Outsourcing Contract Guide: The Different Types and Best Practices

Outsourcing services can be a cost effective way of meeting the needs of business operations without an internal source. Outsourcing a service is when a company hires a third-part to perform specific tasks outside of the regular company operations. A dedicated team will perform tasks for the hiring business without the need for a full training and hiring regimine to be completed by the hiring company. Outsourcing is a great way to lower costs, but a comprehensive outsourcing agreement and contract is a necessity for a quality outsourcing relationship.

Three common types of outsourcing contracts:

1.    Time and Materials Contract

Within this type of contract, the hiring business pays the supply for work time and materials used by the outsourced service. The hiring company pays agreed upon hourly rate or wage for each member of the dedicated team as well as the cost of any software or licenses needed for the performance of duties.

Advantages: 

• Flexibility
• Decision making power
• Cost is directly related to hours worked
• Adjustments of responsibility can be made to lower costs

Disadvantages:

•  Requires some level of management
•  Cost may vary

2.    Fixed Price Contract

A fixed price outsourcing contract allows the supplier and customer to agree on one steady price for the service. A set price is provided by the outsourcing service based on the scope of work the hiring company requires. 

Advantages: 

• Cost and expectations are clear
• There is a set deadline for project completion or service cancelation
• Low cost risk

Disadvantages:

• Less flexibility
• Requires extensive pre-planning

3.    Target Cost Contract

In this type of contract, also known as “gainshare/painshare”, the outsourcing company and the hiring company agree on a figure that represents the expected cost to the outsourcing company for providing the needed service to the hiring company. Should this cost be less than projected, the two companies split the savings. Should this cost exceed the projected cust, then both companies are responsible for the extra payment.

Advantages: 

• Both parties have a common interest in maintaining cost
• The outsourcing service has a greater stake in the project
• The hiring company gains money if the cost in below target but does not lose as much if the cost goes above the target

Disadvantages:

• Cannot be utilized for open-ended assignments 
• Changes may require renegotiation

No matter the contract type, a well formed outsourcing agreement should include:

• Intellectual property rights
• Business process
• Detailed description of services
• Payment schedule
• Insurance requirements
• Warranties
• Contract terms
• Service level agreements
• Project scope
• Exit strategies
• Terms and conditions
• Expected timeframe
• A confidentiality clause
• Policies
• Marketing plans
• Force Majeure
• Transfer of Assets
• Dispute Resolution
• Failure to perform clause
• Indemnification clause

One type of outsourcing agreement will not be the best choice for every business need. It is important to evaluate each project need and determine which type of outsourcing relationship best fits your needs. You may desire to include pre existing intellectual property rights for one project but you may not need to include in your agreement marketing plans for the same project. 

Certain contract components may be more beneficial for a hiring company than others. These have been determined to be:

• Detailed Project Scope

This provides a clear expectation of service to the contractor. For example, an outsourced call center should be provided with a list of duties such as taking incoming calls, performing outgoing calls, and maintaining a chat forum.

• Service Level Agreements

This sets a benchmark for the quality of service expected from the    outsourced company. Service levels should be clearly written out with expectations and quality control benchmarks.

• Intellectual Property Clause

This prevents the theft of ideas by the third party company or service workers. 

• Cost and Payment

This allows for a clear layout of cost, as well as payment schedules and payment structure.

• Duration of Completion

This defines the scope and deadline of the project to layout a potential compensation plan for any failure to meet the deadline or requirement for extension of deadline.

• Transfer of Assets

This allows for the safe transfer of assets necessary for project completion  such as software licenses, telecommunication equipment, or computer hardware. 

• Warranty for Product

This safeguards the hiring company from any breach of contract and surrounding litigation.

• Ownership of Product

This provides guaranteed ownership of the results of the service such as software development, or customized goods created. Upon completion of the contracts terms, the product should be clearly stated as owned by the purchasing company.

• Dispute Resolution

This allows for a third-party arbitrator to be assigned in the event a dispute were to happen to minimize cost. 

• Indenification Clause

This ensures that any neglect on the part of the outsourcing service is felt by the outsourcing company only.

• Exit Strategy

This lays out a plan for smooth termination of business with the outsourced company. Long term contracts should still expect to have a well thought out exit strategy.

Contracts are a very important component of business to business transactions. Every contract should be read over extensively by both parties lawyers and business partners to ensure each company’s best interest is being taken into consideration. A company thinking of outsourcing a portion of their business should be sure to perform extensive research on the potential contractors and their business practices. There are many different options for outsourcing that should be taken into consideration based on what type of service your business requires. 

Outsourcing Company Options

1.    Onshore Outsourcing:

The outsourcing service resides within the same country as the hiring business. 

2.    Nearshore Outsourcing:

The location of the outsourcing company resides outside of the country of the hiring company, but within close proximity.

3.    Offshore Outsourcing:

The outsourcing company resides outside of the scope of the hiring company.

Types of outsourcing:

• Professional Outsourcing

This type of outsourcing encompasses all specialized services such as accounting, administration, marketing, call centers, and purchasing.

• Process-Specific Outsourcing

This provides niche services such as knowledge process outsourcing (KPO), Legal process outsourcing (LPO) and recruitment process outsourcing (RPO).

• Business Process Outsourcing

This allows for a third-party company to handle any mundane business activities you may require.

• Manufacturing Outsourcing

This can be utilized when demand overruns supply.

• Project Outsourcing

This can be utilized for both short or long-term projects that may require skills that the company lacks.

Operational Outsourcing

This includes services such as landscaping, delivery and equipment repairs.

Clearly, there are many factors to consider when deciding to outsource a business operation. These factors can range from the duties needed to be performed to the country of origin of the outsourcing business. Outsourcing requires extensive thought and ample planning on the hiring companies end.

A business should not simply choose the cheapest options or take shortcuts when it comes to the contract and its clauses. Be sure to choose the outsourcing service that fits your business needs the best and decide what type of contract your needs require.

These contracts may take time to develop and perfect. It is important to be patient and wait until all protections have been implemented before beginning a business partnership. Outsourcing can be a cost-effective business option, but it is not without risk so it is imperative you include these terms and conditions mentioned in your outsourcing contracts. Contact us and learn more about outsourcing contracts.