5 Strategies for Success in an Outsourced Supply Chain

Procurement organizations are increasingly tasked with leading outsourcing initiatives to enhance supply chain resiliency, optimize costs, and drive innovation. The opportunities available in outsourcing various supply chain functions are undeniable. 

From planning and production to warehousing and transportation, outsourced providers can provide access to specialized expertise, scalable capacity, and advanced technology as well as introduce risk. Proactive planning and management of the legal, operational, and financial risks presented in an outsourced supply chain will help supply chain leaders act strategically to maximize value and avoid common pitfalls.

1.     Run deep due diligence on prospective outsourcers

The primary focus at the outset of any procurement will typically be cost and capability and rightfully so; however, customers often wait too long to run deeper due diligence on prospective outsourcers. Procurement organizations should begin these diligence efforts at the outset to avoid surprises or delays later. This can be accomplished through formal means, such as a request for information (RFI) in advance of a full request for proposal (RFP) or through other diligence, considering topics such as the following:

§  Financial stability: Review audited financials, public filings, credit ratings, and capital structure.

§  Safety and compliance: Review OSHA/WMS records, identify and ensure compliance standards (e.g., FDA and ISO 13485 for medical devices), and validate labor and environmental standards.

§  Cybersecurity: Conduct cybersecurity due diligence, including any history of data security incidents and compliance with frameworks such as NIST or ISO 27001.

§  Subcontractors: Require disclosure of the intended use of affiliates and subcontractors. Critical third-party providers should be identified early and included in diligence.

§  Current client references: Ask to speak directly to multiple current clients and ask for candor with respect to transition-in, service reliability, and relationship management.

§  Insurance coverage: Confirm sufficient insurance coverage, with coverage types and amounts that align with the relevant risks.

2.     Bake critical legal requirements into the RFP

Legal terms should be developed at the outset of the procurement and incorporated directly into each outsourcing RFP – not introduced after negotiations start (or worse – end) on price and service requirements. Failure to establish required contract terms early invites bidders to change their solution – and pricing – in response to perceived “new” requirements when the legal terms are introduced. This will delay procurement, reduce negotiation leverage, and trigger a series of ongoing modifications to pricing that undermines the intent of a formal RFP. To create a strong foundation:

§  Include a “required agreement” as part of the RFP. The required agreement should be the full outsourcing contract with the customer’s preferred legal terms, and bidders should be required to respond with their proposed mark-up.

§  Prohibit bidders from submitting their own standard contract terms as part of their response, and make clear that no supply-provided terms will be considered.

§  Similarly, prohibit bidders from pointing to or relying on existing agreements that may be in place between the parties. Historical agreements or those without an outsourcing focus will detract from value that can be realized through an effective procurement and vendor selection process.

§  Require bidders to articulate objections to legal terms with specificity and in writing, and make clear that identifying something as simply “N/A” or “Unacceptable” will be considered non-responsive.

3.     Identify and protect data, integrated systems, and IP

Any modern supply chain outsourcing will rely heavily on technology and require integration with and interoperability among customer, outsourcer, and third-party environments. Outsourcing often has a transformational component, which may result in the creation of new intellectual property (IP). To best tailor a solution, protect data and information and technology assets, and ensure necessary IP and ownership rights:

§  Identify data and systems that may be impacted by an outsourcing before the RFP is issued and establish standards for permissible data processing and system access, data ownership, and data licensing/third-party data rights.

§  Identify necessary integrations and dependencies with the outsourcer’s and third-party systems. Do this before the RFP is issued and validate both prior to signatures and during transition-in.

§  Identify the new IP that will be introduced to or developed for the organization as part of the outsourcing, and establish clear expectations for how new IP will be developed, maintained, and owned both in the agreement terms and during solutioning discussions.

§  Ensure that operational deliverables (e.g., reports, operations manuals, handbooks, SOPs, and other contributions to the customer’s operating environment) are either owned or sufficiently licensed such that there will be no restriction on continuing to use the same operating standards and documentation when the outsourcing ends.

§  When an outsourcer will bring a new system to the customer’s environment, ensure clarity on how the customer will be transitioned off of the system at the end of the outsourcing – whether by bringing the function in-house or transitioning to a different provider.

4.     Contract for consistency and transparency under changed circumstance

Supply chains are likely to – and ideally designed to – fluctuate in response to both internal and external factors. Outsourcers can often use this natural ebb and flow as an opportunity to introduce new charges. This reduces the effectiveness of the outsourcing and can lead to a breakdown in the relationship. To help avoid being nickel and dimed:

§  Include “sweep language” in the legal terms to make clear that activities do not need to be expressly listed in the contract to be required as part of the outsourcing services – activity that is inherent and necessary to the solution must be included as part of the services – and not at an additional cost.

§  Ensure the outsourcing covers all of the functions performed internally, or through incumbent providers, through a sensible lookback period. Periods between 13-18 months are typical, provided that the nature of the outsourced functions, seasonality, and other business cycles should dictate the appropriate period to cover.

§  Clearly establish the distinction between activities that are part of “business as usual” (BAU), or are otherwise “non-recurring initiatives” (NRI) to identify whether certain activities are included in, or incremental to, the outsourced services.

§  Avoid overbroad language around assumptions, dependencies, and validations frequently introduced by outsourcers.

§  Require outsourcers to invest in appropriate diligence to ensure they understand the fluctuations that are inherent in the business operations and the supply chain itself, and account for those in the proposed solution.

5.     Build outsourcing contracts that anticipate and address disruption and disputes

Outsourcing requires the supplier to step into a customer’s organization, act alongside its personnel, and third-party providers, and drive the achievement of its business objectives, and thus requires a robust relationship management framework. Any sophisticated agreement will have termination rights, formal dispute resolution, indemnities, and insurance coverage, but these are remedies of last resort. Supply chain outsourcing is a critical business function and merits contractual terms that better anticipate and accommodate the near inevitable conflict that will arise in the course of the relationship. Focus on tools such as:

§  Performance management: Service levels and key performance indicators should be identified, verified, and measured internally (or with incumbent providers) before issuing the RFP. Service quality and consistency is often a key metric by which the success or failure of any outsourcing is measured, so service levels should be outcome-based and driven by business requirements.

§  Governance: Outsourcing requires more than an account manager. Define roles and responsibilities for relationship management, escalation paths, and ongoing structured business review.

§  BC/DR planning: Robust Business Continuity/Disaster Recovery (BC/DR) plans and regular testing and reporting on results must be required. Ensure that outsourcer BC/DR plans and practices align with the customer’s business and standards for its operations. 

§  Withhold rights: Customers may need to ensure a breach of contract is addressed, without the desire (or feasibility) to terminate the relationship. Ensuring fair rights for the customer to withhold fees in proportion to, and for the duration of, an outsourcer’s material default of the agreement provides a path to remediation that does not require termination.

Organizations can gain transformative benefits when outsourcing – provided these engagements are entered into strategically and thoughtfully. The most significant advantages in outsourced supply chains will be realized by procurement, legal, and operational professionals who can unlock the potential value while identifying and minimizing the potential risk.