Outsourcing is a cost-effective way of handing over specific business processes to a third-party company.
But it’s not without its risks.
You should have a comprehensive outsourcing agreement with the service provider to minimize these risks, detailing everything from payments and data protection to milestones and penalties.
In this article, we’ll explore what an outsourcing agreement is, three types of outsourcing agreements, and 15 components you must include in your contract.
This article contains:
(Click on the links to jump to a specific section)
- What is an Outsourcing Agreement?
- 3 Types of Outsourcing Contracts
- 15 Things to Include in Your Outsourcing Agreement
Let’s get started.
What is an outsourcing agreement?
An outsourcing agreement is a legally binding document between you (the client) and the outsourcing company. It details what you expect from the third-party service provider.
Now the most common types of outsourcing include BPO (Business Process Outsourcing), including accounting and Human Resources (HR), and IT (Information Technology) outsourcing.
But regardless of the type, the third party may need access to your confidential information, Intellectual Property (IP), and even business assets. That’s why you should ask the third party to sign an NDA (Non-Disclosure Agreement) to protect your IP.
But before we jump into what you should include in one, let’s explore the three types of outsourcing agreements.
3 types of outsourcing contracts
Depending on the type of contract you enter with the outsourcing vendor, you can pick from any one of these three outsourcing agreements.
Let’s look at them in detail:
1. Time and materials contract
One of the most popular outsourcing agreements, this contract outlines what you owe the outsourced team for their time and materials. Here, time refers to the prearranged hourly rate for each team member, while materials refer to resources such as specific software equipment.
You should opt for this outsourcing contract if you have a long-term project requiring a lot of flexibility.
The contract ends when the goods/services are delivered as per the requirements. So, it’s essential to keep manageable milestones and routinely analyze progress reports.
2. Fixed price contract
This contract defines the project’s scope, usually in an RFP (Request for Proposal).
What’s an RFP?
An RFP is a formal document that details the project and asks vendors to submit proposals describing how they’ll meet these requirements through a bidding process.
The contract begins once you accept the outsourcing company’s bid and agree to a fixed price.
Commonly used in IT outsourcing, this contract doesn’t offer much flexibility as the requirements from both parties are defined beforehand.
However, if the project scope changes, you need to create a change order for the same.
Once both parties agree to the new effective date and compensation, it should become part of the existing contract.
3. Dedicated team contract
Here, you hire a dedicated remote team to act as an extension of your in-house team. They work exclusively on your projects and can handle multiple tasks simultaneously.
Rather than pure give-and-take, it focuses more on business growth and creating a long-term outsourcing relationship.
Ideal for projects requiring continuous collaboration, such as web development, this contract typically doesn’t feature an exit strategy or clause.
Due to different timelines and resource needs, an agreement for call center outsourcing will be very distinct from a software development outsourcing contract.
However, certain clauses and components are usually applicable to every outsourcing contract.
15 things to include in your outsourcing agreement
Before you draft an agreement with a specific company, you should ensure they don’t have a conflict of interest, i.e., work for your competitor.
If there is, they have an obligation to inform you — as such information could potentially jeopardize confidentiality and lead to legal troubles in the future.
If there’s no conflict, you can go ahead and create an outsourcing agreement with the following 15 components.
1. Description of services
The first thing your contract needs is a detailed description of the project and its scope.
You can also include the RFP and the subsequent response by the outsourcing service provider here.
As the heart of the contract, this section should include:
- All service requirements.
- Description of each element of the required services.
- General service standards, such as compliance with international standards.
- A sweep clause outlining functions not specified in the statement of work but an inherent part of the provided services (optional).
Once you’ve defined the general purpose of the outsourcing agreement, you can go into the specifics, such as the primary deliverables.
2. Service levels
A service level is a specific, measurable standard the service provider must meet.
For an IT contract, this is typically a Service Level Agreement or an SLA.
The SLA sets specific quality benchmarks for providing such services, which is advantageous for both parties.
For instance, you can clarify the desirable Average Speed of Answer (ASA) in your call center based on the industry standards for your business. You should then mention the necessary steps to maintain that level, such as retraining employees, investing in software solutions, etc.
Defining these aspects enables the service provider to understand your expectations.
It also lets them know that they’ll get paid and might receive a renewed contract if they meet these milestones within the given time frame.
Other aspects you can mention in this section are:
- Milestone dates and contractual penalties if the service provider fails to meet them.
- Compensation for poor quality service – could range from damages (fines) to early contract termination.
- Detailed processes to request contract changes or reviews from either party.
- Specifying whether the outsourcing company can subcontract certain services. If yes, what steps the company needs to take before they do so, e.g., disclosing the subcontractor’s identity so you can vet them.
You can also outline Key Performance Indicators (KPIs) or other metrics relevant to the outsourced service.
3. Fees and payment
Your outsourcing partner needs to know the total amount payable to them for services rendered.
The actual amount depends on many factors, such as the project scope and the job staffing requirement.
For offshore outsourcing, you may also need to address exchange rate fluctuations.
Additionally, you should specify whether the service provider is responsible for all tax payments in their domicile (place of residence). They should ideally also shoulder the responsibility of staff and independent contractor salary payment.
There should be a clause to cover the negotiation of contract terms due to changing market conditions. It could include compensation for variable components such as new technologies.
Ideally, you should consult a financial law firm for legal advice regarding changing pricing structures and payment terms.
4. Contract duration
The duration of a contract or the contract term is essential to the success of your outsourcing transaction.
Ideally, this duration clause should also outline causes for early termination.
If you don’t, you could get stuck in a long-term agreement that doesn’t benefit you.
A prime example is the BBC-Siemens 10-year contract signed in 2004 for outsourcing IT services. About 60% of the projects were delayed and over budget in the first year, reducing cost savings.
But the agreement barred the BBC from signing any other IT outsourcing vendor contract during that time.
That’s why it’s recommended you begin the outsourcing relationship using a short-term contract with smaller, achievable milestones.
It allows you to test the waters and extend the same contract if things work well with the outsourcing vendor.
5. Transfer of assets
To provide a key deliverable, your outsourcing partner may need you to transfer or give them access to specific business assets.
Some examples of IT assets include telecommunication equipment and software licenses.
You’ll need a sales agreement to transfer these assets formally.
Transferring certain assets, such as software licenses, may lead to additional taxes and stamp duties. Ensure your legal contracts account for these transferring costs.
6. Representations, warranties, and liabilities
The outsourced company generally gives a representation of its ability and competency to provide the necessary deliverables.
Similarly, your company represents that you’ll provide timely payments.
Both parties generally give the following warranties to each other:
- The outsourcing company gives a warranty that their services will comply with industry-specific regulations and demonstrate reasonable skill. If not, they will incur any fallout costs.
- Your business gives warranties about its assets or equipment.
Contractual liability specifies the liabilities of the outsourcing company that it would be held responsible for, e.g., compensation in case of data loss, liabilities of subcontractors, etc.
However, the written agreement typically limits the direct and/or indirect liability to an insurable figure. This is to better clarify the liabilities arising from any breach or failure to perform, also called limitation of liability.
Indemnities can refer to both compensations as well as an exemption for liabilities and damages. Both parties provide them, i.e., you and the contractor.
For your contract, the indemnification clause clarifies that the contractor is solely responsible for any losses you incur due to their negligence or failure to deliver. It protects your company while also stating the outsourcing service provider will compensate you for such damages.
The indemnity clause applies for losses incurred both during and after the project.
8. Product ownership
If you’re outsourcing any IT development, you need to state ownership of the finished product.
For example, let’s say the outsourcing company customizes or improves the pre existing intellectual property (software). If ownership isn’t specified and communication breaks down, you may be unable to access your software’s modification control or even its source code!
You can avoid this situation by having a crystal clear ownership clause that leaves nothing to chance.
However, some companies may also choose to share ownership rights with the vendor.
9. Intellectual property rights (IPR)
Intellectual Property Rights (IPR) can often cause problems during outsourcing.
To protect your company’s intellectual property (IP), you can ask the outsourcing service provider to sign an NDA and a Non-Compete agreement or clause.
The Non-Compete agreement helps ensure the service provider won’t work for your competitor for a certain period of time.
Some other ways you can protect your IP and safely outsource are:
- Copyrighting your IP.
- Trademarking software and other goods.
- Applying for patents.
When working with another company, you should ensure all their employees working on your projects sign NDAs and Non-Competes. This will help legally protect any disclosure of your trade secrets.
10. Data protection
Outsourcing services, such as customer service and payroll management, require access to confidential information such as bank details.
To ensure information security, both you and the outsourcing company must be compliant with the laws in your regions.
For instance, in the EU, you need to be GDPR-compliant.
The General Data Protection Regulation (GDPR) specifies what a business must include in its data processing agreements. These agreements should define how the third party should process, maintain, secure, respond to access requests, and delete personal data.
The GDPR also states the outsourcing provider can’t hire a subcontractor without the client’s written authorization. If the client approves it, the subcontractor is subject to similar data protection clauses.
You should also make sure you’re complying with any region-specific data protection regulations.
For example, when dealing with data from the United Kingdom, you should ideally start with the GDPR, then refer to the supplementary provisions of the Data Protection Act of 2018.
11. PCI DSS compliance
If your organization deals with payments or card processing, you must comply with the PCI DSS (Payment Card Industry Digital Security Standard) requirements.
The compliance allows everyone to store, process, and transmit sensitive authentication or cardholder data.
So, you need to ensure that your outsourcing partner complies with these requirements as well.
12. Performance monitoring and audit provisions
Monitoring your outsourced team’s progress through regular audits is a crucial part of outsourcing.
These performance audits can promptly help you take any necessary corrective measures.
It’s also good business practice to keep records of:
- Reporting duties.
- Frequency of audits.
- Service delivery disruption procedures.
- Increased monitoring if service falls below the agreed standards.
However, if the provider can’t meet these service requirements even after increased monitoring, this clause allows your business to step in and take over management control.
Auditing can help catch potential issues and even mitigate disputes without going to litigation.
13. Dispute resolution
Sometimes things can go wrong.
If the service provider breaches your contract, you might consider taking legal action. But doing so may drain necessary resources.
That’s why the contract should have an amicable resolution provision to help you avoid getting caught up in complicated legal issues. It’ll allow both parties to negotiate and come to a mutual agreement about the situation.
14. Business continuity and disaster recovery (BCDR)
BCDR ensures your business operations can continue with little to no delay if the supplier can’t provide the agreed-upon deliverables due to an unforeseen interruption or disruption.
Examples of such events include:
- Force majeure events.
- Viral or malware attacks.
- Supply chain issues.
- Changes in governing laws.
- Employee illness or resignation.
Under these circumstances, the supplier can be excused from their duties and hand over any business assets, data, and IP back to the outsourcer.
15. Termination and exit management
Your contract should have an explicit exit clause in case an outsourcing deal doesn’t work out, especially if it’s causing losses.
Early termination allows you to take back control of the outsourced service. You can either move it in-house or offer it to another provider.
But it isn’t a quick process. So, the contract should have a solid exit plan to ensure termination doesn’t affect either business too much.
You should specify how many days’ written notice is required before you begin the termination process. The termination clause should also outline:
- Procedures for returning business assets and equipment.
- Any liabilities for canceling.
- Penalties on the service provider for non-performance.
- Handling of IP after termination.
As one of the most crucial components of the agreement, how you leave the outsourcing relationship impacts your business reputation.
As you can see, there’s quite a bit you need to include in your outsourcing agreement.
However, if you don’t want to write one from scratch, the following templates can serve as a good starting point:
- A general outsourcing services contract.
- A software development agreement.
- A website development agreement.
- A customer service SLA.
Doing your due diligence is the key to a successful outsourcing agreement.
When you have clear expectations and deliverables, it’s easier for your outsourcing partner to provide the same.
However, a new outsourcing arrangement needs to be formally defined and managed regularly. Use the information we covered here to understand what goes into an outsourcing agreement and draft a solid one with ease.
Andy is a technology & marketing leader who has delivered award-winning and world-first experiences.