New Zealand: IT outsourcing contracts – five tips for SMEs

Last Updated: 15 January 2019
Article by Andrew Oh
Most Popular Article in New Zealand, January 2019

When Kodak famously outsourced its entire IT function to IBM it marked both the dawn of IT outsourcing as a business strategy and, arguably, the beginning of Kodak’s end.

Since then, the breadth and prevalence of IT outsourcing has grown. It is common now to have third parties providing IT consulting, maintenance and support, and operations functions for critical business systems. SaaS products have replaced many substantial enterprise systems.

Outsourcing has become normal at all levels of the economy, but failures can hit small to medium enterprises hardest.

More often than not those failures flow from unrealistic expectations on both sides as to what can be achieved, what is involved, and at what cost. And the delays and changes come at cost.

What can you do to minimise the risks inherent in engaging an IT service at the outset? These are our top five tips for IT outsourcing agreements.

1. Know what you will do if it doesn’t go right.

The first tip is a practical one. Do you have a way back? Do you have the in-house expertise to roll back to a legacy system, or maintain business as usual if things go awry. If not, take mitigating steps in your contract.

How can you terminate? Do you have step-in rights that will allow you to pivot to a competing supplier, and will your supplier cover those costs? Do you have underlying control of the key infrastructure and code base if you do need to exit?

2. Leverage

Is your supplier proposing to be paid monthly on a time and materials basis, or even with a large upfront deposit?

Will they be in charge of critical IT assets, with all of the technical know-how, and you entirely reliant on them if you fall into a dispute?

Consider structuring your payments to give you some meaningful leverage. For example larger instalments on successful (and clearly articulated) milestone completion.

Encourage your supplier to share the risk (which can mean improving their upside if it all goes well).

3. Pay attention to warranties

It is important to establish exactly what the warranties your supplier gives you entitle you to.

The concept of a warranty in an IT context is slipping and sliding ever closer to the concept of support and maintenance.

It was once the case, in the days of large installed software, that the warranty period was the length of time during which the software, once installed would operate error free. If it didn’t, your supplier would fix it at their cost. Sometimes, if you had negotiated particularly well, you were also entitled to reparations (service credits, rebates, etc.) for that downtime or failure.

In the SaaS age though, a warranty period is often no more than merely a period of free support and maintenance. The supplier provides the software, integrated or not, on the basis that it may well have errors from the get go, but the supplier will iron them out during the warranty period. A very different set of expectations.

Neither of these are to be confused with a formal legal warranty, in the sense of a promise, such as a warranty of non-infringement of third party intellectual property.

All of them can work for you or against you, some are must-haves and some are situation specific, but you must be clear what you’re buying.

4. Keep it local

Even a significant dispute may be uneconomic to pursue if you have to go to another jurisdiction. Where at all possible, keep your dispute venue local.

As well as jurisdiction, it is well worth spending time on the dispute mechanisms. There aren’t many other types of agreement where they are more likely to be used.

Lightweight dispute processes which amount to little more than management negotiations are not much to rely on when the going gets tough and the relationship has broken.

For larger deals it is not uncommon to require the international supplier to provide a letter of credit from a local bank or in some other way guarantee their own performance.

Failing to incorporate thorough dispute and venue provisions can leave you writing off your initial outlay at the same time as you spend more to pick up the pieces.

5. Contract management and change control

Scope creep (or perceived creep) is one of the leading causes of dispute. Either a supplier thinks they’re giving away value, or a buyer thinks the narrow scope excludes things they thought were in scope from the start.

Spend the time up front to scope the project out fully, ensuring deliverables and acceptance criteria are clearly defined.

If a supplier claims that too much contractual detail jeopardises an “Agile process” (or similar), have a very frank conversation with that supplier about what exactly they think they can deliver. Be clear on the outcomes, and write it all down.

Suppliers need certainty as much as buyers. Both parties want a successful outcome.

If a project is staged or too big or uncertain to scope out end to end at the get go, ensure the first stage is clearly scoped and realistic off-ramps exist.

Be clear who can change the contract scope, and how. Scope and requirements will inevitably shift, so change control is critical to avoiding dispute.

The last tip: seek legal advice, preferably from a lawyer who is not directly connected to the project’s success and who can impartially work with you to draft the documents accurately and clearly.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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