The Ins and Outs of Outsourcing

According to a recent Outsourcing and Insourcing Report compiled by Deloittes, the trend towards IT outsourcing is increasing, with clients looking to optimize vendor relationships and improve operational efficiency. The report noted that the outsourcing industry is set to grow by several key dimensions, including functions, services and locations. Technological advancement and innovation such as cloud computing, big data, mobility, and business process as a service, are changing the game and demanding expert management, integration, analysis and advice.

In this regard, Preeta Bhagattjee, director and Head of the Technology, Media and Telecommunications practice at Cliffe Dekker Hofmeyr has put together a short guide on the initial steps in the outsourcing process.

The first step is always the comprehensive analysis of a customer’s specific business processes and problems in order that a practical and workable solution to a client’s needs can be found.

This solution is then drawn up into a request for information (RFI) or request for proposal (RFP) specification document. The customer then identifies and invites potential bidders to respond to the RFI or RFP. In some cases, a customer may first issue a RFI and then require formal bids in a subsequent RFP process.

As part of the RFP documentation, the customer may include the text of the outsourcing contract, which it intends to conclude with the successful bidder (or a term sheet containing the key legal risks which a bidder must assume); its required service levels; and specific service requirements.

The customer then assesses and evaluates the RFI and/or RFP responses. This may include onsite investigations, client site visits and due diligence exercises on the bidders.

The bidders may also carry out a due diligence exercise of the customer’s service environment to allow for more accurate and binding pricing offers. The timing of these due diligence exercises depends on the number of phases in the tender process. Generally, the customer does not choose a successful bidder before it has shortlisted and entered into negotiations with a number of the bidders. Additional regulatory requirements apply to outsourcing in the public sector.

With the high rate of innovation and technological advancement, some technologies are not seen as a good fit for the lengthy RFP model. In this regard big companies will be looking for new purchasing processes, such as enterprise marketplaces, where customers can subscribe to Software-as-a-Service applications that are integrated with their current services providers.

Legislative requirements

When it comes to legislative requirements, South African law does not specifically regulate outsourcing transac­tions but there are specific requirements for those entering these sorts of arrangements, and they differ depending on the sector of the businesses involved. 

In the financial services sector, banks in South Africa who outsource operations to a third party are required to notify and/or obtain prior written approval from the South African Reserve Bank (SARB) of any outsourcing arrangements that constitute material business activities and functions of a bank, according to the Banks Act Guidance Note 5/2014.

The Financial Services Board also prescribes similar requirements for financial services institutions in terms of the Financial Services Board Directive 159A, which places significant duties on insurers to make sure that, in respect of any outsourcing arrangement, sustainable business continuity and disaster management is in place and that the outsourced service provider is properly assessed to ensure it can fulfil its responsibilities. Insurers are required to notify the Registrar at least one month prior to the effective date of the proposed outsourcing agreement.

There are no specific regulations that are relevant to business process outsourcing or IT outsourcing. And while, there are also no regulations that deal specifically with telecommunications outsourcing, the supplier must comply with any relevant aspects of the telecommunications laws and regulations (the main law is the Electronic Communications Act 2005).

The supplier may also need to be appropriately licensed and/or to obtain consents or approvals. In some cases, depending on the outsourced services, the supplier must comply with telecommunications regulations over and above those which apply to the customer.

Any public sector outsourcing or procurement tender process requires careful consideration of the various legislative constraints under which it is conducted. All government procurement in South Africa must be fair, equitable, transparent, competitive and cost-effective (according to the Constitution of South Africa). Statutes regulating these activities include: The Public Finance Management Act; The Municipal Systems Act; The Municipal Finance Management Act; The Broad Based Black Economic Empowerment Act; The Promotion of Administrative Justice Act; and the Preferential Procurement Policy Framework Act.

Common law and the general rules applicable to administrative and constitutional law also apply and public entities are required to act strictly within the legal bounds conferred on them by statute.

Legal structures of outsourcing transactions

There are various legal structures that are commonly used once the outsourcing project is ready to go ahead. The right structure for the outsourcing deal will depend on the nature of the transaction.

Single supplier outsourcing

Single supplier outsourcing is the most common form of outsourcing arrangement. An entire service requirement is outsourced to one supplier with whom a comprehensive outsourcing agreement is concluded. If the services require the services of a third party other than the supplier, it is the supplier’s responsibility to subcontract such services to any third parties, usually with the customer’s prior written consent. Despite any such subcontracting, the supplier continues to retain full responsibility for the service provision to the customer. Therefore, the supplier is responsible for meeting the full set of service levels which are imposed on it by the customer in terms of the agreement. The supplier is usually required to take out adequate insurance to cover its risks under the contract. The customer may require a parent company guarantee from the supplier’s ultimate parent company.

Multiple-vendor sourcing

For strategic business or technical reasons a customer may prefer to engage in sourcing arrangements with multiple suppliers within the same service or operational area or division within its business. If so, the customer enters into separate agreements with each supplier but must ensure that appropriate accountability is contracted for with each supplier, with stringent provisions that each supplier fully co-operate with the others when required. This type of arrangement requires specific management of each of the suppliers and the interfaces between the services which each supplier provides to the customer. 

One of the key trends in outsourcing is the growth of multiple-vendor outsourcing, due in part to the popularity of the cloud and also because of Software-as-a-Service. This has increased the need for the continuous management of supplier IT risk, with companies now integrating IT supplier risk into their day to day business operations.

Service provider with an integrator function

In the multiple-vendor sourcing model, the customer must integrate and co-ordinate the services of each of the suppliers. In this model the customer contracts a third party to carry out this function instead and has that party ensure timely, seamless and continuous service performance between all the relevant suppliers.

Joint venture (JV) arrangements

In some cases, the customer enters into a JV arrangement with its supplier, setting up a separate company in which both the customer and supplier has an interest. This allows both parties to commercially benefit from the arrangement. The customer can therefore exercise greater control in the management and opera­tion of the JV and the ultimate service provision to itself.

As the complexity of outsourcing transactions grows and clients become increasingly sophisticated in their needs and demands, the provision of the right set of outsourcing services will become as much about IT analysis as it is about expert advice. Enterprises now need outsourcing projects that are carefully managed and integrated to take into account the growing usage of multiple services providers delivering ever-changing IT products to a demanding market. The right legal processes, structures and advice are crucial.