January 26, 2010

A Better Way to Structure Outsourcing Contracts

You may be faced with the daunting task of establishing an outsourcing contract with a new vendor. Typically you are confronted with a few well-established approaches to tackling this challenge. We’ll review the options you’ve likely considered, and offer a model that Waverley has been using for many years that we believe offers a better approach.

First, the “big contract” approach is to establish a multi-year legal structure that defines the areas you wish to outsource combined with various terms to set out the goals you wish to reach through the relationship. This long-term commitment is highly lucrative for the major outsourcing vendors, but requires you to have remarkable insights into where the relationship will go, and how you will keep the vendor on track. This approach is similar to fixed bid contracts we’ve discussed before, appropriate for some projects, but often fraught with peril due to the uncertainty of future events and the unknown evolution of your vendor partnership. You want the best terms with your new vendor, but you need to ask yourself how much a huge investment and long-term commitment help you to build a truly win-win situation for the two of you.

Another approach is to establish detailed project specifications and contract the outsourcing vendor to execute on those precise plans. This also has many parallels to typical fixed bid projects, but fails to lay a foundation for the building of a relationship with the vendor. Are you just looking to satisfy the short-term needs of a specific project, or are you interested in building a real vendor partnership that can deliver value across many projects?

What you may really want is what we at Waverley have developed over the past several years: legal protection for critical issues like pricing and intellectual property combined with a framework for both you and your vendor to grow to trust each other and build a foundation for long-term work. This approach uses a boilerplate Professional Services Agreement (PSA) combined with simple Statements of Work (SOW) for each project the vendor works on. The PSA makes no commitments on your part to engage the vendor for more than a month or two on termination. The vendor is constantly proving themselves to you each month through the quality of their work. You have the legal and price protection you’re looking for in the PSA, and each new project only requires a new SOW without PSA renegotiation. You start small and build a mutually beneficial relationship with the vendor from the very beginning. As you both grow to get comfortable working together, you can adapt the growing team to the areas that best fit your business. We think you’ll find the value in this arrangement is substantial.

Our PSA + SOW approach provides a nimbler, more adaptive alternative to the contractual side of outsourcing; a middle ground between the multi-year “big contract” on the one hand and the project-based fixed bid contract on the other. Something to consider.