Growing Trend in Re-Shoring: Exploring Termination/Expiration Provisions

A recent special report in the Economist focused on the general state of the offshore outsourcing industry, with a particular focus on the emerging trend of companies relocating the performance of IT services from offshore locations to locations closer to home in the United States (known as "re-sourcing"). The report cites a number of reasons for this trend, such as the increase in wages in offshore locations, performance issues by offshore service providers, and the inherent challenges posed by the distance between a U.S.-based customer and the offshore service provider. The Economist isn't the only one to take notice, a recent article on CIO.com cited a number of similar factors contributing to the new attractions in keeping outsourced resources stateside.

The Economist notes that 67% of American and European outsourcing contracts have some element of offshore outsourcing, so most customers with any sort of outsourcing agreement are impacted by the changing landscape of the offshore outsourcing industry. However, deciding to move services back from an offshore location isn't as simple as flipping a switch (or sending a notice of termination). There are major risks in terminating and transitioning IT services, and the service provider, having been notified that their services are no longer required, is hardly in a motivated position to help mitigate those risks.

Common risks associated with terminating an outsourcing contract include potential disruption to, or degradation of, service, loss of critical resources (e.g., people, equipment, software) and loss of historical knowledge relating to the impacted environment (i.e., scant or insufficient knowledge transfer by the service provider to the customer or the successor provider). Put another way, at the time when the customer is most vulnerable to service disruptions and unanticipated costs, the service provider has the least incentive to provide quality assistance and services. The question that follows is, what can a customer do to protect itself from the pitfalls of re-shoring services either by taking the services in-house or sourcing them to a successor provider?

The best answer is to make sure that the contract addresses the risks inherent in re-shoring services by including robust termination/expiration assistance requirements. It may feel like planning the divorce while preparing for the wedding, but it is crucial that a customer obtain clear contractual rights that will make any exit from the contract go as smoothly as possible. In particular, the customer should ensure that the contract includes:

  • An obligation for the service provider to continue to provide the base services while the services are being re-shored;
  • A right to procure from the outgoing provider sufficient rights in the critical assets that are used to provide the services, such as equipment, software and third party contracts;
  • A right to hire critical personnel from the incumbent service provider (while the customer ordinarily will not be hiring offshore personnel, there are often key on-shore personnel assigned to the account that the customer may want to hire);
  • Clear ownership rights in deliverables that were developed by the service provider;
  • A requirement that the service provider provide sufficient knowledge transfer to the customer (or successor provider) about the services;
  • A comprehensive re-transfer plan, which should include the details of the knowledge transfer requirements;
  • Clear pricing (usually in the form of a pre-agreed personnel rate card) for services requested and approved by the customer that are in addition to the base services, if any;
  • A list of operational activities that the service provider must perform to re-transfer the services, assets and knowledge; and
  • An obligation for the service provider to provide general cooperation and assistance to the customer and any successor provider.

While obtaining these types of contract clauses as part of the initial contract is ideal, what if a customer is contemplating re-shoring an existing offshore contract that lacks these protective exit clauses?

  • First, be prepared to devote more time and resources to marshal the actions needed to mitigate the risks. Whether or not the contract contains the robust exit terms described above, a customer will be well served by assigning a dedicated transition manager to oversee re-shoring of the services, and an internal team to manage the re-shoring effort.
  • Second, the customer should start the planning process as soon as it decides (or is fairly certain it will decide) to re-shore the services. The timing of notice to the incumbent service provider must be carefully considered and, if possible, should be orchestrated to occur only after (i) the successor approach (be it in-house or external re-shoring) has been decided, and (ii) some form of transfer plan has been developed by the customer.
  • Third, in the absence of an existing plan (and detailed terms) under the contract, formulate a "proxy" plan that establishes the key steps and requirements (analogous to the key points noted above) for an effective transfer. Of course, this may require some measure of negotiation with the incumbent service provider and may require some additional financial investment to secure the cooperation of the service provider (e.g., payment of time and materials charges based on a negotiated rate card). However, this investment may well save time and money, including by reducing the headaches, risks and potential costs of service disruption.

As with any major transition of services, re-shoring carries inherent risks and potential headaches. The best preparation is a combination of the right contractual terms and a mindset (and process) premised on the need for a dedicated team and advanced planning.