Governance: practical steps to making it work
Profit warnings are nothing new to the outsourcing industry. Looking at the end of Q1 2013, FTSE support services and FTSE software and computer services companies are again the sectors reporting the highest number of profit warnings. With the sourcing sector most vulnerable from falls in confidence due to ongoing issues in the eurozone, US and China and a decrease in government spending, it is unsurprising that this sector should continue to suffer at the hands of our difficult financial markets. However, in addition to these external factors, a failure to keep a tight grasp on governance issues could be doing far more damage. Dedicating time to due diligence at the initial stages of a project and working with your legal teams to create a solid governance structure, should help prevent problems further into the relationship.
A strong governance model
A direct and honest approach about what can and cannot be achieved early in the relationship promotes trust and sets good groundwork for the development of a positive and constructive relationship.
A strong governance model allows contractual issues to be dealt with contemporaneously, promoting a stronger relationship with greater transparency, flexibility and, ultimately, sustainability.
However, there are often issues surrounding what is promised and what is (or indeed can be) delivered. If these unrealistic promises begin at the negotiation stage, the relationship is unlikely to be successful as it will be based on mistrust and a blame culture is likely to develop. A well-advised customer will challenge the service provider’s pitch teams on all aspects of their solution, whilst a prepared and competent service provider will ensure it can substantiate its solution with sufficient resource dedicated to appropriate and timely due diligence, particularly in connection with IT solutions which may be dependent upon the customer’s existing infrastructure or software.
Suitable due diligence and a mature governance model coupled with its strong implementation is – or at least should be – at the heart of any successful sourcing relationship between a customer and service provider. Without it the parties leave themselves vulnerable to problems and complications, ranging from a loss of value in the contract, through to termination and, potentially, bad press or even litigation for non-performance or non-payment.
The parties need to recognise the importance of an accepted common purpose at a strategic level and an understanding that both will ultimately benefit from the arrangement. Taking time at the start of the relationship to develop what a collaborative business relationship means to the parties is imperative for a successful governance model. If this is developed and adopted during the negotiation phase, a customer should feel confident it has identified a service provider with the right cultural fit for its business. A broad approach to a collaborative business relationship promotes institutional relationships, allowing each party to react intuitively and manage issues as they arise, so limiting their impact.
The customer must be prepared to retain accountability for the service, albeit whilst managing and allocating risk to its service provider. The customer cannot simply expect the service provider to understand and manage the services for it – this would be directly contrary to the collaborative business relationship. The importance of each party taking responsibility for establishing clear strategic and operative roles and activities and having capable individuals with the right authority and skills in those positions to manage (and understand) the operation of the services and monitor performance is critical. Both parties should be dedicating resources to developing skills and talent from within their own organisations for this purpose. Without suitably talented individuals managing the relationship and learning from past experience, it is possible that, aside from basic cost reduction, a customer may not fully benefit from outsourcing a function.
A good governance model allows for matters to be recorded as they arise, how they should be resolved and what steps are then taken in an effort to achieve resolution. It is essential for both parties to have a record of what issues have arisen, how swiftly they were resolved and what lessons should be learnt for the future operation of the services. This becomes even more critical where there are questions raised about performance of the service provider and where the customer may seek to demonstrate that there is a recurring problem. In extreme cases, a customer may wish to use this data to support a termination right due to persistent failures.
Whilst a governance model should be robust, it should also be capable of evolution and flexible enough to suit service demand, critical business issues and technological innovation. A well-advised customer should insist upon a mechanic to allow the operation of the services to be changed or diversified to address changing markets and evolving business demands. Connected to this is ensuring that the contract also provides for a timely approach to changes in regulation and is proactive with its responsibilities in that regard. It is in both parties’ interests to ensure the flexibility of the governance model to attempt to future-proof the contract.
With recent reports suggesting that the UK economy is perhaps finally getting back on its feet and the claims that Wall Street is “back”, there is an argument that if sourcing companies can learn from past mistakes and institutionalise strong governance models, being top of the charts for profit warnings could be a thing of the past.
About the Authors
Megan Paul is a senior associate in the Corporate team at international law firm Mayer Brown. Megan has significant experience with outsourcing transactions, acting on behalf of suppliers and customers across multi-jurisdictions and in a variety of industry sectors.