Lessons Learned From Outsourcing Disputes

The New Norm

The current challenging economic conditions are driving additional outsourcing activities. However, the need for companies to achieve greater efficiencies and reduce budgets means that customers are being forced to do more with less. In addition, the pace of technological change is accelerating and companies need to be able to swiftly react to unanticipated changes in the marketplace or otherwise fall behind the competition.

With outsourcing contracts historically having terms ranging from five to ten years, the industry has reached a point where there are examples of high profile failures—and the hidden risks and causes of these failures can be identified more easily. Recent examples of cases that have ended up in court include the dispute between Ericsson and H3G, arising out of the termination by H3G of an IT outsourcing contract, and the well-publicised case between BSkyB and EDS/HP, where EDS/HP paid BSkyB a reported £318 million in damages.

For every example of a failed outsourcing deal that is taken to court or reported in the media, our experience shows that there will be several more troubled deals in which the issues are resolved quietly between the parties behind closed doors.

The purpose of this article is to consider what lessons can be learned from some of those troubled sourcing deals.

Improving the Chances of Success from the Outset

When many of the long-term sourcing transactions now reaching maturity were entered into, the economic backdrop was very different: no one had foreseen the global downturn or the pace of technological change. Although most contracts provided for a limited degree of change without the parties having to renegotiate the contract (e.g., by use of the ARCs and RRCs model), they were not sufficiently flexible—in terms of their operating or charging models—to cope with the degree of change required.

It is essential that customers and suppliers need to recognise that through the lifecycle of any contract, unanticipated macroeconomic events or significant technological changes may arise which could materially impact the demand for services (both in terms of nature and volume).

One obvious way to mitigate this risk is to have shorter contract terms. Over the last few years, terms of between three and five years have become the norm. As a consequence, if and when unforeseen events do arise, the parties are more likely to be able to find a solution to address them. However, that is by no means the only potential mitigation.

When entering into an outsourcing contract, a key issue for the customer will be whether the value of the deal is greater than the value of the alternatives that the outsourcing arrangement will preclude. It is common to undertake financial modelling when making these assessments, but companies will not properly understand the real value unless risk is factored in. If not, it is easy for the up-front financial value to be eroded quickly and for disputes to arise.

In recognition that the environment to be supported...