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Sourcing
Governance:
A Critical Necessity
By
CA Khushroo B.
Panthaky
An
Outsourcing Contract
is much about
transferring the
performance of
non- critical
functions to an
external party
so as to get free
from the mundane.
Outsourcing helps
enterprises save
money by leveraging
the economies
of scale realized
by the outsourcing
suppliers. When
effectively managed,
it also helps
relieve enterprises
from the problems
of manpower constraints,
shortage of skill
sets and operating
efficiencies.
But such relationships
are no less than
a marriage; a
binding commitment
on the part of
the outsourced
vendor and a matter
of concern for
the outsourcing
party to ensure
compliance and
delivery on time
and as desired/mutually
agreed upon.
Offshore
outsourcing comes
with manifold
benefits, but
the following
concerns are to
be borne in mind:
• Multiple
organizations
and their security
systems are now
involved, making
design of security
system and ongoing
operations complex.
• Since
different countries
are involved,
different laws
and regulations
are applicable.
The management
of such companies
is required to
ensure that legal
and regulatory
compliances are
adhered to.
• Offshore
service providers
usually cater
to the needs of
many enterprises
(clients), and
therefore results
in additional
complexities.
• Priorities
and standards
of the service
provider for business
continuity or
disaster recovery
preparedness can
be different from
those of the client,
on many occasions,
and this could
result in complications.
• Work is
conducted at remote
locations and
this results in
a loss of control
unless suitable
ways are implemented
to ensure ongoing
control. An outsourcing
agreement is one
of the tools the
service provider
uses to deliver
lower costs; spreading
of some other
costs over the
term of the agreement
and leveraging
the service level
to match it during
the entire period
of the contract.
Sourcing governance
is a process of
confirming that
outsourcing companies
meet not only
functional service
commitments but
also desired regulatory
and compliance
standards. This
has become a critical
function of the
outsourcing organization
in extensively
dynamic environments
which prevail
currently, where
the only constant
factor is change!
The initial stage
that is the contract
stage is a very
crucial stage.
Whether the contracts
are short term
or long term,
outsourcing agreements
may not go as
planned. To give
strength to an
outsourcing relationship,
to protect both
parties from undue
difficulties arising
out of misinterpretation
of terms and to
ensure smooth
functioning and
effective enforcement
of the contract,
it needs to be
ensured that Service
Level Agreements
(SLAs) are carefully
drafted. Further,
prior to signing,
such contracts
could be reviewed
and cleared by
a legal consultant.
Positive efforts
need to be taken
to ensure that
all probable contingencies
are covered in
the contract.
In the development
of the agreement,
the following
need to be clearly
stated:
• Partners
agree to develop
a relationship
based on trust,
at all levels,
which enables
collaboration
and mutual assistance.
• Partners
agree on clear
and concise sharing
and respecting
of roles and responsibilities.
• Partners
agree to practice
a high level of
openness and transparency
in communication
and decision making.
Principle of good
faith: To protect
the organization
from any unforeseen
problem, a “good
faith” clause
should be incorporated.
Good faith requires
that each party
is fair and honest
in negotiations
and, once the
agreement has
been reached,
the parties also
perform their
respective obligations
and enforce their
rights, honestly
and fairly.”
In the context
of outsourcing
agreements, the
principle of good
faith applies
to the creation
of a contract
during negotiations
and the performance
of a contract.
Good faith is
also necessary
if actions are
required to enforce
the contract and
to manage the
almost inevitable
business disputes
that arise.
Executive audit
committees (often
overseen by or
composed of board
members) are finally
beginning to understand
their fiduciary
responsibilities
with respect to
IT governance
- specifically
as it relates
to outsourcing
vendor management
and outsourced
service procurement.
As part of the
overall corporate
governance policy,
audit committees
should identify,
categorize and
evaluate all outsourcing
risks and promote
governance best
practices in order
to manage these
risks. Many corporations
now mandate that
outsourcing vendors
meet minimum thresholds
for financial
stability, size
and internal control
and compliance
infrastructure
- which could
mean that they
have implemented
Common Maturity
Model level 5
and Six Sigma
standards. Such
demands are usually
made implicit
on contractual
agreements and
should withstand
all varieties
of internal and
external audits
as well as stand
the test of transparency.
A right to audit
clause is also
important to incorporate
in an outsourcing
agreement. The
outsourced vendor’s
business continuity
and security measures
should be a point
for audit and
under the Sarbanes
Oxley legislation,
where the processing
done by outsourced
vendor is a substantive
part of the organization’s
cost, a SAS 70
audit report pertaining
to the security
practices adopted
by the outsourced
vendor has to
be obtained. Alternatively,
where it is not
by mandatory legislation,
the outsourcing
organization must
incorporate a
right to audit
clause, whereby
their auditors
can audit the
vendor’s
organization for
controls and ongoing
operational effectiveness
and efficiency.
Principles of
a good sourcing
agreement: There
are a few principles
of good sourcing
agreements which
need mention-
1) Creating a
workable relationship-
When two organizations
come together,
there is a blending
of management
and cultures that
needs to take
place. To eliminate
friction and interference,
processes should
be in place to
respect the management
methods, specific
to each partner
and to benefit
from each other's
corporate culture.
This is particularly
important when
client staff is
being transitioned
to the outsourcer.
Organizations
should ensure
that the outsourcer
has a suitable
transition plan
in place for the
client's staff
that moves to
the outsourcer's
organization.
In a study of
more than 35 outsourcing
deals from 2003
to 2005, Gartner
cited the following
invaluable factors,
which build successful
long-term outsourcing
relationships:
• The investment
in the client's
internal team
members
• The effectiveness
of the relationship
management within
the partnering
organizations.
• The active
management of
trust
• The clear
and measurable
understanding
of a “good
deal”
2) Shared vision
and strategic
engagement-There
are organizations
which look at
outsourcing contracts
for transforming
their operations,
rather than a
mere client/supplier
relationship.
Based on a partner
relationship,
it is imperative
that a shared
vision exists
to achieve business
objectives and
realize business
transformation.
In creating and
sustaining this
vision, it is
expected of all
management levels
to define and
embrace guiding
principles to
govern the contract.
3) Transparency
and accountability-
When engaging
in an outsourcing
relationship which
is centered on
both, transformation
and mutual benefit,
it is important
to incorporate
transparency into
the reporting
processes. When
both parties to
the contract are
engaged in open
and honest communication,
where issues are
put on the table
and accountability
for the issues
is clearly accepted,
a true partnership
approach is achieved.
4) Relationship
management- When
top management
applies guiding
principles to
the outsourcing
relationship and
a clear governance
strategy is executed,
all parties align
to benefit from
the agreement.
The end result
is that disputes,
issues and problems
which might otherwise
be escalated to
senior management
in the traditional
vendor/supplier
relationship get
resolved without
escalation in
a strategic sourcing
relationship.
Management distractions
are reduced, service
delivery teams
remain focused,
and projects move
forward with fewer
delays or budget
overruns. To introduce
joint decision-making
and respect, agreed
upon priorities
and schedules
is an enabler
to a strong relationship
management.
5) Rights for
Superior Results-
When selecting
a partner, it
is important to
scrutinize their
governance strategy
to ensure that
it encompasses
necessary roles
and responsibilities
and is a strategic
fit for the organization.
The result is
a management structure
which aligns with
the client's operating
model and ensures
a high level of
coordination,
which is essential
for success.
6) Quality of
services- This
principle centers
on use of proactive
management an
end to end approach
to service quality
to seek the satisfaction
of the “ultimate
client”.
The governance
process cited
above ensures
that partners
are informed in
a timely manner
of quality issues
by providing an
integrated delivery
and account management
view of the partnership.
Strategic sourcing
relationships
are about building
long-term value.
By entering into
such relationships,
organizations
can achieve a
wide range of
goals, such as
driving greater
systems and business
process flexibility,
optimizing IT,
and enabling business
transformation.
Clients can then
focus on their
core business
and rely on their
sourcing partner
to leverage economies
of scale, exploit
new technologies,
and source the
wide range of
necessary skills.
By developing
and committing
to a set of guiding
principles, the
two parties can
elevate the sourcing
model from traditional
outsourcing to
a strategic outsourcing
model.
Good sourcing
relationships
require a level
of trust, respect
and accountability
than can only
be accomplished
by jointly defining
and mutually applying
guiding principles.
While much is
being emphasized
about the ability
of outsourcers
to bring about
real change and
enable business
transformation,
only in a strategic
sourcing relationship
can business transformation
be realized. Intuitively,
one recognizes
that fair and
honest behavior
during any dispute
will greatly improve
the chances of
satisfactorily
resolving an issue.
Guiding principles
provide the ethical
compass for clients
and outsourcers
to resolve issues
in a fair and
honest manner
and facilitate
the development
of a strategic
sourcing relationship,
based upon mutual
benefit.
Outsourcing Governance:
The recent trends
in business and
market dynamics
dictate that companies
of all sizes consider
outsourcing vital;
be it of operational
services or of
IT processes.
Organizations
are not fully
aware of the multitude
of new risks that
inevitably surface
with the outsourcing
of increasingly
complex business
processes and
data supply chains.
Today's businesses
must constantly
engage in concentrated
risk mitigation
and liability
management - especially
as it relates
to diligence in
corporate governance
practices and
compliance with
the laws of the
land.
Provisions of
the Sarbanes-Oxley
Act require that
companies closely
scrutinize any
business or data
procurement processes
that may affect
corporate financial
controls (and
the accountability
of those controls).
As a result, enterprises
need to make sure
that their current
and prospective
outsourcing vendors
strive to:
• Satisfy
all current regulatory
and compliance
requirements which
may affect the
relevant business
spheres of a client
and, specifically,
the business areas
which drive the
processes and
functions being
outsourced; and
• Have in
place appropriate
internal governance
controls and policies.
A service provider's
stated commitment
to quality management
may imply solid
corporate governance;
however, specific
credentials should
be well documented
and made available
to prospective
strategic partners.
If an external
vendor is managing
operations that
have a bearing
on a company's
financial controls
or business quality
methodologies
such as ISO and
GAP standards,
lack of attention
to a client's
compliance requirements
can quickly cause
severe problems
for both. For
instance, the
outsourcing of
the payroll function
is very common
but it may form
30 to 40 percent
of the total cost
of operations
of the organization.
A relationship
based on trust
and good faith
gives mutual benefits
to both parties
to an outsourcing
contract. Proactive
alignment makes
both sides strive
for a continuous
improvement of
service levels
and a flexibility
based on understanding
of each other’s
culture and needs.
The dual objectives
of service delivery
and costs have
to be met and
they must keep
in line with the
strategic and
tactical goals.
Strong channels
of communication
will help building
a high-trust relationship,
where governance
principles are
shared, both inside
and outside the
scope of service
contracts. The
value proposition
for effective
forums of information
sharing and collective
decision-making
is obvious. Further,
improved service
supply chains
without concurrent
increase in expenditure
are always desired.
A mutually agreed
upon means to
monitor, manage
and measure not
only deliverables,
but also service
levels should
be established.
Compliance and
regulatory requirements
should be met
and an ongoing
identification
and mitigation
framework of all
associated risks
should be established.
Achieving optimum
benefits from
sourcing relationships
without having
the burden of
forceful litigation
and enforcement
issues is an integral
part of good sourcing
governance measures
as it is a relief
for both parties
and a good enabler
for business growth.
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