

Outsourcing is, of course, about more than IT. Business Process Outsourcing (BPO) is the phrase now used to describe all the different aspects of outsourcing. A survey run in May and June 2001 on the FMLink Web site, found that there is a trend not only towards a higher number of FMs being outsourced, but also the number of functions being outsourced. These functions include custodial and housekeeping, design and architecture, major moves, security, preventative maintenance, engineering and utilities maintenance.

Advantages of outsourcing

These are generally regarded to include:

1. improved shareholder value, according to a PricewaterhouseCoopers survey of the senior executives of 304 multinationals;

2. the benefits of importing skilled service providers;

3. the cost benefits gained from importing such skills without having funded their development;

4. the ability to make a company's infrastructure as efficient as possible yet enabling management to focus on the core business; and

5. the ability to keep up with increasingly complex applications.

One of the advantages which help companies keep competitive edge, is that outsourcing can help satisfy customers' evolving needs. The flexibility that outsourcing, if properly managed, can offer, is of incalculable benefit to a company. However, the cost of obtaining that benefit does have to be agreed.

Disadvantages of outsourcing

Apart from the obvious mistake of outsourcing when an in-house resource can adequately provide the required service, the major disadvantages are perceived to be:

1. the risk of transferring knowledge, and perhaps, power, to an outsider;

2. the problems of maintaining continuity and reputation with customers when a customer-interfacing function is outsourced;

3. the difficultly of managing the outsourcing relationship; and

4. the difficulty of exiting from the outsourcing relationship.

Outsourcing contracts

Here is a summary of the key issues: Selecting the right contractor is no easy issue, but that is often because a company has not fully considered its needs and demands and set these out clearly in an invitation for proposals document to select the contractor. The invitation for proposals document is therefore the first thing to get right. A well-prepared invitation for proposals will contain a specification for the services to be performed and general conditions of contract.

The specification will usually set out the client's requirements in relation to services to be performed, quality standards to be met and various information that the outsourcing contractor will need in order to perform the services in accordance with the contract. It may also set out any mechanism the client may wish to include in the contract to adjust payment to reflect performance. As it is the specification that the outsourcing contractor will look at when calculating his tender for supplying the services, the client should take great care in drafting the specification to ensure that it contains all information necessary for the outsourcing contractor to adequately price the provision of the services.

It should, for example, set out in some detail the services to be performed. Any restrictions in relation to operating hours on site or in relation to access to or from the site should be clearly stated. If the outsourcing contractor is to undertake any work prior to commencing the services on site, for example in relation to liaising with an outgoing contractor to ensure an efficient handover of any plant, staff and equipment, then such work needs to be described in the specification.

There are two different approaches to describing in the specification how any performance standards in relation to such services are to be met. The approaches are (1) an "input" specification; and (2) an "output" specification.

A traditional "input" specification will set out in detail the exact services to be performed by the outsourcing contractor in a prescriptive fashion. For example, in relation to cleaning services, not only would the standards the contractor is to achieve be set out in the specification but also the exact means by which those standards are to be met - ie the specific way in which the contractor has to carry out the cleaning.

In recent years, clients have increasingly moved away from the use of "input" specifications in favour of "output" specifications. An "output" specification would not prescribe how the contractor is to achieve performance standards set out in the specification. The contractor would be expected to come up with his own proposals for how to achieve those standards. The logic behind the use of "output" specifications is that the client's main concern is not the means by which performance standards are met but the fact that those performance standards are met. A contractor should be entitled to use his own expertise to offer solutions that achieve and exceed the client's performance requirements.

It is argued that an "input" specification will not allow the contractor sufficient freedom to use his expertise and to offer innovative solutions to the client's performance requirements. Also allowing the contractor to define how he will achieve the client's performance requirements will result in lower tenders being received by the client as contractors may be able to suggest more cost-effective ways of achieving the client's requirements than those that may have been specified by the client in an "input" specification.

"Output" specifications offer further advantages. As the outsourcing contractor is to define how performance requirements are to be met, this obviates the need for the client to spend the considerable time and expense necessary in preparing detailed "input" specifications. This in turn should reduce the cost to the client of tendering the outsourcing of services. It will, however, result in an increase in the tender costs of the contractor and it can be expected that the contractor will endeavour to recover such costs in his tender.

Whilst "output" specifications do not require the detailed text necessary for an "input" specification, they do require very careful drafting. The client should be aware that if an "output" specification is used, unless they make detailed references in the specification as to how particular services are to be performed or they will lose control over the detail of how the services are to be performed. For example, if the client has very specific requirements in relation to security arrangements for the site, if these are not set out in a prescriptive fashion, the contractor will be free to provide a level of service he feels meets the client's performance requirements. In certain circumstances, it may therefore be necessary to utilise a hybrid specification incorporating both "input" and "output" elements.

It is also important for the client to be precise in the output specification on what exactly is required. A service simply stating that a room is to be "kept clean" is too vague. Is this to include cleaning blinds and upholstery? Telephones? Computer equipment? Floors or windows? If a service in an output specification is too vague, the contractor may not price for performing a service that the client expected to be included in the contract price, and this will invariably lead to conflict between the client and the contractor. In addition if a specific service is not referred to, and if it cannot be argued that such a service was obviously required, then the contractor may demand additional payment for performing the service.

A final point for those considering whether or not to use an "output" specification is the different approach required of the client in assessing the performance of the contractor. Whilst it is relatively easy using an "input" specification to judge whether the contractor has complied with the same (has the relevant task been carried out?), with an "output" specification, the client must look instead at whether the performance requirements, often drafted in a relatively subjective way, have been met. The very subjective nature of many performance requirements means that "output" specifications are most likely to be successful when used in a contract where the relationship between the contractor and the client is not adversarial but is proceeding on a "partnering" basis.

As to the general conditions of contract, the most fundamental consideration in outsourcing is the apportionment of liability. This will vary according to what is being outsourced and the level of autonomy the outsourcer will have. The risk allocation in relation to the multitude of risks that may exist in any outsourcing project will obviously affect the fee structure as well as the wording of indemnities and warranties.

Another important issue in outsourcing contracts is to consider up front how to deal with any misunderstandings of breaches which may occur further down the line. This will usually go hand in hand with how the outsourcing relationship is managed. The company does not want to deploy so much management time on the outsourcing function that it distracts from management's usual role, but the contract should allow for frequent addressing of potential problems and suggest proposed remedies up front. These can include, for example, a price adjustment formula linked to the outsourcing contractor's performance standards.

These types of formula can take many forms; a typical example would be a performance point system linked to service levels. Here, the outsourcing contractor would accrue points for failing to achieve specific service levels. The points accrued would be weighted according to the significance of the failure to perform the services to the standard required. If the accrued points exceed a certain threshold, the payment due to the outsourcing contractor is reduced in accordance with the formula in the contract.

We would usually also advise on including provisions dealing with security measures, agency (to ensure the outsourcer does not act outside the scope of its authority and make the company liable for something it does not intend), intellectual property, ownership issues, confidentiality, data privacy, employment issues, insurance and termination.

Apart from these points, the contract should consider the issues dealt with under the headings above of Advantages and Disadvantages. These will need careful negotiation, even if this is the last thing two parties hungry to start work together want to focus on.

PPPs'

A public private partnership (PPP) is a relationship between a private sector and a public body which aims to use private sector resources and/or expertise for the provision of public sector assets and/or services. The term PPP is used to describe a wide variety of working arrangements from loose, informal and strategic partnerships to design build finance and operate (DBFO) type service contracts and formal joint venture companies. We are finding that PPPs are being more widely accepted in Asia, to the extent of overcoming traditional hurdles such as face (an admission of a need for outsourcing is not automatically seen as an admission of weakness in one's own organisation) and spending (tenders for outsourcing used to be predominantly assessed according to cost). Here in Hong Kong, the government has a formal IT Outsourcing plan as part of its "Digital 21 strategy". It aims to have outsourced at least two thirds of all IT projects by 2001, and started by awarding its first contract for outsourcing government IT application maintenance services in March 2001. The reason for this? "To tap into talents and expertise outside of the Government. The deployment of resources is also quicker and more flexible", according to a government spokesman. The government currently has four tenders for IT outsourcing in progress. As the Government's budget deficit grows, Government appears to be looking increasingly to the possibility of procuring services via the PPP route. A number of Government feasibility studies are currently underway that are considering this procurement option in relation to various types of service.

nternational outsourcing

What is good for a company in one country may be good for its sister company elsewhere. If the same outsourcer is to be used for different jurisdictions, consideration must be given as to whether to have (a) a single master agreement; a master agreement backed up by local agreements tailored to the local jurisdictions as appropriate; or (c) only local agreements. Considerations such as tax, employment, culture, currency regulation and regulatory laws for the particular function will vary from one jurisdiction to another. Our experience leads us to strongly recommend that the co-ordination between the jurisdictions be carefully considered by the company and its advisers at the outset: this is vital to ensure both the smooth operation and consistency of the outsourcing, and, if and when necessary, the end of the outsourcing relationship.

Outsourcing as a strength or weakness?

It is generally believed that those organisations which view outsourcing as a strategy for empowerment rather than a sign of weakness are those most likely to succeed. However, that success will only come after finding the correct outsourcing partner and settling into a mutually-satisfying long term relationship whose terms are set out in a contract with which both parties feel comfortable.

CMS Cameron McKenna's international outsourcing practice covers a wide range of outsourcing options from business processing outsourcing to public private partnerships, and facilities management. In Hong Kong, please contact Mark Badger on mark.badger@cmck.com on telephone + 852 2846 9108 or Janine Canham on janine.canham@cmck.com or + 852 2846 9120. In Beijing, please contact Luke Filei on luke.filei@cmck.comor +86 10 6590 0389. For London and European inquiries, please contact Simon Jeffreys on simon.jeffreys@cmck.com or +44 207 367 3421.