The Outsourcing Weblog

Lawyers and Outsourcing Deals

September 1st, 2009 › Outsourcing Issues › admin ›

Sometimes, one reads an article and wonders what was going through the author's head. This article, about how lawyers are a barrier to outsourcing contracts, is one of those moments.

Have lawyers stopped outsourcing deals? Certainly. The question is "why" not "whether." To this end, lets look at the lawyers' place in outsourcing deals.

First, take the role of in-house counsel. Even in the most hostile of environments, they have at least three main jobs: (1) to address the company's legal needs; (2) to keep the company out of trouble; and (3) to be one of the executive-level professionals who can, from their perch, look across silos in companies.

To the chagrin of sourcing and consulting professionals everywhere, outsourcing contracts are complicated. That's why in-house counsel either develop expertise – usually by starting with help from the outside, but over time bringing the deals inside or by outsourcing the entire task to law firms. This is how the legal services are procured.

But lets not forget their role as risk managers. Anytime a company's critical information is outsourced (and remember, information in a company is pretty much like water in the body – a company is about 95% information in one form or another), a risk is presented. How that risk is managed is, ultimately, the responsibility of the in-house counsel – the "Chief Risk Management Officer" if you prefer.

Protecting against such risk is costly, no doubt. It takes time to figure out, no doubt. And in 99% of the relationships, that effort doesn't add to either party's bottom line, certainly. However, it is a real risk – prudence (and the law in many cases) requires that attention be paid to it.

The perch is another important item. Often, counsel is the only one involved in a deal that has some idea what other parts of an organization is doing. A good in-house counsel uses that information to avoid conflicts and encourage consistency. Ask any commercial counsel in a large organization how many redundant contracts, suppliers, etc., they have in their contract portfolio – they exist because corporate silos don't effectively communicate. And such redundancies are profitable to only one cohort – suppliers.

Another interesting aspect of this article was the complaint about profit margins being affected – and the lawyers being the culprit. When a company outsources, it seeks price certainty. Does it have that with employees? No, but it has the ability to "right-size" its labor force when it needs to. Most outsourcing contracts (at least those on vendor paper) are great when it comes to escalation clauses (e.g., underlying costs are too high, forecasts are too low, etc.), but remarkably silent on shrinkage. But companies need to control their costs as much as suppliers need to control their margins.

Business grows and shrinks. COLA grows (and in some cases) shrinks. But prices grow. A good attorney can spot these trends – and will fight them. Sure, they may affect the supplier's back-end bottom line… but ignoring them affects the customer's back-end bottom line. This aspect of the deal is, for the most part, a zero sum game.

Then we get to my favorite part – innovation. Suppliers constantly complain about the lack of flexibility with regard to innovation. They are, in many ways, correct – innovation in outsourcing deals is abysmal. Two things to remember, however. First, innovations within companies – particularly in areas being outsourced – is rarely encouraged or significantly rewarded. Second, the company, when innovating or paying for it, even in the most mundane areas, wants that innovation to become a competitive advantage. It doesn't want the same innovation to be handed to its competitor tomorrow.

Contrast this with the innovation provisions that outsourcers seek. They usually want ownership and the ability to commercialize innovation paid for by their customers. In other words, they want company A to fund innovation that will benefit company A's competitors – and remove a competitive advantage that company A is seeking. It's no wonder why IP ownership, along with indemnities, warranties and limitations of liabilities, are the most time-consuming provisions to negotiate.

This is a difficult "rock and hard place" problem, no doubt. And it is a good example of an area that the article is correct about – the difficulty in contracting today for a future that is unknown. Drawing these lines properly requires patience, caution and thoroughness. There is no short cut here.

This is a skill not taught in law school, and one not learned in the bulk of other contracting work that is done by counsel (UCC rules, interestingly, contemplate ongoing relationships – and the bulk of materials procurement, etc., can be addressed by them). Neither is this skill one that comes naturally to procurement organizations – in fact this "long term" approach often affects the "save" adversely. However, most suppliers' approach – "just trust us" – is not an approach that is supported by evidence anywhere.

As long as suppliers use their own in-house or outside counsel to draft contracts that are skewed in their favor (at best), or completely one-sided (at worst), customers must protect themselves with equal zeal. Maybe, there will one day be a "UCC" for outsourcing deals – and we can all rely upon "default terms." But until then, lawyers will be a necessary good. Remember, a good deal must be good for both parties in their entirety, not just the supplier's margin.

NB. Mr. Zeiss is a Los Angeles-based attorney with a focus on technology and outsourcing deals.

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