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As the Thanksgiving holiday approaches, we are all juggling a whole host of “to-dos”, such as working out family travel logistics, making sure the turkey is thawing, and shopping for all of the “fixins”. Many of us are also starting to contemplate our impending consumption of too much turkey, stuffing and pie. Yes, we know everyone tries to be strong and resist temptation, but we generally just give in. Fortunately, we can all take solace in the fact that calories consumed during a holiday don’t count as much as non-holiday calories – well, at least that is the wise advice I got from my Aunt Simone (which, by definition, makes it a “fact”).

Thanksgiving is also a time when you can sit back and think about those things you are thankful for. In this blog, we decided to reach out to our Pillsbury Global Sourcing group to find out what outsourcing industry trends they were thankful for. Here are a few responses mixing outsourcing trends with Thanksgiving themes – enjoy:

1. We are finally addressing the “messy middle”. You might be misinterpreting this item to be the state of your stomach following dinner. Actually, this refers to IT service integration that is required to align service delivery among multiple players typically found in an IT environment. We refer to the service integration layer as the “middle”, because it usually sits between leadership and service delivery execution. We also refer to it as “messy” because most IT operations are at very low maturity levels in optimizing their service integration capabilities. Implementing a successful service integration framework can be difficult, time consuming and challenging. That said, we are thankful that many of our clients recognize harmonizing the activities of internal IT and multiple of third party providers is critical if they want to be in a position to mitigate operational risk, promptly address incidents and maximize efficiencies in their environment.

2. The trend away from asset-heavy deals. It used to be that the price point of technology assets meant that if you outsource your operations, you had to deal with what to do with all those big assets (think facilities management deals, or more recently, termination for convenience costs full of “stranded asset stuffing”). With hardware costs continuing to decline, those asset costs are becoming less of a headache for customers who can retain the assets and structure more straightforward and flexible services-only deals. With less asset issues to digest, customers can tighten the belt a notch and be more efficient in their sourcing decisions.

3. Chef’s still matter even if you’ve hired a cook. Our clients (the owners and executive chefs) who are more satisfied with their suppliers (cooks, chefs, sous-chefs, etc.) understand that they have to be active, hands-on participants and managers in and of the services that they receive from their suppliers. We encourage our clients to actively utilize their contractual rights, not to “game” the system but to ensure that they are receiving the value that they expect from their strategic sourcing relationships. We’re finding clients are recognizing the value of their contracts as effective management tools and getting better outcomes as a result. That doesn’t mean stepping in and cooking the meal, but it does mean active participation in the receipt of services to allow customers to identify surprises early and to bring an end to problems quickly, before they fester and risk develop into issues that could endanger the strategic relationship.

4. It’s worth the upfront travel time. Sometimes, sitting in traffic on Wednesday afternoon to get over the river and through the woods to grandmother’s house is a much smaller price to pay than having grandmother staying in your house …especially if she extends her stay. We are seeing companies begin to recognize that they will need to incur an up-front transition cost in order to enjoy longer term savings. There is less appetite on the supplier side to simply finance the transition costs through the deal, and that can actually be good for customers. If the cost of transition is funded through the unit rates in the deal, and the deal is renewed, you keep paying for the transition even though the supplier has long since been made whole.

5. Sourcing strategy really matters. Just like in outsourcing, deciding what parts of your Thanksgiving meal to cook and what parts to buy is critical. Turkey is an obvious example. Who wants a precooked turkey? Cooking the turkey is of strategic importance for the holiday as it not only makes the meal, but it fills the house for hours ahead of time creating anticipation that heightens the entire experience. Now cranberries are another story. I’ve always found canned cranberries, either the jelly or the whole cranberry kind, to be perfectly fine – an opinion reinforced the one year we decided to insource cranberries sauce preparation and they literally “exploded” on the stove. Cranberries are permanently outsourced. So prepare your menu, choose your sourcing strategy wisely and enjoy!

6. BYOD (Bring Your Own Dessert…um…Device). There is an increasing multitude of wireless devices, carriers, applications, services and operating systems among family members. Wireless is an integral part of a comprehensive telecom solution, and while all of these wireless options have made life unduly complicated for IT staff, resistance is futile (the kids are all going to have wireless devices) and clients are beginning to set rules for BYOD rather than limiting choices. End users will bring their own devices to the table (even during meals), a comprehensive proactive strategy and rules of the road will make for a more enjoyable mobile experience (and maybe even better conversation).

7. Finally, it’s time for Dessert. To close on this Thanksgiving holiday blog, here are a few new Thanksgiving outsourcing terms and phrases (remember, you heard them here first):

  • Don’t get a “turkey of a deal,” so please be sure to conduct due diligence in advance of signing;
  • “Tofurkey” means the act of toe dipping in cloud computing with funky lurking legal issues to address;
  • RFPs (Really Fantastic Pilgrims searching for the best place to land); and
  • Thanksgiving Incumbents (don’t be the Guest that maybe should leave sooner).

On behalf of the entire Pillsbury Global Sourcing group, we wish you a happy and healthy Thanksgiving holiday.

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The Federal Communications Commission (FCC) is considering whether to make fundamental changes to how carriers (and ultimately their customers) pay for federal programs that provide greater access to telecommunications and Internet services. The dilemma facing the FCC is that Universal Service Fund (USF) program expenses are increasing, while interstate and international telecommunications revenues, the source of the funding, are on the decline. Facing a carrier contribution rate that is now 17.4 percent – a hefty rate in any economy – the FCC is looking at alternatives to revenues, including assessments based on telephone numbers or network connections.
No one disputes the laudable goals of USF. These include funding for: a) carriers who provide free or low cost telecommunications services to the poor; b) high cost telephone companies so that customers in rural and remote areas can access telecommunications at rates similar to customers in the cities; c) schools and libraries to get discounted rates for essential telecommunications services; and d) telecommunications services for rural health care providers. In 1998, these programs cost about $3.9 billion. In 2012 the cost will be more than $9.5 billion. The FCC has taken steps recently to cap or slow the growth of these programs, and put in place rules and regulations to reduce fraud, waste and abuse.

The growth on the expense side has put added pressure on the revenue side – all of which comes from carriers providing interstate and international telecommunications and VoIP services. As a result of the declining cost of telecommunications services combined with reduced demand because of email and free voice services, there has been a reduction in assessable revenues from 1998 to 2012, from $80 billion to about $66 billion. Accordingly, the contribution factor has risen from 3.19 percent in 1998 to 17.4 percent today. The FCC adjusts the contribution factor quarterly.

Large users of telecommunications services, carriers and consumer groups are participating in a FCC proceeding that is considering whether to change how USF is funded. Large users are particularly concerned about changes that might shift a greater portion of the contributions to business users or services used by businesses. They are also looking for a stable revenue source, concerned that the quarterly changes impose substantial burdens on budgeting by businesses that purchase large quantities of telecommunications services.

One option proposed to the FCC would be to make administrative changes to the current revenue system. These could include expanding the contribution base to include additional services, including broadband service, which is now exempt. Another option would be to establish an annual contribution factor, eliminating the volatility of quarterly changes.

A more fundamental change that has been proposed would be a monthly assessment on telephone numbers. Supporters suggest telephone numbers provide a stable base for funding, and can easily be monitored, reported and verified. Some opponents suggest that assessing telephone numbers would unfairly burden entities with lots of telephone numbers, including universities.

A third option would be to assess physical connections to either the public telephone network or the Internet. Connections are verifiable and less subject to changes in technology. However, the debate continues whether assessments should vary based on capacity or connection speed, and how to assess connections between carriers.
This is expected to be near the top of the FCC’s to-do list for 2013.

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I recently attended the UK Society for Computers and Law’s Annual Conference where Cloud Computing was one of the ‘IT Law Hot Topics’ under discussion. The others, in case you are interested, were Big Data, Apps and Mobile Payments. The event was sold out which goes to show how ‘hot’ these topics really are!

One of the speakers was Christopher Millard, Professor of Privacy and Information Law at Queen Mary, University of London where he leads the Cloud Legal Project – a three-year Microsoft funded academic project undertaken by the Queen Mary Centre for Commercial Law Studies. Started in October 2009, its mission is to reduce uncertainty regarding legal and regulatory status of essential aspects of cloud computing by “the production and dissemination of a series of scholarly yet practical research papers to address various legal and regulatory issues that will be fundamental to the successful development of cloud computing… [which will] demonstrate thought leadership in several complex and difficult areas of law and regulation that are of vital importance to governments and businesses globally.”

The Cloud Legal Project website contains a rich source of content and is recommended reading for IT law practitioners whether in house or in private practice. Topics covered include an analysis of Cloud service provider’s standard legal terms; data protection issues in cloud computing; law enforcement access in a cloud environment; and the role of competition law in the cloud; as well as a report on some of the differing legal issues in cloud computing as compared with conventional outsourcing or hosting contracts.

Professor Millard thought that cloud computing was often perceived as being high risk and potentially unreliable, comparing it with the growth of the electricity industry at the end of the nineteenth century. Initially, Professor Millard said, companies had been wary of buying electricity from outside preferring to generate their own electricity instead, but in just a few years everyone was buying from the grid, and that the world of cloud computing is developing in a similar way. Sticking with the ‘utility’ theme, the Cloud Legal Project website describes cloud computing like this:

“Cloud Computing is a way of delivering computing power to you, wherever and whenever you need it, as a utility like water or electricity. Like such a utility, it allows you to use as much or as little as you need (be it processing power or data storage), when you need it and, thanks to the internet, where you need it. Like a utility, the provider shares a large resource among a pool of customers, allowing economy of scale and efficient sharing of demand. And like a utility, if you pay for Cloud computing services you often do so in proportion to your use, rather than a flat fee.”

Rogue Buying
Further, given the ease with which cloud resources can be allocated and reallocated, he commented that, contrary to complex outsourcing and other technology transactions, this makes it more likely that it will be done without an appropriate review of the relevant legal issues. An interesting example of this bypassing of procurement / legal review, was given by another of the speakers who told the story of an unnamed investment bank where the traders each bought cloud services on their company credit cards and, in doing so, circumvented the procurement department as each individual purchase was under the company’s approval threshold; together the purchases made the company the biggest customer of the cloud provider – something which an embarrassed CIO only found out about by chance at an industry conference! That CIO was then left with the headache of trying to figure out, should he decide that his company should exit these “unapproved” cloud arrangements, how the company would get its data back, in what format it should be returned (and at what cost) and how will it be cleaned from cloud provider’s infrastructure, since none of this was covered in the cloud provider’s standard online terms and conditions.

Who’s the Provider?
A related and important point made by Professor Millard is that when lawyers do get to advise, they really do need to understand the structure of the particular cloud deal and from where services are being provided – often the customer may not have any direct relationship with or even awareness of the organisations that ultimately store or process its data because the cloud provider that the customer deals with may itself use one or more other storage or processing providers. This can give rise to questions relating to ownership of data and liability for its loss or misuse; further, it is not uncommon for cloud providers at this integration layer to over-promise, that is to say, to make promises in their contractual agreements which they are not entitled to make per the underlying cloud provider agreement.

Negotiation
Another interesting topic was whether cloud service providers will negotiate their contracts on a bespoke basis; the perception being that they will not. The key here is leverage; much as the big utilities routinely negotiate the terms of their electricity supply agreements with their largest electricity customers (whereas individual consumers do not), the largest cloud providers will negotiate if a deal merits doing so in terms of value or strategic importance. The Cloud Legal Project team analysed a number of such deals (gleaning data through a combination of off-the-record interviews with cloud providers and integrators, freedom of information requests and review of public sector contracts where details have been published, such as CSC / Google / City of Los Angeles). Six issues emerged as subject to the heaviest negotiation or as deal breakers. Unsurprisingly, these are:

– Limits and exclusions of Liability – Service levels, including availability – Security and Privacy, especially EU data protection compliance – Lock-in and exit, including term & termination, and return of data – Provider instigated changes to service features – Intellectual Property Rights, especially ownership of developed apps, bug fixes and enhancements

As a final point, it is interesting to note that while cloud contracts continue to evolve at a rapid pace in response to factors such as competitive positioning, customer and regulatory demands, and judicial intervention, the European Commission, in its September 2012 communication paper ‘Unleashing the Potential of Cloud Computing in Europe’ has called for model SLAs for “professional cloud users” and model contracts for consumers of cloud computing service’s by the end of 2013.

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Sitting in the Northeast, our news has been dominated by only two stories for the last week–Hurricane Sandy and the Presidential Election. Both events have far reaching impacts on this country and its citizens, and both have (or could have) significant impacts on our industry.

Sandy . . .
Hurricane Sandy tested disaster recovery (DR) plans and operations. With outages in power and internet, and flooding of operations creating multiple points of failure, redundancy plans were pushed to the brink. Transportation options significantly limited in the hardest hit areas even where technology was available and workers were often unable to get to a viable work site. While some companies were able to swing operations to backup locations seamlessly, some had primary and secondary outages that prevented such successful recovery operations.

For companies experiencing an outage, it is worth considering whether there is insurance coverage for the outage. In addition, in some cases, policies may contain separate (higher) deductibles for damages due to hurricanes, so the classification of the storm when it affected business operations may be relevant (note that Sandy was downgraded from a Hurricane before making landfall).

As industry begins to put itself together, first focusing on human capital, and then on IT assets, we expect an increased focus on review of existing agreements. In addition, we can expect more attention to be placed on DR planning and force majeure in new technology agreements.

Of course, many companies are still hard at work trying to restore operations – in many cases working hand in glove with their service providers – so contract considerations may, rightfully, be a secondary priority. Once companies turn to their contracts, in addition to looking specifically at the DR obligations, it will be important to understand how DR requirements interplay with service levels. And that force majeure (aka Act of God) clause many businesses often “leave to the lawyers” will be important in assessing how, or to what extent, Hurricane Sandy impacted the service provider’s obligations.

Uncle Sam – The Presidential Election . . .
Outsourcing has long been a political “bad word,” and true to form during an election year some say a different type of storm is again brewing (on Capitol Hill) when it comes to outsourcing. To many politicians “outsourcing” is synonymous with “offshoring” and domestic outsourcing projects are ignored. It will be interesting to see whether the results of the presidential election affect views on domestic outsourcing and offshoring, and what, if any, mechanisms the federal government can practically put in place in order to limit offshoring.

For example, as discussed in a CIO Magazine article, the government could limit the ability of companies to treat as deductible business expenses the costs involved in transitioning services offshore. The government could also increase the limitations on government work or data being accessed offshore. That said, despite the rhetoric on the subject for the past few presidential terms, little broad-based change has been implemented. Only time will tell if the next presidential term will bring about real change to the outsourcing landscape (e.g., a shift from offshore to onshore), but it is unlikely that any change will substantially eliminate the outsourcing model.

It has been a difficult week for our country and our industry. Our best wishes go to those affected by Hurricane Sandy, and we are hopeful that the presidential election, whatever the outcome, can help bring us together in healing.

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In negotiating outsourcing agreements, I sit on both sides of the table – obviously not at the same time. I represent customers about half of my time, and I spend the rest of the time representing suppliers.

It’s always interesting seeing a transaction from one particular viewpoint, but also knowing the dynamics that are at play for the other side. One thing that strikes me is that, regardless which side of the table I am on, my clients always think that they have little or no leverage, and that the other party in the negotiation holds all the bargaining power.

The customer sees itself pitted against a team of professionals who negotiate outsourcing agreements day in and day out, whereas the customer might have an agreement (or a handful of agreements) that is up for replacement or renegotiation every few years. They may be under time pressure to get the transaction executed, either to meet internal deadlines, to implement new technology, or to give termination notice to an existing supplier.

On the other hand, the supplier sees a customer with choices to move some or all of its business to other suppliers; competitors who may be using balance of trade interests or C-suite relationships to get back in the door; internal targets pushing for faster realization of revenue; and personal sales targets that greatly impact compensation.

So as a customer, what leverage do you have? Here are a couple of things to think about and use when you’re next in negotiations:

  • Money: You hold the wallet. The supplier wants to hang on to the share of it that they may already have. They want more. They want to stop their competitors from getting any of it. Don’t underestimate how much a supplier wants your business. If the terms of the deal aren’t what you need, then don’t accept them. The supplier knows you have other choices. Sure, it might be hard (or costly) to change suppliers at some points in your relationship, but it’s always possible. You may not be in a position to completely move business away from an incumbent if you are not getting your way in negotiations, but you probably do have the ability to direct new businessto someone else. Make the supplier work for the money you are going to pay them, and give you the terms and conditions that you need.
  • Time: If you’re negotiating new or additional business, then the the supplier will be under considerable pressure to get the deal inked as soon as possible. Use that to your advantage. If they will not agree to terms, make no move; make it clear that you’re willing to hold out for as long as it takes to get the right terms in your agreement. The supplier will be sweating bullets to get the deal done by the end of quarter, by the end of year, before compensation levels are determined, or before some other date that won’t be of any concern to you. Even if you have your own deadlines, act as if you don’t. Putting time pressure on the supplier will eventually get some movement. Of course, when that happens, then you may need to be ready to close the deal quickly.

For suppliers, think about these advantages that you have:

  • Terrain: You know who you’re up against to win the customer’s business. You know your products and services, and how they differentiate you from the competition. You know where your price points sit in the market. Use the advantages you have over other suppliers – the customer doesn’t want an inferior product, or to pay a higher price for the same product. You know what you do well, and the customer needs what you have, so leverage that.
  • Experience: This business is your lifeblood, and you know outsourcing transactions. You know what other customers have asked for, and what you have agreed with them. You should have a fairly good idea of what you competitors will agree to as well. If a customer or their lawyer is asking for something that’s totally off-market, call them on it. Use your industry knowledge and experience to support the position you’re taking in the agreement. Without disclosing confidential information, share how you have resolved issues with other customers. Show that you’re there to find a mutually acceptable solution, and that you know how far the envelope can be pushed – in either direction

Of course, I am not suggesting that every negotiation should be entirely adversarial but each party should make the most of the advantages that it has, even when building strategic or collaborative arrangements

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As noted in our previous blog posting on the subject, the most prevalent model for pricing applications outsourcing services involves the following components:

(1) a fixed monthly charge for applications maintenance;

(2) a fixed monthly charge for a baseline number of application enhancements hours (typically included as part of the fixed fee for applications support) with authorized incremental hours charged on a time and materials basis; and
(3) a framework for pricing significant development work on a project-by-project basis on a fixed fee, capped time and materials, or straight time and materials basis.
This is the second of three blog postings that describes the basic features of each of these pricing components, and discusses some of the key considerations in structuring and negotiating them. The first posting discussed pricing for applications support. This posting focuses on pricing applications enhancements.

Applications Enhancements
Applications enhancements refer to the ongoing, steady state level of discretionary enhancements that are performed on the applications portfolio supported by the supplier. This is in contrast to major development projects that are generally priced on a case-by-case basis and will be the subject of Part 3 of this series of blog postings. The contract should provide the customer flexibility in classifying a particular enhancement as either a routine enhancement priced along the lines described below (which typically requires less than 80 – 160 productive hours of work to complete) or a major development project that is priced separately (and potentially competitively bid by the customer).

Baseline Hours
Staffing and associated pricing for applications enhancements are based on a projection of a baseline number of hours that is reasonably expected to be expended by supplier personnel each month in performing this work. The baseline hours are often included in the fixed fee for applications support, but may also be priced as a separate bundle of hours.

Under this pricing construct, the baseline represents a minimum number of hours that the customer commits to purchase each month. This means that the customer (i) pays for any unused hours, and (ii) incurs an incremental charge for any excess hours expended during the month on a time and materials basis. Therefore, it is important that the contract contain a number of protections for the customer, including the following:

Adjustments – The customer should have the right to adjust the baseline hours on short notice (e.g., 30 days) to reflect its changing requirements, subject to reasonable limitations on the extent and frequency of these adjustments. If the customer adjusts the baseline number of hours, there will be a corresponding adjustment to the committed monthly charge for applications enhancements based on the increased / reduced number of hours multiplied by the applicable hourly rate(s).

Excess Hours – The contract should require the supplier to obtain written authorization from the customer before expending any chargeable hours in excess of the baseline and permit the customer to prioritize work in order to minimize any incremental charges. Any unauthorized hours expended by supplier personnel should not be chargeable.

Workload Balancing – The supplier should be required to “load balance” work between applications maintenance, applications enhancements and other in-scope activities in order to maximize utilization of supplier personnel and minimize charges. For example, if the workload for enhancements during a particular month is expected to be less than the baseline number of hours, then supplier personnel should be required to use the extra hours in reducing the maintenance backlog or performing other applications related work requested by the customer. Similarly, if there is a spike in applications enhancements during a particular month, the supplier should be required to use reasonable efforts to utilize applications maintenance resources included in the monthly fixed fee for this work (consistent with meeting service level requirements) to minimize incremental charges for enhancements.

Rates and Charges
The pricing for applications enhancements is fundamentally a time and materials model. As a result, the contract needs to address the range of issues that are relevant to this type of pricing model, including the following:

Personnel Rates – The parties need to agree on the personnel rates that will apply to the performance of applications enhancements. It is a fairly common practice to establish a single blended rate (or small number of blended rates) that reflects the expected skill mix and geography of the supplier personnel performing this work. A blended rate has the advantage of being easier to administer than basing the charges on a granular rate card. However, it is still important to include the supplier’s rate card in the contract. Among other things, it will serve as the basis for making any adjustments to the blended rate(s) to account for material changes to the skill mix or location of the services (e.g., as a result of changes to the supported applications portfolio).

Inflation Adjustments – Most applications enhancement work is performed offshore by low cost offshore resources. While suppliers will point to steeply rising salaries in offshore locations and attempt to negotiate annual inflation adjustments based on offshore wage inflation indices, our database of outsourcing transactions does not show any appreciable difference in the rates for offshore resources from deals signed 5 years ago to deals signed today. Further, as reflected in their financial reporting, suppliers have been able to maintain their profit margins on this work without increasing hourly rates, mainly by offsetting wage increases with cost savings in other areas (e.g., through reductions in telecommunications costs). As a result, customers should expect to be able to lock-in personnel rates for 3 – 5 years without inflation adjustments. Any subsequent adjustments should be based on the U.S. Consumer Price Index (All Urban Consumers) and not on the faster rising and more volatile offshore indices tied on wage inflation.

Productive Hours – Only “productive hours” of work performed for the customer should be chargeable. We generally recommend including a definition of “productive hour” in the contract that specifically excludes items such as travel time to / from the work site, lunch breaks, vacation time, sick leave, administrative time (including billing), general skills training, and marketing / sales activities. These activities are overhead costs of the supplier that are factored into the supplier’s rates and should not constitute chargeable work.

Overtime – As a general rule, there should not be any uplift in the supplier’s rates for working more than a standard workday. It should be the supplier’s responsibility to manage its work force in a manner that minimizes any such costs to the supplier.

Daily Time Sheets – Supplier personnel should be required to complete daily time sheets describing the work performed each day. This information will be important both for invoice management and also baselining the productivity of the supplier staff as described below.

Productivity
From a customer perspective, the most challenging issue in pricing applications enhancements is ensuring the productivity of the supplier’s staff (that is, the “Q” in the “P x Q” calculation of the supplier’s charges). Time and materials pricing does not provide an incentive for the supplier to strive for a high level of productivity and, therefore, needs to be coupled with other mechanisms to address this issue. While there is no silver bullet, consideration should be given to some combination of the following:

Skill Mix – Requiring a minimum skill mix of the supplier’s staff dedicated to performing applications enhancements with financial credits if it is not maintained. This requirement will discourage the supplier from using an excessively high level of entry level personnel who are inefficient and is particularly important if a blended rate is used to price applications enhancement work.

Attrition Rate – Establishing a meaningful attrition rate service level with financial credits if not met. There is a learning curve to be able to support an application efficiently which is lost where there is a high level of turnover of supplier personnel on the account. High turnover is a major problem on many customer accounts, particularly in offshore locations where most applications enhancement work is performed. This needs to be countered with strong financial incentives for the supplier to keep attrition to an acceptable level.

Estimation / Completion Service Levels – Establishing aggressive service levels for the estimation and completion time frames for applications enhancements with financial credits if not met. This will provide some incentive for the supplier to perform work efficiently in order to meet the performance requirements under the contract.

Baselining – Careful measurement and tracking of productive hours for completing applications enhancements. This information can be used to establish baselines for measuring productivity over time. That is, similar types of enhancements and the hours expended can be compared to establish a baseline of the expected number of hours required to complete various types of enhancements.

Demonstrated Productivity Gains – Requiring the supplier to reasonably demonstrate year-over-year productivity gains (or at least no degradation in productivity) based on the measurement and tracking of workload hours through the baselining process described above. If the supplier fails to achieve the productivity requirement, the customer would receive a significant financial credit against the supplier’s monthly invoices.

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In April, we wrote about what we were seeing in the cloud space, including the impact of cloud computing on the CIO agenda. Since then, Savvis published an independent survey of 550 CIOs and Senior IT personnel from large global enterprises concerning their IT outsourcing strategies, including those around cloud computing. We decided to take a look at how some of our personal experiences with cloud computing compared with the survey’s results. Spoiler alert: we weren’t far off.

We’ve seen: Some amount of talk, but not a great deal of action.

Savvis Survey Says: The industry generally agrees.

CIOs are testing the water, but they’re not quite ready to jump in. Even though 85% of respondents said they were using the cloud in some way within their organization, only 6% of respondents said the majority of their infrastructure is currently outsourced in the cloud.

Although we haven’t seen a great deal of action yet, CIOs see opportunity in the longer term. 9% of respondents said the majority of their infrastructure will be outsourced in the cloud in 12 months. That number grows significantly as the timeframe increases to 15% in 2 years, 30% in 5 years, and 40% in 10 years. The survey also predicts that, in order to grow at these rates, outsourcing in the cloud will capture some of the market currently held by traditional outsourcing managed service providers.

We’ve seen: Some interest in internal cloud deployment, especially for test.

Savvis Survey Says: The industry generally agrees.

IT deployment has been a cloud focal point, as “most enterprises have either already begun moving IT applications and services into the cloud or are planning to do so.” Test and development is one of the areas in which private cloud is most popular, particularly in the USA. Globally, test and development is lagging only behind back-up and disaster recovery in partial use adoption. However, organizations have strongly resisted adopting public cloud offerings for test and development.

We’ve seen: Concern over multi-tenancy security, privacy and compliance.

Savvis Survey Says: The industry generally agrees.

Multi-tenancy concerns still exist. Organizations are much more likely to implement private clouds over public clouds, and respondents identified concerns about security as the main impediments to cloud adoption.

Ok, so we all agree. What does this mean?

Things haven’t changed much since our last forecast. The availability of new offerings such as Windows Server 2012, which advertises its cloud capabilities, various open source options, and a marketplace for unused Amazon Web Services Reserved Instances are all indications that the market is maturing, but there is still a general reluctance by CIOs to move large portions of their organization’s infrastructure to the cloud.

Private clouds are currently the preferred choice of cloud adopters, but the choice for CIOs doesn’t stop at public versus private. The pitfalls and shortcoming of cloud identified in our previous post still exist, and analysts have correctly noted that selecting the right private cloud can be difficult. Furthermore, in addition to finding an offering with the capabilities your organization needs, there are contracting issues that need to be considered. The bottom line is if you’re thinking about moving to the cloud, which more people are every day, then you have a lot to think about.

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It has been six weeks since the SEC issued final rules relating to the reporting of conflict minerals. The rules apply to public companies that are subject to reporting requirements under the Securities Exchange Act of 1934 (so-called “issuers”). Issuers must report on the use of conflict minerals in their products. You can read a summary of the rules and an outline of how they are to operate in our Client Alert: SEC Adopts Final Rules on Conflict Minerals Reporting.

In a nutshell, the rules require issuers to examine their supply chains for conflict minerals and to disclose their use in public filings with the SEC. Conflict minerals are certain minerals (including gold and ores from which tin, tantalum and tungsten are extracted) that originate from the Democratic Republic of Congo and adjoining countries. These minerals are used in electronics such as mobile phones, computers and digital cameras, in jewelry, and a wide range of other consumer and industrial products.

The rules are mandated by Section 1502 of the Dodd Frank Wall Street Reform and Consumer Protection Act. As with many gifts from Washington, the complexity of the original legislative directive has mushroomed: the Dodd Frank provision runs for five pages. The SEC’s final ruling, with explanatory memoranda, runs to 356 pages. Consultants, lawyers and solution providers have been monitoring and lobbying for the development of the rules since Dodd Frank was passed. The rules have spawned a mini-industry to advise on compliance and navigate the due diligence and reporting requirements.

With all this material and analysis you might expect that the rules would clearly define the circumstances in which reporting is required, but they do not. As a threshold matter, the rules apply to issuers that “manufacture or contract to manufacture” “products” (none of which is defined). You might assume that this means that the rules only apply to issuers who manufacture products for sale (whether they handle the manufacturing themselves or outsource it), and not to issuers who contract to purchase custom made products, or products made to the issuer’s specifications, for their internal business use but, again, this is not clear. After considering several definitions of “manufacture” the SEC declined to adopt a definition because it believes the term is generally understood.

Many issuers that do not regard themselves as “manufacturers” do procure built-to-spec equipment for their internal use.  These procurements could be viewed as contracts to manufacture products.  Unless and until the SEC issues a clarification to exclude them from the scope of the rules, those issuers should analyze their supply chains to assess whether their built-to-spec product purchases fall within the ambit of the rules.

The SEC offered some guidance on this issue:

  • Whether an issuer “contracts to manufacture” a product depends on the degree of influence it exercises over the materials, parts, ingredients or components to be included. This is a classic slippery slope: merely negotiating contract terms that do not directly relate to manufacturing (e.g. limitation of liability and indemnity) is not enough. Stipulating particular product specifications or components might be.
  • Tools and machinery that are used to manufacture an issuer’s products are not treated as part of the products themselves. For example, if an issuer contracts to purchase a custom made lathe and then uses the lathe to make tables, under the rules the lathe is not treated as a part of the tables. However, it is not clear whether the lathe itself would be caught as a product that the issuer contracted to have manufactured.
  • Assembling components into a finished product may be sufficient to constitute manufacture of the product.
  • There is no “de minimis” exception to the rules, so the presence of even small quantities of conflict minerals in an issuer’s products requires analysis and compliance.

Hopefully we will see some clarifications to the rules soon.  Meanwhile, procurement organizations need to consider their compliance obligations wherever they are involved in purchases of built-to-spec or custom products.

It is worth noting that in September 2011 California passed Senate Bill 861. This law prohibits California state agencies from doing business with issuers that are found, by court judgment or settlement with the SEC, to be in violation of the SEC’s conflict minerals rules.  Those issuers are barred from contracting with the State until they come into compliance.  Other states may pass similar laws.

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The pricing structure of outsourcing transactions often reflects a balancing of competing objectives. In the case of applications outsourcing services, most customers want the pricing structure to provide predictability and proper financial incentives for the supplier to continually increase productivity and efficiency in service delivery. At the same time, both the customer and supplier usually desire a pricing structure that is relatively simple and easy to administer.

While there are a variety of models used to price applications outsourcing services, the most prevalent model involves the following components:

  1. a fixed monthly charge for applications support;
  2. a fixed monthly charge for a baseline number of applications enhancements hours (typically included as part of the fixed fee for applications support) with authorized incremental hours charged on a time and materials basis; and
  3. a framework for pricing significant development work on a project-by-project basis on a fixed fee, capped time and materials, or straight time and materials basis.

This is the first of three blog postings that describes the basic features of each of these pricing components, and discusses some of the key considerations in structuring and negotiating them. The discussion also highlights the complexities and financial incentives inherent in each component.

Applications Support – Fixed Fee Pricing

The fundamental commitment by the supplier is to support a defined set of applications for a fixed fee regardless of the actual level of effort required to perform the services. The fixed fee is established based on the supplier’s projection of the level and skill mix of personnel resources and associated costs required to support the in-scope applications. Except as noted below, if the resources or associated costs are higher or lower than expected, the supplier bears the additional cost or realizes additional profit.

Services Covered by the Fixed Fee. Under a fixed fee pricing model it is important to carefully define the scope of services included within the fixed fee and the circumstances under which the fee is adjusted. There are two key aspects to defining the services covered by the fixed fee: (i) the applications that the supplier agrees to support; and (ii) the functions that the supplier agrees to perform with respect to those applications.

In most cases, it is relatively easy to identify the existing portfolio of applications to be supported by the supplier. However, the portfolio is likely to change over time as applications are added, removed, enhanced and replaced. The contract should contemplate this possibility and provide a mechanism for adjusting the fixed price where appropriate to account for these changes.

The functions to be performed by the supplier may include production support, corrective and preventive maintenance, testing and installation of new releases, documentation, user support, and other activities. The description of in-scope functions should be robust and allow for their natural evolution over time.

Anticipated Productivity/Efficiency Gains. In most outsourcing transactions, suppliers anticipate (or should anticipate) increased productivity and efficiency of the applications support staff over time. The level of anticipated gains will, of course, depend on the efficiency of the in-house staff as well as the customer’s flexibility in allowing the supplier to utilize its own processes and methodologies in servicing the customer. If the in-house staff is believed to be inefficient, it is not uncommon to see projected gains in the range of 15 – 30% over the first two years, leveling off to 3 – 5% per year in later years of the contract.

The fixed fee should capture anticipated productivity and efficiency gains (i.e. the fixed fee and underlying resource baselines should decline over time assuming there are no material changes to the applications portfolio or scope of services). During the proposal evaluation and negotiation process, customers should require bidders to disclose projected staffing levels each contract year broken down by labor category and geography. This will enable the customer to understand and evaluate the staffing levels and projected efficiency gains and to ensure that they are reflected in the fixed fee.

Adjustments to Fixed Fee. As noted above, there should be mechanisms to adjust the fixed fee to account for material changes in the supported applications portfolio, such as a major addition, removal or replacement of an application or applications group. In general, “normal” ongoing enhancements should not trigger adjustments to the fixed price; otherwise, the fixed fee would lose predictability.

Adjustments to the fixed fee should be based on the increase or decrease in the number and type of skill sets of personnel resources required to support the affected applications. Before the contract is signed, the customer should negotiate personnel rates for a comprehensive set of labor categories that will be used as the basis for any such adjustments. The supplier should be required to keep accurate records throughout the term of the contract of the time devoted by its personnel in supporting each application so that the customer can assess the reasonableness of any proposed adjustments to the fixed fee.

Finally, customers should consider negotiating a sharing of the cost savings if the supplier is able to successfully provide the services with fewer resources than projected at the start of the contract due to better than anticipated (i.e. below resource baselines) productivity and efficiency gains. The supplier may argue that it should be entitled to the benefit of all such cost savings as long as it is able to meet the agreed service levels since it is taking all of the risk if more than the projected level of resources is required. Service level metrics, however, cannot fully capture all important aspects of the supplier’s performance and the customer should have the right to assess whether its performance requirements can be met with fewer resources.

As an incentive for the customer to agree to a proposed reduction in resources if the supplier can meet the customer’s performance requirements, the contract could provide for the parties to share in the cost savings. To implement this arrangement, the fixed fee would be reduced by a percentage (e.g., 50%) of the personnel charges of the resources removed from the account. This would allow both the supplier and customer to benefit from the supplier’s unanticipated productivity and efficiency gains.

Advantages and Disadvantages. The primary advantages of fixed fee pricing for applications support are that it provides a high level of predictability in the supplier’s charges (in the absence of major changes to the applications environment) and a strong financial incentive for the supplier to continually increase the productivity and efficiency of its applications staff. If the supplier is able to “overachieve” by providing the services with less than the baseline level of resources and there is a gain sharing mechanism, both parties will benefit from the cost savings.

The fixed fee, however, adds complexities that are not present in a level of effort pricing model (i.e. where the customer purchases a dedicated staff or number of FTEs on a time and materials basis to provide applications outsourcing services, including applications support). The parties must distinguish between maintenance/support activities that are covered by the fixed fee and activities that are priced separately (e.g., enhancements). In our experience, this can be source of friction between the parties. In addition, if the customer application environment is unstable or highly dynamic and there are a number of significant changes to the applications environment, it may be difficult for the customer to effectively monitor and manage the resulting changes to the baseline (and thus the fixed fee) and the predictability of the fixed fee may be eroded in these circumstances.

A fixed fee pricing structure for applications support does not by itself assure that the supplier will achieve specified levels of output. Therefore, it is important that the contract contain service levels that, at a minimum, commit the supplier to meet agreed time frames for responding to and resolving incidents and problems and managing backlog effectively.

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London has just witnessed an amazing summer of sport, with the Olympics and Paralympics having come to a close. Yet the impact of the Games may be broader than simply having provided Londoners (and the world) with a brilliant injection of morale and amazing photo opportunities. There are many chances for businesses to learn valuable lessons from the Games, including in the areas of risk management and project management.

1. The Olympic Paradigm – Think Ahead

As expected, the Games brought certain challenges for businesses in London. Many challenges were clear and highlighted well in advance so that businesses could plan and ensure that sufficient contingencies, tailored to their specific business needs, were in place to keep things ticking over.

For example, a combination of anticipated road congestion, increased security and millions of visitors in London was expected to impact deliveries for businesses. To avoid delays, companies receiving or sending deliveries could plan in advance to arrange for off-peak deliveries or accept deliveries in bulk prior to the busiest days.

Courier companies had to consider not only the anticipated road congestion but also the ways in which their clients might look to mitigate such risks. Courier company DHL hired a team of jogging couriers to help with deliveries during the Games. JogPost, a delivery company that solely uses on foot couriers, was contracted by DHL to carry out crucial business deliveries by foot and public transport.

Phil Couchman, CEO of DHL Express UK, said “Keeping London moving is a priority for us; our customers expect their critical deliveries to arrive on time regardless of what’s happening in London. By using innovative delivery methods we are able to sustain our high service levels during what will be a busy time for businesses, and also reduce our carbon footprint by sending fewer vehicles into the city.”

Another example of savvy advanced planning came in the form of the website testing that the London Organising Committee of the Olympic and Paralympic Games (LOCOG) undertook. Paul Bunnell, the Lead Web Architect for LOCOG has been quoted as saying “We began working with SOASTA CloudTest six months prior to the games to find all the possible bottlenecks which could prevent the best user experience possible and avoid a catastrophic situation, which could impact the London 2012 brand. The application, infrastructure and all the third-party integration points needed to go through capacity planning and stress testing with different load patterns to ensure reliability and performance 24/7 especially during popular events such as the Opening Ceremonies and 100-meters final. The testing teams were spread across the globe and utilized CloudTest’s ability to provide real-time results to adapt the testing, something that legacy toolsets are unable to do.”

Doesn’t this all sound like a recipe for thoughtful and well-targeted planning for complex outsourcing? Let’s review:

  • Contingency planning to meet anticipated business needs;
  • Use of alternative delivery times to avoid service complications occasioned by peak volume (traffic);
  • Innovative delivery models to sustain high services levels; and
  • Stress testing (with different load patterns) to ensure reliability across applications, infrastructure and third-party integration points.

2. Planning in the Outsourcing Paradigm

In the context of supply or outsourcing arrangements, the customer should identify at the outset the primary risks and potential issues that may arise during the life of the project to ensure appropriate actions are taken to reduce these risks. The customer, in conjunction with its supplier, should develop strategies for mitigating the risks, and also put in place practical solutions if those risks or related issues arise. A thoughtful risk assessment should yield contractual protections for the customer, such as an obligation on the supplier to prepare for, test and implement business continuity (BC) and disaster recovery (DR) plans.

It is equally important for a customer to ensure that the contract and operational risk registers are evaluated regularly throughout the life of the outsourcing. The smart customer carries the “torch” of diligence throughout the life of an outsourcing by reviewing the contract and associated operational risk mitigation mechanisms (such as BC and DR plans) to assess whether there have been (or should be) any changes to the assumptions or scenarios that were envisaged when the contract and plans were put in place, and whether the risk profile of the engagement has changed.

3. Teamwork is Paramount

Management of third party suppliers is absolutely vital. Imagine, for example, if DHL neglected to managed and integrate the JogPost foot courier solution with its own. A good contract will provide a framework for regular and ongoing communication between the parties so that there are no surprises for either side. Moreover, the contract should set out a process for escalating issues through internal management levels within appropriate timescales, so that concerns can be addressed and resolved promptly at the suitable level.
Customers may also look to include specific remedies in the contract which gives the customer certain rights if problems surface that are not quickly resolved or are severe enough to merit more significant intervention. For example, the customer may require increased performance-monitoring following supplier failures to allow for more informed analysis of the problems and possible resolutions. Depending on the service, for more severe service issues the customer may also include “step-in” rights, which allow the customer or their nominated provider to take over responsibility for all or part of the services if the supplier fails to meet its obligations.

Finally, the customer should consider carefully its termination rights to ensure it has the rights it needs to exit a contract upon supplier default and engage with other suppliers promptly.

4. Practice Makes Perfect

Like the athletes themselves, LOCOG honed its skills with a series of test events prior to the Games themselves. There were full dress rehearsals for both opening and closing ceremonies for Games and various other events. The official London 2012 sports testing programme helped to test vital areas of operations ahead of the Games with 42 test events across 28 venues.

This principle can be and is applied to many aspects of well framed supply or outsourcing contracts. A good example is in relation to transition and transformation. Where an outsourcing involves significant transition and, in particular, transformative activities, those activities are often conducted in a staged or iterative process (e.g., by service tower, by region, etc.), rather than under a big-bang approach. This way, the impact of any failures can be limited to and the solutions achieved can be applied to subsequent installments of the service. Under this approach the lessons learned and applied in earlier iterations enable more effective downstream delivery.