Here, we take a look at some legal trends that will surely affect your BPO operations. Some of the trends are simply tactical responses to the global economic liquidity freeze. Others will have a long-term or permanent strategic impact on the BPO global services markets.
If you have any questions or comments about the implications or implementation of these trends for your organization, please feel free to contact the author (firstname.lastname@example.org).
1. Back to Basics: Contract Renegotiations.
The global economic shocks following the sub-prime mortgage crisis, the stock market crash of 2008 and the governmental takeovers or forced marriages of distressed financial institutions sets a compelling framework for renegotiation of all existing outsourcing contracts. The focus of renegotiation might be “the same for lower cost,” “more for the same cost” or “restructuring for flexibility.”
Technically, a service recipient seeking to restructure a contract runs the risk of engaging in “anticipatory repudiation” of the contract, leading to damages and/or termination fees. This risk is actually temporary, since every outsourcing contract can be ended by allowing an expiration to occur. To avoid re-bidding (and loss of renewal), global BPO providers will listen carefully and try to keep clients happy.
Enterprise customers can be expected to take advantage of this situation for productive discussions. Key goals for the customer may include:
* Pricing flexibility, to account for more volatility in demand for resources;
* Improved flexibility on management of service levels;
* Improved governance procedures to reduce costs of administering multiple services from multiple sources, implement new customer-focused control procedures and gain visibility and improved alignment relating to the enterprise customer’s core business.
Prediction: Every contract that expires in 2009 will be renegotiated early, and 80% of BPO contracts expiring in 2011 will be renegotiated in mid-2009.
2. Globalization: Consolidation by Mergers, Acquisitions and Rollups of Suppliers.
Classic economics analysis indicates that industries consolidate when there is an excess of capacity or shortage of demand. Some providers exit the market; others merge or acquire the strongest or more prescient conduct rollups, a process of serial acquisitions. For the global services industry, a rollup strategy must be multinational. Hence, a downward economic cycle offers special opportunities to acquire operations across the globe.
Prediction: The year 2009 will likely see an increase in such consolidation, with some significant global rollups in BPO.
3. Globalization: “Right Shoring”.
Risk management is founded on identification, assessment, quantification, prediction and diversification of risks. In contrast, outsourcing is based on scalability of volumes, cost savings and often involves dependency on one supplier for critical businesses functions. In short, outsourcing conflicts with risk management. So customers need focus on risk management techniques.
Among the greatest risks in global services are geopolitical risks. Diversification requires alternative delivery service centers, preferably across time zones, electric grids and national boundaries.
Enterprise customers also are concerned about “right shoring.” The global economic freeze offers new reasons for considering “right shoring” of services on a cost-justified, risk-adjusted basis.
Prediction: Enterprise customers will increasingly demand business continuity solutions that involve multiple service delivery centers and rapid shifting of work across borders in case of force majeure.
4. Deal Structure: Virtual Captives.
Direct captives in shared services centers in locations of plentiful labor supply at modest costs have the advantages of direct ownership and control, continuity, flexibility for the employer to change tasks and transparency of costs. They have the disadvantages of lack of upward mobility and career path for employees, thus resulting in potentially high attrition rates. Direct captives also have special issues in management and training programs and the limited footprint (regardless of size) and thus limited breadth of capabilities. These are the classic challenges of managing one’s own information technology and business processes across multiple jurisdictions.
Virtual captives can provide effective management for the human resources employed by the captive. In a virtual captive, the service provider delivers service levels and manages the human resources function, subject (as in any recruitment process outsourcing) to the ultimate control of the nominal employer. Virtual captives will continue to be of interest, provided that the service provider offers variability in volumes that allow flexibility in costs and thus an ability to respond to rapid and significant changes in market conditions. Virtual captives will become the “BPO model du jour” where there is excess labor capacity, as in a global stagnation.
Prediction: Virtual captives will continue, but the enterprise customer’s own management will take a greater role in local management. Hence, growth of virtual captives will be concentrated on the mid-market global enterprises.
5. Vendor Selection: Socially Conscious Outsourcing.
Outsourcing has an impact on the environment and on society. The impact can be positive or negative, depending on where the impact occurs. Lou Dobb’s book Exporting America argued that outsourcing is socially harmful because it results in job losses due to low foreign wages, weak foreign environmental protections and weak foreign labor laws. Senator, now Secretary of State Designate, Hillary Clinton filed a draft law to measure the conformity of foreign laws to “international” standards of environmental and labor protection. As Secretary of State, she will have an opportunity to seek political commitments from foreign governments to implement this approach, failing which the United States could abrogate trade agreements or apply other political or economic pressures to raise the level of domestic laws globally for the protection of the environment and the rights of employees to organize into unions and to escape “abusive” termination of employment. (Of course, the “at will” employment principle remains the general rule in the United States, so there is some doubt about what universal standards might be to govern “abusive” terminations.
Thus, outsourcing becomes entwined in local politics about the healthcare, pension rights, unionization procedures and job entitlements of U.S. workers. As a result, countries that have no history of granting or enforcing worker rights are likely to face some form of U.S. governmental challenges to the openness of the U.S. economy. China and Russia are likely targets. India and Pakistan, South Africa and Latin America may benefit, but they will be nudged to improve the “rule of law” for workers rights.
Prediction: Membership in organizations, such as the Global Sourcing Council, www.gscouncil.org , will rise rapidly, and programs for socially aware outsourcing will gain traction.
6. Vendor Selection: Rule of Law, especially Intellectual Property Rights.
Global services depend on intellectual property rights. The enterprise customer wants protection, and the global services provider wants to ensure that prior IPR, developed without reference to the customer’s work, will enable accumulation of proprietary procedures and competitive advantage.
Prediction: Countries who continue to disregard copyrights will likely result in some U.S. governmental challenges to outsourcing with their service providers.
7. Operational Control: Meet “Seymour”.
Today’s outsourcing agreements treat the supplier as an extension of the business operations of the enterprise customer. It’s no surprise, therefore, that the bidding process includes due diligence for verification of the supplier’s security and operations generally and that the contract terms focus on setting standards of conduct, audit, compliance review and remediation.
Prediction: The year 2009 will bring a renewed focus on the police enforcement apparatus for contract compliance: new compliance-verifying software, new informal and formal reviews and new investigation into the details of the service provider’s operations. The SAS 70 audit will be necessary, but enterprise customers may want to “see more.” Hence, the enterprise customer’s retained team will be sure to include someone with a “ Seymour” function.
8. Termination: Relationship between “No Exit” and Use of Morals Clauses and/or Cross-Default Clauses
Music performers, movie stars and professional athletes may be leading the way for outsourcers. These highly-paid popular idols invariably sign contracts with “morals clauses,” which allow termination if the performer engages in conduct deemed unbecoming to a gentleman (or lady). Such clauses are rarely invoked but have a sobering effect on exuberant showmanship.
Global enterprises typically consider the outsourcing supplier’s possible impact on the customer’s brand name. Most commercially immoral conduct is illegal: bribery, extortion, fraud or breaches of law that don’t relate to your operations, or simple fraudulent accounting, supporting outlaws. But the real challenge is the association of a global enterprise with a sourcing provider that might be accused (but not convicted) of illegality, or bad moral conduct. Should a party be entitled to terminate a commercial agreement where there has been no conviction of illegality?
The “morals clause” fills the gap, allowing unilateral termination for uncertain, unpredictable and arguably arbitrary reasons. This works for rock stars. Should such uncertainty be embodied in business deals? In the real world, divorce occurs in outsourcing due to operational and legal breaches, but almost never for immorality, a cross-default between the supplier and its bankers or other customers. The “termination for convenience” clause (if there is one) fills the gap where a “morals clause” would otherwise be needed.
The question for prudent senior management, in the compulsory quest to adopt a culture of compliance and enforcement in order to meet their own fiduciary duties to shareholders and their legal liability to regulators, is whether some form of morals clause or cross-default clause is necessary or desirable in outsourcing contracts. Generally, such clauses are unnecessary where the customer has the right to walk away (perhaps after paying a termination fee). Generally, if the customer cannot walk away, then a morals clause or cross-default clause could spur the supplier to allow the customer to have a walk-away right, as the lesser of two evils.
This leads to a new consideration of best practices in outsourcing. If the customer has no right to terminate, then under contract law, the customer is liable for the full monthly payments for the unexpired term plus the termination fee that will be due when a termination-for-convenience clause does come into play.
So, do we need morals clauses and cross-default clauses in our outsourcing contracts? Should they be reciprocal? The question is on the table in the age of outsourcing as an extension of the global enterprise.
Prediction: “Termination for convenience” will be a mandate from day one, even if never exercised. Enterprise customers will increasingly demand some form of morals clause or cross-default clause where suppliers insist on a no-exit period.
9. Restraints on Globalization: Closer Review of Foreign Direct Investment in USA.
The United States has a legal framework for the governmental review of “national security” issues relating to any foreign acquisition of a U.S. company. This framework has existed since 1988 as Section 721 of the Defense Production Act of 1950 (popularly known as the “Exon-Florio Amendment”), which set up an inter-agency Committee on Foreign Investment in the United States (“CFIUS”). In 2007, it got a facelift with the enactment of the Foreign Investment and National Security Act of 2007 (“FINSA”). In turn, the statutory framework was implemented under administrative procedures codified, effective December 22, 2008, in a Final Rule adopted in November 2008 by the U.S. Department of the Treasury.
Under Exon-Florio as amended and the 2008 regulations, the government continues to focus on reviewing “covered transactions” where foreigners may acquire control of U.S. business operations in sensitive industries or companies. Under the statute, a “covered transaction” covers any merger, acquisition or takeover that “could” result in “control” of a “ U.S. business” by a “foreign person.” Under the 2008 Final Rule, a transaction may require U.S. governmental review as:
1. A direct or indirect acquisition of a U.S. business;
2. An asset acquisition, where the assets constitute a U.S. business;
3. A joint venture where the foreign person could control assets contributed by the U.S. business;
4. A long-term lease where the foreign person makes substantially all the business decisions as if it were the business owner;
5. A loan where the foreign person acquires governance rights to make business decisions relating to finance or governance.
The 2008 Final Rule raises the question of whether a national security review with Exon-Florio will be deemed mandated for these types of contracts. This legal analysis involves a determination of whether a long-term business process services agreement authorizes a foreign person to make substantially all the business decisions as if it were a business owner, or that the service provider acquired governance rights with the characteristics of an equity investment. "Control" could be exercised by contractual rights, even without any shareholding. The 2008 Final Rule fails to define critical infrastructures (which remain subject to review on a case-by-case basis), but it does list the critical technologies that form the core of national securit concerns. Penalties for violation (intentional or by gross negligence) are not to exceed $250,000 per transaction, but willful violation of conditions of investmen can jeopardize the entire value of the investment.
The inauguration of Barack Obama as President invites further review of this issue as labor and other political interest groups target global trade and investment for protectionism or more subtle regulation. As foreign BPO providers expand their local operations in the U.S. to have a more local footprint (as did the Japanese carmakers in the 1980’s and 1990’s), the review of “foreign direct investment” for “national security” reasons will pose greater risks. BPO service providers consolidating through acquisition will need to develop a strategy for identifying and managing the risks of being labeled a “national security” threat.
Prediction: A renewed vigilance on foreign direct investment regulation will guide enterprise customers in the selection of BPO service providers. BPO service providers from countries that are considered “sensitive” (i.e., non-democratic) will face increasing scrutiny and may even consider changing their home base to maintain open access to U.S. and Western European markets.
*Full Disclosure: The author is a member of the board of directors of the Global Sourcing Council, a global non-profit organization promoting a balance between economic benefits and societal impacts of global sourcing.