A&L Goodbody LLP
  April 12, 2005 - Ireland

Offshore Outsourcing

Outsourcing is not a new phenomenon. As business processes become more complex and costly many Irish companies are concentrating on their core activities and handing over responsibility for running expensive systems and managing large numbers of employees to expert third parties, for an agreed price. Irish companies are also increasingly outsourcing for strategic reasons, looking to leverage the specialist expertise of service providers to open new product and market opportunities. The Drive towards Offshore Outsourcing Outsourcing solutions are not restricted by national boundaries. As technology and communication infrastructures improve, customer demand for higher levels of service increases, and local cost and market pressures increase, companies are beginning to examine overseas service solutions. Ireland has to date benefited from these factors, with many American and UK-based businesses in particular “near shoring” outsourcing processes, such as call centre management, into Ireland. The phrase “near shoring” denotes the practice where foreign companies, with UK companies in particular, moving to reasonably close, and familiar jurisdictions, such as Ireland, for their service requirements. That near shoring of activities into Ireland, to take advantage of our relatively lower cost base and employment pool, shows that businesses are prepared, where appropriate, to move outside national boundaries to source their service requirements. “Offshore outsourcing”, on the other hand, denotes the process whereby companies, again usually American or European now are looking to service providers in more distant, low cost locations, such as Russia, Eastern Europe and the Far East, for their service requirements. This is a trend which we believe can only increase. As first world economies begin to feel the pressure of high wages and a shrinking labour pool, outsourcing to countries such as India which has a large, well educated, available and relatively inexpensive workforce becomes attractive. India has seen the development of an enormous outsourcing services industry, with many multinationals such as Dell, Ford, Alta Vista, American Express and GE Capital outsourcing to India, with some going so far as establishing their own captive operations in locations such as Bangalore. Some American and UK analysts in fact predict an explosion in such outsourcings with a resultant effect on local jobs, with high cost local labour being substituted by low cost solutions in countries such as India, the Philippines and of course Russia and Eastern Europe. American analysts point out that the salary for a US based programmer can be US$90,000 p.a., as against US$15,000 p.a. for similarly skilled offshore programmers. It is probable that Ireland, the UK and the US will, in the near future, experience pressure on their indigenous services industries similar to those pressures which, in the early part of the twentieth century resulted in a marked decline in indigenous manufacturing in the UK with heavy industry moving to offshore locations which had a lower cost base. Many Western economies are becoming quite concerned about the potential effect which the growing trend in offshore outsourcing will have upon local industry and jobs. For example, a number of States in the US are looking to prohibit the outsourcing of certain types of services and business processes outside the State. The effect which an offshore outsourcing will have upon the existing employees of any Irish company is of course a factor which will have to be carefully managed, not only in terms of employment law issues and rationalisation costs, but also in terms of possible negative industrial relations and PR which may arise. Should you go Offshore? If you have decided to outsource a process or service, and are considering an offshore solution, then the first, and perhaps biggest, issue to consider is whether that process or service is in fact suitable for offshore outsourcing at all. Irish companies should be very careful when considering offshoring services which are business critical, the more complex the process which you wish to outsource or the more business critical it is to your existing local operation, then the less suitable that service may be for offshore outsourcing. Despite improving communications in a shrinking business world the reality is that the more distance there is between you and your service provider, the less control you will have over that service provider. That lack of proximity, interaction and control increases the risk of things going wrong. That said, it used to be the case that the only processes offshored were simple component manufacturing processes, driven by low technology requirements, needing only low levels of integration, and low information or technology exchange between the user and the service provider. Recently, however, service providers in offshore locations point out that with improved technology and telecommunications, and readily available, highly educated labour pools, this need no longer be the case. Offshore service providers are now aggressively competing with local Irish service providers to provide outsourcing solutions for business processes such as software maintenance and support, back office administration, medical/legal transcriptions, payroll and HR services, accountancy services and data input services. Other offshore providers are moving into areas such as software development. In short, therefore, offshore service providers are moving up the value chain and are beginning to compete for business in the real added value sectors. Offshore Operations – What structure suits you? Generally speaking, there are four different structures which an Irish company could use to do an offshore outsourcing. The first is a straightforward contractual outsourcing to an offshore service provider. Here the Irish company simply identifies its preferred offshore location and supplier, and then negotiates and signs an outsourcing contract for the services with that foreign service supplier. The second alternative is to do the outsourcing as an “indirect outsourcing” where the Irish company contracts with a specialist service provider resident and operating in Ireland, or indeed, in the UK, which in turn manages an offshore operation on your behalf. A third option is to establish your own wholly owned “captive” operation in the offshore location. Finally, you could establish and own part of a joint venture vehicle with a suitable service provider in the offshore location of your choice. You would then contract directly with that JV for your services. A number of factors should be considered by any Irish company when deciding which of the above four structures is the one most suited to its requirements. Generally speaking, the simpler and less business critical the process or service to be outsourced, the more suitable it may be for a straight contractual outsourcing, directly with a local service provider in the offshore location. The more complex or business critical the process, the more perhaps one should look at indirect outsourcing, where the customer contracts directly with a locally resident and established service provider who is familiar with and aware of the customer’s business culture and needs and readily available and at hand in the event that issues arise. Going the “indirect” route with a locally resident management team whose function is (i) to manage issues and difficulties which can arise in exchanges with the offshore location and (ii) to actually carry out some, or all of the real value added processes within the state, providing only the less complex services from the offshore location, can also reduce the risk of an offshore outsourcing, as well as the amount of the user’s management time required to manage the contract. Indirect outsourcing could also be more attractive for Irish users who are outsourcing offshore for the first time. Locally resident operations are of course easier to monitor and are subject to the same legal and regulatory regime as the customer. The complexities and costs inherent in establishing a captive operation in an offshore location mean that this option is only realistic for large multinationals familiar with cross-border establishment and integration issues. Similarly, establishing a joint venture is probably only an option for larger entities who either have a very long-term strategy, or are themselves looking to enter the service provider market in the relevant offshore location. The business drivers for establishing a captive or joint venture operation are therefore usually very different from those facing most Irish businesses looking to outsource a service or process. Planning and Managing Risk Factors If you are considering an offshore outsourcing solution, there are a number of factors which you should bear in mind and plan for when putting your solution in place in order to minimise the risks which are inherent in offshore outsourcings. Factors such as quality of local transportation, and telecommunications, and the cost, quality and availability of the local labour pool are self evidently important. Additionally “softer” issues such as government attitude and stability are also relevant. Very few companies have sufficient legal, financial, tax and technical expertise within their own organisation to optimise the opportunities which outsourcings can offer, and which are required to establish a clear, robust, properly costed and workable outsourcing solution. It is important therefore that senior management in a company looking to effect any outsourcing, particularly an offshore outsourcing (a) achieves internal management buy in to the process. This buy in is vital for their company to be able to clearly establish its own costings and requirements and (b) gets that expert advice (both Irish and in the country to which the services are being offshored) to ensure that its goals are met and that the company is adequately protected. We would advise any Irish company considering an offshore outsourcing to: (i) Carry Out Due Diligence on the Location Do due diligence on the country in which your potential service provider is located. Again, factors such as stability and Government attitude to Western business are obviously key; (ii) Clarify your costs Clarifying obvious cost drivers (such as service rates) is critical. However, hidden costs such as currency costs, higher transport and telecommunication costs, the increased amount of management time required to visit the offshore location and to run the relationship, all add up. Make sure that lower service rates are not in fact eroded or completely removed by such additional cost; (iii) Carry Out Due diligence on potential service providers In addition to the obvious checks such as financial stability and track record of the potential service provider which need be established, to include doing site visits and existing customer references, unexpected issues such as ethical responsibility and business practices of that potential provider are also relevant. No company wants to find itself dragged into a PR mire if it emerges that its service provider runs “sweat shop” or other unacceptable practices; (iv) Investigate Local and Offshore Regulations and legislation Check whether there is a legal impediment in Ireland, or the offshore location, on your outsourcing plans. Specific regulatory issues will need to be addressed for heavily regulated industries such as the banking and insurance sectors. The FSA in England are increasingly scrutinising outsourcing arrangements and have published rules and guidelines which must be complied with by all regulated entities when outsourcing. The Irish Financial regulator, IFSRA can be expected to follow similar principles. Local law in the outsourcing jurisdiction may contain nasty surprises for the unwary. Their attitude to issues such as copyright and the ability to recover damages under contract may be unpleasantly different to those we are used to at home; Make sure your structure enables you, and your provider where required, to comply with all relevant data protection legislation. As data rich processes such as call centre handling are moved from Europe to offshore locations, EU data protection legislation (which, for example, protects personal details and data of credit card holders), creates significant issues which have to be carefully dealt with when outsourcing offshore. Implementing your Offshore Outsourcing If you have taken the decision to go offshore for your services then it is important that a potential user bears a number of factors in mind when agreeing the terms of, and implementing that outsourcing. Our firm has generated helpful checklists in this regard which could usefully be taken into account by anyone considering such an outsourcing. Briefly it is important that the user has a competent and appropriately skilled management team in place to negotiate and implement the outsourcing. Structuring handover of responsibility for service delivery so that you have a test period is sensible. Issues such as data security, reporting and audit rights, contingency and exit planning are obviously important. The fact that your service provider is offshore also raises employment and IR issues, as well as tax planning and currency risks which need to be carefully managed. Finally, an offshore outsourcing increases the need for a clear, locally enforceable, service contract. Conclusion As outsourcing becomes an increasingly popular strategy for companies seeking to lower their cost and improve efficiencies we can expect to see outsourcing activity increase. As telecommunications and technologies continue to improve and reduce in cost, we can also expect to see an increase in the number of offshore outsourcings occurring with Irish entities seeking solutions in countries which have a lower cost base and a readily available, well-educated labour force. Careful consideration needs to be given as to whether the business process or service which you wish to outsource is in fact suitable for an offshore outsourcing. The more complex and business critical the relevant process is, then generally, the less suitable it probably is for outsourcing offshore. There are a number of different structures which Irish companies can consider using to effect an offshore outsourcing. The costs and drivers behind each structure are different The financial case for offshore outsourcing needs to be carefully examined in light of additional hidden costs which can arise. Regulatory, implementation and management complexities which arise on an offshore outsourcing also need to be carefully considered by management looking to outsource a business process. A company looking to do an offshore outsourcing needs expert legal, financial and technical advice to ensure it gets the deal right. Finally, the terms and conditions agreed on an offshore outsourcing must be properly detailed in a robust, clear and enforceable contract.