Shifting from Traditional to Digital Contract Terms
By leveraging digital technology, outsourcing providers … This is a fundamental change in outsourcing that will require fundamentally different contract terms. Brad Peterson discusses the difference between traditional and digital contract terms in this video. Here, Rebecca Eisner, Daniel Masur and Brad Peterson further explore the history – and future – of outsourcing.
The future of outsourcing is digital. Outsourcing providers will increasingly use digital systems to offer faster, smarter, better and cheaper services. Functions currently performed by people will increasingly be automated. Outsourcing contracts built on the traditional assumption that the services are provided by people supported by tools will be fundamentally changed to reflect that the services are provided by digital tools supported by people.
Traditional Outsourcing in the Rear View Mirror
Traditional outsourcing started with IT specialists running massive computing equipment in data centers in the 1960s using knowledge and skill developed from serving numerous customers. Later, outsourcing innovators found ways to use shared service centers to have teams of people deliver a wide range of business processes to many customers.
When low-cost global connectivity became available, outsourcing innovators created shared service centers using people in low-cost locations to share the benefits of those services across a global customer base. More recently, advances in grid computing and virtualization allowed outsourcing innovators to share use of standardized IT infrastructure in what has been called “cloud” and cloud-based software in one-to-many “Software as a Service” (SaaS) models.
Adoption cycles for new types of outsourcing have begun with waves of small, innovative deals, including pilot projects and deals with previously unknown players. In the offshoring era, buyers were puzzled by, and later embraced, previously unknown Indian companies. The cloud era surprised buyers with new leadership from an online bookseller, a software company and a search engine provider, along with hundreds of venture-funded point-solution SaaS providers. As integration challenges increase and some providers develop winning solutions, leading providers have emerged.
Each new type of outsourcing has added a lane to outsourcing instead of fully replacing prior types of outsourcing. For example, customers continue to outsource data center management. With each new lane, the ecosystem of outsourcing providers and advisors have pivoted— successfully thus far—to find new ways to deliver the next 10 percent to 30 percent of customer savings and value using new processes and technologies, while outsourcing lawyers have found contractual and compliance solutions to address the new risks in the new lane.
The Digital Outsourcing Lane
Switching our gaze from the rear view mirror to the road ahead, we see a new lane that we call “digital outsourcing.” Unlike traditional IT and business process outsourcing, the services in digital outsourcing are performed entirely by machines instead of people. In this new lane, people create digital execution strategies, maintain and configure digital systems, handle exceptions, integrate across digital platforms, monitor outcomes and interpret data. However, people do not directly perform the services. Unlike a traditional cloud provider, a digital outsourcing provider takes responsibility for performing a customer-specific business function instead of providing a standardized one-to-many service.
In the near term, the quick wins in the digital outsourcing lane are coming from software dubbed “robotic process automation” (RPA). RPA software operates at the presentation layer (so it looks to a software application like a human user). RPA software can be programmed to carry out rules-based tasks now performed by people in traditional outsourcing deals.
A larger opportunity, but further away, is artificial intelligence (AI). AI is being used today to replace human spoken conversations with “chatbots,” to replace drivers with autonomous vehicles and to derive human-like insights from patterns in data. In the future, AI may be able to provide services that are beyond human capabilities.
Still farther down the road, we see digital outsourcing providers providing and maintaining blockchains and other shared digital ledgers to store information and effect transactions for multiple customers. These technologies would create savings by having a single system of record for many companies instead of having each company maintain its own system of record.
Digital outsourcing will gradually replace the work in the other lanes, but we expect the other lanes to continue. There is a great deal of currently outsourced work that is too idiosyncratic, unstructured or inherently human to automate. Innovation, creativity, relationship building, physically delivered services, software maintenance and adapting to technological and market changes are well beyond the headlights of digital technology for the near future. We thus expect to see both digital and traditional outsourcing lanes for years to come, much as providers have delivered both offshore and onshore outsourcing services in past years.
Changing Lanes from Traditional Outsourcing Terms to Digital Outsourcing Terms
The best contract terms for digital outsourcing are fundamentally different than the best contract terms for traditional outsourcing. The differences are not merely a few terms to be addressed as a simple rider, but are instead pervasive. For example:
Transition is no longer merely knowledge transfer and training, but also includes programming, testing and acceptance of the provider’s automations and integrations with retained systems. However, transition investment is reduced, because fewer people are trained and fewer assets are transferred. These changes continue the long-term trend of reducing transition costs and thus reducing the need for long contract terms to recover the provider’s investment in transition.
Scope is not FTEs performing designated tasks in accordance with policy; instead, it is completing defined actions, producing specific outputs or achieving specific outcomes. This requires a shift from role descriptions and sweep clauses to defining what problems the provider is to solve and how to measure how well the provider has solved those problems.
Service levels do not measure processing speed and accurate transcription (which are almost inherent for digital labor) and instead measure, for example, how quickly coding defects are corrected, the percentage of work slowed by exception handling or the value of the outcomes generated.
Governance provisions become more important because the seamless digital interface removes the opportunity to solve problems by talking directly with the people performing the services. Governance provisions must establish a connection to the “bot managers” who can change how the digital service works and the “exception managers” who can change how people do what the automated service cannot do.
Personnel provisions requiring good and workmanlike effort by adequate numbers of suitably experienced, qualified, trained and drug-tested people, which serve as a proxy for quality in traditional outsourcing agreements, become less important. Promises of quality shift to the quality of actions, outputs or outcomes versus the quality of the humans who are acting.
Pricing moves from charging for effort to charging for actions, outputs and outcomes. Pricing thus is less about wage costs and the difficulty of scaling human operations. Pricing based on actions, outputs and outcomes requires higher levels of drafting skill and understanding of the business, particularly if the results depend on actions by the customer.
Change control becomes focused on changes that will require changes to the automations and integrations. The customer can no longer assume that the people on the supplier team will figure out minor changes. The complexity of change control is thus increased, particularly if the digital outsourcer is acting as an integrator of evolving third-party technologies or running processes that are deeply integrated with processes retained by the customer.
Technology standards focus on the customer’s ability to exchange data effectively with the provider and to take back responsibility for the service upon an expiration or termination. A common approach, for example, is to designate the type of RPA software used to create “bots” to automate repetitive tasks. That allows the customer to take back responsibility for a function by getting a copy of the RPA scripts and licensing the RPA software.
Data security focuses less on policies designed to teach and control the people performing services to and more on policies and tools designed for digital cybersecurity threats.
Data localization requirements might be addressed by having local processing of local data on local servers (although this represents a real challenge to blockchain and distributed ledger systems).
Data rights become more central and more contentious because the digital system may generate derived data and insights that human workers could not identify. This may be a new source of value in the outsourced process, generating new revenue or savings opportunities for the customer if the supplier has the obligation to pass them along. Increasingly, we are seeing providers asking for the right to monetize the insights they gain from sitting astride flows of customer data.
IP rights fundamentally change and must be addressed by contract, because machine creations may not be property under copyright laws written to protect only human creations.
Third-party consents may be required for use of automated services with licensed software or cloud subscription agreements. Some prohibit interfaces with robotic users. Some deem use by RPA software as “indirect use” by the people who get data through the RPA software, which could create noncompliances or surprise charges.
Exit rights continue to include the return of customer data and the provision of reasonable transition assistance. However, if the digital outsourcing is performed on a multi-client platform, there may be no people, software, equipment or facilities to transfer. Functions that are performed using “black box” AI technology may be impossible to transfer to other AI platforms. Additional services may be required to decouple integrated processes.
Where to Go Next
Digital transformation is creating a new lane for outsourcing. For you to maximize value and avoid pitfalls in that new lane, you need new and different contract terms in both existing and new contracts and to adapt third-party contracts to digital outsourcing. That adaptation requires investments in understanding the digital outsourcing model and outsourced businesses and adopting new sourcing, contracting and governance approaches.
The opportunities are not limited to new deals. Your current outsourcing providers likely have begun digital outsourcing under traditional outsourcing terms. They may have stayed quiet about the changes, preferring to capture all of the cost, data and other benefits of new technologies and to avoid taking on new contractual obligations described above. To maximize value and avoid pitfalls, we recommend that you identify the changes that existing providers have made, send correspondence noting the changes required approval under your contract and renegotiate to obtain suitable protections.
With respect to both current and new deals, smart investments include updating forms and policies to include digital outsourcing terms where applicable, planning larger investments in deal structuring and negotiation to address novel issues and adapting governance specific for digital outsourcing. With those investments, your company will be able to maximize value and avoid costly pitfalls in digital outsourcing, the new lane on the outsourcing highway.
This article originally appeared in the Mayer Brown e-book, Technology Transactions: Thriving in an Age of Digital Transformation. It is republished here with permission.