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Jon Edgell is a partner in the London office and a member of Morrison & Foerster's Technology Transactions Group and Global Sourcing Group. He is a leading outsourcing lawyer in the U.K. and advises clients on complex IT outsourcing transactions and business process outsourcing involving human resources, facilities, payroll, accounting and other systems and processes.
Gabriel E. Meister is a partner in the Technology Transactions Group in the New York office and a member of the firm's Global Sourcing Group. Meister has substantial experience in a wide variety of high technology and intellectual property-related transactions. His practice is focused on large-scale outsourcing deals, including IT and business process outsourcing (both offshore and onshore).
Nigel Stamp is a partner in Morrison & Foerster's Hong Kong office. He specializes in providing advice on information technology, outsourcing, e-business, communications and digital media law and practice.
Mr. Stamp has advised some of the world's leading financial institutions, technology suppliers and telecommunications companies on major projects, including the leading telecommunications company, some of the leading banks and a leading film company in Hong Kong. Mr. Stamp provides advice on all types of technology contracts, B2B and B2C e-business ventures on the Internet and digital media projects such as digital interactive television.Global Trends
Twelve months ago, Morrison & Foerster's annual review of trends in the sourcing market anticipated a trend toward smaller, shorter deals; an increased reliance on global service delivery models; an expansion of offshoring to Asia; increased adoption of elements of IT and business process outsourcing by Japanese companies; Europe, becoming an engine for outsourcing growth; and heightened awareness of privacy and data security issues by sourcing customers. For the most part, these trends have indeed developed over the course of 2007 and, in our view, will continue to develop in 2008.
Cost-Driven Deals
There is little doubt that, in the early days of outsourcing, cost saving was one of the primary drivers of outsourcing deals. However, as both customers and service providers matured, it became clear that focusing on cost savings alone was merely scratching at the surface of the potential of outsourcing. Customer organizations realized that the service providers really were experts in their chosen fields and that outsourcing offered a range of additional benefits such as access to new skill sets, best-of-breed services, greater innovation and transformation and better speed-to-market for new products and services.
In fact, we started to see deals that were cost-neutral or even reflected a higher cost, but in return for an enhanced service offering. And the service provider community realized that cost, while important, was not the only criterion for winning or losing deals. As bid processes became more competitive with a greater number of competent service providers entering the market, service providers had to tailor their offerings to ensure that they could win the battle not only on cost but also in the areas of "added value."
As a result, the drivers for outsourcing deals have been cyclical. In slower economic times, cost has played a more significant factor, while, in better times, the other benefits of outsourcing have received a greater focus. In light of the predicted economic slowdown in 2008, we believe that cost will again become more prominent. This seems almost inevitable.
But, as in previous economic slow-downs, this tightened focus on cost over value needs to be approached with caution. "Outsource in haste, repent at leisure," to paraphrase the old proverb. Outsourcings driven by cost-saving issues tend to be short-term solutions. Companies should look back to previous economic cycles and appreciate that projects driven by value or service issues tend to be more successful.
The "Post-Signature" Phase
There has been a notable shift in the quality of outsourcing contracts that have been put in place over the last past few years. Five or more years ago, companies experiencing problems with their outsourcing relationships often had in place very poor-quality contracts. In light of the lack of clarity in the contracts, it is no surprise that there was a mismatch of expectations between the customer and the vendor -- and relationship breakdown was an almost inevitable consequence.
As the market has matured, we have seen a significant increase in the quality of the typical outsourcing agreement. However, the number of disputes has not diminished, and customer satisfaction does not seem to have increased (possibly in part due to rising expectations). On examination, it is clear that many of the contract management mechanisms in place (e.g., governance regimes, service level measurement and reporting, balanced scorecards, gain-sharing, innovation and improvement forums, etc.) either are not being used or are being implemented poorly.
In light of this, we believe that in 2008 outsourcing customers generally will pay greater attention to the post-signature phase. Our clients are already placing a greater emphasis on contract governance and management, and we are being asked more and more to help with the design and running of the "retained function" (business functions that are not outsourced and are responsible for managing the outsourced contract). We are also seeing a far greater incidence of six month reviews where the negotiation team and the contract management team of the customer work together to identify areas that are working well, areas that require improvement, and activities that are not taking place but should be. This is also leading to an increase in the number of midterm renegotiations -- a trend that we believe will continue.
Pharmaceutical Offshoring
Offshoring of critical functions by pharmaceutical companies -- particularly to providers in China and India -- showed signs of growth in 2007, and we expect this growth to continue in 2008. As competition from generics increases and patents on more and more big-ticket pharmaceutical products approach their expiration, pharmaceutical companies are looking for new ways to cut costs and focus on core competencies such as late-stage product development and sales and marketing in order to sustain their respective drug pipelines.
To accomplish these goals, we have seen the pharmaceutical industry increasingly willing to outsource not only "traditional" IT and business processes, but also functions that some would consider within what were previously considered pharmaceutical companies' core competencies -- including the manufacture of active pharmaceutical ingredients (APIs) (the key ingredients of drugs), clinical research and development activities and clinical data management.
Of course, there are potential perils: Moving the manufacture of critical drug components or the management of clinical trials or data overseas carries quality control issues, legal and regulatory risks, and raises potential intellectual property concerns.
Nevertheless, U.S. and U.K. pharmaceutical companies in 2007 expressed increased interest in offshoring critical functions. Pfizer and AstraZeneca have each discussed large-scale plans to offshore manufacturing activities and Eli Lilly, Bristol-Myers Squibb, and Wyeth Pharmaceuticals have outsourced certain high-level drug discovery and development functions to Indian firms.
Green IT
During 2008, as environmental concerns continue to grow globally, there will be an increased interest in the use of "Green IT." Green IT covers a broad range of measures aimed at reducing the environmental impact of corporate IT use.
We are already seeing customers seeking more energy-efficient IT solutions. We see outsourcing customers insisting on the introduction of energy-efficient best-practice standards and processes (and even data centers powered by environmentally friendly energy sources). As more and more customers seek to reduce their corporate carbon footprint, we expect to see a greater take-up of services that make use of Green IT.
The U.S. and the Dollar
One of the key issues affecting the progress and development of outsourcing in 2007 has been the decline of the U.S. dollar, particularly as against the Indian rupee (a drop in value of roughly 11%). For service providers carrying significant currency risk, and especially for those providers with a large portion of their revenue derived from deals with U.S. entities, the declining dollar cuts directly into their bottom line. If the dollar continues its decline in 2008, service providers may push more aggressively for new means to hedge their respective currency risks and cut costs overall, both contractually and behaviorally.
The weaker dollar may also lead to more mid-term re-negotiations. Where offshore service providers have taken the currency risk in the initial deals, a continuing decline in the dollar may turn profitable deals into loss-making deals. And, it is important to stress, because of the behaviors that it drives and the loss of incentive to invest, a loss-making deal could be a disaster for both parties, not just the party initially holding the exchange risk. While customers are always reluctant to agree to a price increase, some of the more mature customers may realize that it is in their best interests to ensure that their provider is not in a loss-making situation and so may agree to certain price increases. However, such price increases will come at a cost, and providers will be pushed even harder to innovate and provide more added value.
Where customers have taken the currency risk, the exchange rate fluctuation may blow a hole in what once looked a rosy business case. This could lead not to re-negotiation, but to a mid-term switch to a domestic U.S. provider.
This summary was adapted from a longer report by Morrison & Foerster. To read the entire article, including outsourcing trends in specific regions of the world and a greater discussion of how the economy and politics is affecting outsourcing in the United States, click here.
POSTED BY: Ron (April 12, 2008 08:43 AM)
Obviously he has never had to deal with the problems it causes the people that have to work with outsource companies. I personally have doubled the amount of hours due to the incredible lack of talented people that work for those companies and I have had to pick up all the slack. That's something that people like him don't care about. All they care about is how much money can I save never mind all the people I burn out that have to fix it.
POSTED BY: Jeff Mills (April 16, 2008 04:07 AM)
I thought I would let you know, I have posted over 15 videos on how to outsource many of the tasks of "internet marketing" to help firms get more free leads and web traffic.
Your readers may find them educational and beneficial.
outsourcesecretsrevealed.com/blog
Jeff Mills
POSTED BY: Rudy (May 29, 2008 05:34 PM)
I am interested in knowing if the green IT will have a positive affect on the environment.
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