Duncan Pithouse considers some of the principal contractual issues arising when implementing a multi-sourcing strategy.
In September last year, ABN AMRO announced that it "multi-sourced" its IT infrastructure services from five suppliers, while earlier this year General Motors announced that it would be undertaking a multi-sourcing programme worth 15 billion dollars. These examples are evidence that after the rise of off-shoring and insourcing, the latest public trend in the sourcing market is for multi-sourcing, a strategy moving away from outsourcing to a single supplier and into allocating bundles of inter-connected services to a number of "best of breed" service providers at competitive prices, who will in turn provide to the client a joined-up service.
Service Delivery and Contractual Structure
In some senses, multi-sourcing has been around for a long time in that few customers would be entirely dependent on a single vendor for all of their external service or product requirements. In the current context, however, we are looking at the situation where it would be feasible to acquire all of the organisation's requirements from a single source but the organisation instead decides to split them across multiple suppliers.
In order for the customer to receive the optimum benefit of a multi-sourcing strategy, the contracts with the suppliers all need to work together so as to provide, to the greatest extent possible, a seamless service. The customer can approach this in one of three main ways.
The first option is for the customer to enter into the various agreements with its chosen suppliers on a simple customer/supplier basis and to include in these agreements provisions requiring the various suppliers to work together. The agreement must also provide for an interface of the services. This model will result in the customer having to expend a significant amount of effort in managing the overall relationships between the parties, but this is, of course, a frequent feature of sourcing functions in general. By way of illustration, Gartner estimates that the internal cost to the customer of managing a "traditional" sole supplier outsourcing agreement will be in the region of 3-11% of the cost of the contract, while TPI suggests that with a multi-sourcing arrangement, the internal costs are likely to be in the region of 15% to 50% of the overall contract values.
Secondly, the customer could appoint a single supplier as its lead contractor and require it to enter into agreements with the other suppliers that have been selected by the customer, in what would resemble a traditional prime contractor/subcontractor model. This enables the customer to focus the majority of its relationship management on the lead contractor and gives the customer a single entity at which to direct any issues the customer has with the overall service delivery. The difficulty here is that the suppliers may not wish to contract in this manner and the lead contractor may not wish to take responsibility for the subcontractors (which it may not itself have selected or approved); similarly, the subcontractors may not want to be answerable to the prime contractor. If the suppliers concerned are competitors, the issue will be magnified. In addition, the lead supplier is likely to increase its price so as to include a premium to cater for the additional costs in managing its subcontractors and to guard against the failure of the subcontractors. The lead contractor is also likely to want some input into the negotiation of the subcontracts, which is likely to increase the time taken to get to signature.
Thirdly, the customer could contract with each entity individually but give one supplier (perhaps the supplier with the most "important" element of the sourced services) management responsibility for the other suppliers. In this case, the lead supplier would be required to accept responsibility for a failure on the part of the other managed suppliers to the extent that failure can be attributed to the lead supplier's failure to "manage" it. This takes some of the relationship burden away from the customer. Assuming a supplier is prepared to do this (which is in itself doubtful), the real difficulty is defining the scope of the management responsibility, which will be a concern for a supplier who is expected to take some degree of responsibility for a supplier with which it does not have a contractual relationship and, accordingly, whose ability to force that supplier to comply with its instructions is limited. It might be possible to include in the customer-supplier agreement rights in favour of the managing supplier to enforce specific terms of that contract so as to give the managing supplier the ability to comply with its management responsibilities, but this is likely to be a thorny issue and the managed suppliers are likely to resist it, especially if they would be managed by a competitor. Again, the managing supplier is likely to include a premium in its pricing for the performance of, and risks associated with, the management tasks.
In all scenarios, the customer will need to try to achieve a standard form of contract across its supplier base, which should mitigate the management effort and cost and go some way to ensuring a consistent approach from and to the suppliers. The customer will be helped in this regard by developing contract terms which are couched in deliberately reasonable and/or balanced terms, so as to increase the likelihood of acceptability to multiple suppliers.
Scoping the Services
The definition of the services will be especially important in a multi-sourcing contract so that each supplier knows exactly the bounds of its responsibility vis-à-vis the other suppliers and so the customer knows that it has not missed anything and no services are falling "down the gaps".
This comprehensively detailed approach requires a more disciplined approach than some outsourcing arrangements where broad-brush obligations requiring the supplier to take responsibility for all the tasks that the in-house department performed immediately prior to transfer of responsibility to the supplier are not uncommon. This kind of wording is unlikely to hold water in a multi-sourcing arrangement because a supplier will be even less inclined to accept a sweep-up responsibility that may impinge upon another supplier's scope of services and increase its overall responsibility. Similarly, the customer should seek to avoid interference with the other suppliers' scopes of services and limit scope creep, both of which will likely cause relationship issues and finger-pointing between the different suppliers in the event of problems. This can be achieved by defining the various service scopes meticulously.
Changes to scopes of services take on an additional level of complexity in multi-sourcing agreements. It will be important to remember that amending the scope of one set of services may well impact on the scope to be provided under another agreement. The agreements themselves therefore need to provide sufficient inherent flexibility in terms of making changes to them. For example, the contract might include an ability on the part of the customer to "force" particular changes on suppliers (subject of course to payment being made for the required changes) and a change control mechanism that includes a change request analysis that requires a supplier to consider the impact that a proposed change might have on the other connected suppliers so that the customer can achieve an holistic view of any proposed change. As ever, the agreements will need to detail carefully the price impact of changes to the services scope.
Procuring a Joined-Up Set of Services
By virtue of giving various packages of services to different suppliers, the difficulty of achieving an end-to-end service is obviously increased. However, there are a number of steps that a customer can take in an effort to mitigate this problem.
The suppliers are likely to need to work together to varying degrees throughout the duration of their respective agreements. Accordingly, it will be important to include in the agreements obligations on the various suppliers to co-operate with other suppliers engaged by the customer, preferably at no additional cost to the customer. It is possible that the co-operation that is required will include the exchange of supplier confidential information and ordinarily they will understandably resist such disclosure to their competitors. However, the customer is likely to take the view that the service it needs to receive outweighs these concerns and that consequently it requires the rights to pass (or to require the suppliers to pass) the confidential information to the other suppliers. Potentially, it may be appropriate for the suppliers to execute direct confidentiality agreements between them so as to give themselves some additional comfort and also perhaps limit the type of information which can be disclosed and the purposes to which it can be put.
Similarly, the scope of licences to use supplier proprietary material which are granted by suppliers under their agreements will need to be carefully scrutinised. As with the confidential information, a supplier may feel uncomfortable granting a licence (either directly or by way of a customer sub-licence) to a competitor, but this, at least from a customer perspective, may be an unavoidable and crucially important aspect of the multi-sourcing arrangement. Again, a form of direct relationship between the suppliers may be helpful in dealing with supplier concerns in this respect.
From a customer's point of view, it needs to remember that if it is granting sub-licences in relation to its suppliers' proprietary material, it will be accepting responsibility for the relevant material. It will need to make sure then that the scope of the use of such material is very carefully defined. Provisions relating to the customer's right to audit the use of the licensed material and to the delivery up of material provided in the course of the agreement will be essential so as to mitigate against the potential for misuse.
Performance Measurement and Fault Attribution
Given the potential for the suppliers to blame one another as well as the customer for failure to achieve service levels, those service levels will, more than ever, need to be structured and measured in a way which allows for transparent and objective measurement of the supplier's achievement against them. Not only is this a issue in relation to the service levels themselves, but the reporting and governance obligations will also need to be carefully constructed so as to ensure that the customer is gaining the right information to monitor the suppliers' performance.
In an effort to provide for a ‘joined up’ service, the customer could consider putting in place a series of agreements between the suppliers (often, referred to as operating level agreements, or OLAs) which regulate the inter-dependencies and performance standards the respective suppliers owe each other. Whilst these are often not legally binding as between the suppliers themselves, the customer can oblige the suppliers to comply with them, which means the supplier will be contractually obliged to the customer to provide assistance and meet standards in relation to the other suppliers. In effect, this allows the customer to ‘back-off’ some of the customer responsibilities contained within the agreement, to the extent such responsibilities relate to procuring the assistance of the other suppliers.
Where disputes do arise then it may be more difficult for the customer to point confidently at one supplier alone as being responsible. To provide for such circumstances, the customer should consider including in the agreements with its suppliers a mechanism whereby they can serve a notice of dispute on each supplier and require each of them to become involved in endeavouring to resolve the dispute. Falling short of this, it would be prudent to include a general assistance obligation that stretches to the provision of information in the case of a dispute.
Customers will need to be careful about suppliers seeking to provide a carve-out from liability relating to the non-performance of the other suppliers. Whilst such a provision is, to some extent, unavoidable (after all it would be harsh for one supplier to take the blame for another's default in the absence of appropriate contractual relationships between them), the agreement should ideally provide that the consequence of non-performance of another supplier does not give the supplier the right to down tools, but it should instead provide for the supplier to keep working and seek to mitigate the effects of the default. The customer may, however, need to recognise that the innocent supplier should be entitled to additional charges if additional effort is required.
Similarly, the customer may want to avoid a situation where a supplier could terminate the agreement for the customer's material breach when that breach relates to an obligation that the customer will provide that the other suppliers perform to the extent necessary to enable the supplier in question to perform; instead the agreement should set out pre-determined discrete termination rights. A supplier would instead be compensated, perhaps by way of a pre-defined ‘rate-card’, set out in the agreement.
In all circumstances where the customer is required to make additional payments to a supplier as a consequence of a customer default that in fact emanates from the default of another supplier (as considered above), the customer should make it clear in the agreements that it will not be prevented by virtue of any contractual exclusions or limitations on liability from recovering these additional amounts from the defaulting supplier.
The delivery of a multi-sourced service will not be without its challenges, from both a service provision and structural point of view. The provisions of the ‘standard’ outsourcing agreements will need to be re-thought in the light of multi-supplier procurement as issues arise that are different from those that occur in a single-supplier outsourcing. However, with sufficient planning, the right contractual structure and provisions and on-going management, these issues are not insurmountable and this best of breed sourcing approach could create substantial benefits for customers.
Duncan Pithouse is an Associate at DLA Piper Rudnick Gray Cary