UK: Maintaining Value in Outsourcing Deals

Last Updated: 28 July 2004
Article by David Strang

Entering into a long-term outsource deal inevitably requires a great deal of commitment on the part of both supplier and client.


A mistake in the due diligence process by the supplier could lock it into a loss making project which will literally bleed cash for a number of years, whilst the client will worry about the effect on its business should the supplier fail to perform, or should the costs escalate beyond what has been budgeted. Much emphasis is accordingly placed on getting "value" from the deal, not just at its outset but also through the remainder of the contract term.

Why Is Maintaining Value Important?

From a client perspective, maintaining value is usually embodied in price controls and review, and ongoing service incentives. If such matters are not addressed in the contract at the outset, the balance of negotiating power will have swung firmly to the supplier, who may seek to squeeze maximum fees from the client for the minimum possible level of service (at least during the early days of the contract, i.e. before the "carrot" of contract renewal or extension is in view). Suppliers are of course used to seeing service incentive and price control provisions on such contracts, but will be concerned to ensure that they are set at a realistic level, so as not to unnecessarily inflate the cost of providing the service (which may make the supplier’s bid seem uncompetitive), or put it at risk of incurring financial penalties when its level of service is, objectively speaking, adequate.

What Are The Tools?

There are 4 key mechanisms for maintaining value in a long term outsource deal namely:

  • Service Levels and Credits
  • Benchmarking
  • Cost Controls
  • Break clauses and termination rights

These are considered in turn, below.

1. Service Levels And Credits

Service Levels are probably the most obvious incentives/monitoring tools which come to mind when considering long term service arrangements. Put simply, they are the means by which the client specifies the expected level of quality for the services it is to receive, and the financial implications for the supplier should the actual delivery experience be less than was expected. The nature of the service levels will obviously depend on the nature of the services being outsourced; common examples in an IT context, however, will include:

  • Time to respond to/fix notified errors or problems with the outsourced estate;
  • Levels of availability of the outsourced systems;
  • Response times, in terms of the speed of completing defined instructions;
  • Packet loss/delay, e.g. the number and/or proportion of data packets sent between particular nodes which are lost or delayed in transit;
  • Adherence to budgets/timescales; or
  • Performance by reference to a "scorecard" (usually incorporating a number of subjective as well as objective considerations).

Undoubtedly, service levels provide an essential mechanism for keeping track of the quality of the services being provided, and keeping a supplier’s mind focussed upon not only setting its service function up correctly at the outset of the contract, but also maintaining a consistent level of service thereafter (for fear of having its margins eroded or wiped out altogether by the application of service credits if it fails to do so). However, simply setting a service level is just the start of the process; other factors to consider include:

(a) The amounts to be placed "at risk"; should there be a limit, and if so should it be an absolute amount or set at a percentage of the supplier’s revenue?

(b) Over what period should performance be measured? The shorter the period, the more onerous the regime will be (as there will be less scope for a supplier to "even out" isolated blips in its service provision).

(c) What will happen once any cap on service credits has been met? Will this simply be the limit of the supplier’s liability, or will such poor performance trigger any additional rights, such as a right of termination or for the client to "step in" to provide the deficient services itself or via another provider?

(d)Whether the supplier will get any kind of bonus for exceeding the defined service levels, either individually or on a consistent basis, or at least have an ability to "earn back" service credits otherwise incurred by establishing a pattern of consistently better performed services during the subsequent measurement periods?

(e) Whether service credits will constitute the supplier’s sole and exclusive remedy for the failures in question, or whether the supplier will in any event also remain potentially exposed to damages claims by the client.

(f) How will performance actually be measured? Will it be automated and therefore objectively verifiable, or will it be the responsibility of one or other of the parties to measure it? What will the parties do if they dispute such measurements?

(g) Can the service levels be adjusted over time, e.g. to reflect advances in technology or simply new areas of activity or business imperatives on the part of the client?

2. Benchmarking

Benchmarking has over time become established as a key component in longer term outsource deals, as a means for a client to compare the fees and levels of service received from its supplier against what is common (or at least readily attainable) in the wider market. It invariably involves engaging a third party consultant (from organisations such as Gartner or Compass) to carry out an analysis of identified services or elements of the fees, so as to "benchmark" them against comparitors in the market.

As ever, the devil is in the detail. There may be difficulties in establishing a statistically significant set of other projects/contracts which are sufficiently similar to that which is to be benchmarked, and the market is in any event fast moving (especially with the distorting effect of off-shore outsource suppliers, who operate on the basis of a completely different cost base). Even if reasonable comparitors are available, the parties must agree what the results of the benchmarking exercise will be; will it, for example, simply trigger "discussions" between the parties, or will adverse findings result in the supplier being bound to raise its service levels or lower its charges? If price reductions are to be made, will the reductions be to the lowest price identified by the benchmarking process, the median price or the one at the top of the range of "reasonable" fees? Might the supplier even receive some kind of bonus or uplift if the benchmarking exercise finds its level of service is abnormally high, or that it is providing a particularly cost-effective service?

Failing to address such issues at the outset can be disastrous; in the recent highly publicised spat between Cable & Wireless and IBM, there was nothing in the contract to explain what would happen in the event of an adverse benchmarking report, beyond the obligation to produce a remedial plan. IBM was so incensed with the findings of the benchmarker’s report on their services that they refused to produce a plan until the exercise was redone, leading in turn to Cable & Wireless commencing a multimillion pound law suit against IBM and terminating the underlying outsourcing contract.

3. Cost Controls

There are various ways in which the contract’s cost and price provisions can be adjusted so as to retain the essential flexibility required to ensure that the contract remains relevant to the changing requirements of the business. They include:

(a) Budget Overruns – i.e. setting target prices or budgets for any work to be undertaken on a time and materials basis, and providing that the supplier’s fee rates will gradually be reduced the further over budget it goes. Conversely, the supplier can be rewarded for bringing in a project successfully under budget by an additional payment of a percentage of the delta between its actual costs and its target/budget.

(b) "Arks and Rooks" – when the actual scope of use or a service is unclear or is likely to vary considerably over time, it may be impossible to come up with a meaningful fixed fee; in such circumstances, a preferable approach may be to implement a usage-based pricing scheme (whether based upon numbers of units/transactions processed, number of FTE staff replaced or otherwise); having set a baseline for such usage pricing, this can then be adjusted upwards if the requirements grow (Additional Resource Costs – ARC’s or "Arks"), or downwards if the needs of the business decrease (Reduced Resource Costs – RRC’s or "Rooks"). Such a mechanism will often be linked to ceiling and basement levels for the client and supplier respectively, which will trigger rights of renegotiation and, potentially, termination once the figures reveal the circumstances faced by the parties have so far altered from what was originally envisaged that a new approach is required.

(c) Transparency of Pricing – clients may be suspicious of an outsource supplier’s costs projections, on the basis that once they have committed to the contract, the supplier may be able to "run away" with the service and end up charging substantial amounts over and above what was originally envisaged, thus depriving the client of much if not all of its projected financial benefit. One way to provide reassurance that this is not the case is to require the supplier to disclose its actual level of profit from the contract (often termed "open book" accounting, a method which is particularly prevalent in public sector outsourcing deals). To this can be added a provision whereby any profit in excess of a defined cap is then remitted, either in whole or (more usually) in part to the client, by way of payment rebates ("gainsharing").

4. Termination & Break Clauses

Ultimately, the only way to ensure that value for the business is maintained may be to actually bring an outsourcing deal to an end; this could be because the supplier’s performance has not met expectations, but may equally be because the needs of the business have changed so dramatically that there is no longer any "fit" between it and outsource provider.

What is key in such circumstances is to try to ensure that the parties have certainty not only as to when the contract can be terminated (e.g. upon specified break events, upon notice, upon adverse benchmark findings, when service levels dip below specified thresholds, or perhaps at certain identified break points) but also as to the consequences of termination. This will extend considerably beyond the potential payment of damages, so as to also include return of data, information and assets, the transfer of staff under TUPE, the provision of assistance to an incoming replacement supplier, and possibly an obligation for the supplier to continue providing some or all of its services for a defined period, notwithstanding the termination of the overall contract. Where the supplier is not itself at fault, it will want certainty as to its rights (particularly as to payment and protection of its confidential information and IPR).


With the accumulated learning from the increasing volume of past outsourcing projects, and the occasional horror stories from those which have gone wrong, one can see the similarities between outsourcing and a successful marriage; they need to be entered into after a great deal of thought and preparation, and require considerable flexibility as they proceed. However, one could add that outsourcing is perhaps more like a Hollywood style liaison, in that each such marriage also requires a thorough pre-nuptial agreement to ensure that both parties understand what they might be taking out, as well as putting in!

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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions