Actual Contract Structure In Outsourcing Of Information Technology

Outsourcing of information technology (IT) services has received much attention in the information systems (IS) works. However, considerably less attention has been paid to actual contract structures used in IT outsourcing (ITO). Examining contract structures yields important insights into how the contracting parties structure the governance provisions and the factors or transaction risks that influence them.

The documents should provide an accurate explanation of the contract’s necessities and how the vendor plans to meet those necessities, provided the obtaining process has been performed properly. A big outsourcing contract classically contains many systems. This report provides a summary of the contract mechanisms that are most significant in evolving a successful contract.

Fundamentally, IT outsourcing arrangements are subject to a range of business and technological uncertainties making it impossible for contracts to be fully specified. Thus the contracts settle on specific factors that are most relevant or most verifiable. By design, ITO contracts specify significant decision rights and payment mechanisms for the service provider, which determine the quantity and quality of effort expended on service delivery. While the vendor is expected to meet specified performance requirements, a failure to do so willfully or inadvertently can impose considerable costs associated with business disruption on the client. Such standard problems of agency are compounded when asset tenure rights are transferred along with decision rights. Now, the client no longer owns the assets for service delivery making it more difficult for the client to bring service delivery back in-house and further raises the risk of hold-up by the vendor. Moreover, the vendor is now charged with choosing the level of ongoing investment in the assets, which may result in under-investment and decaying assets. From the vendor perspective, its exposure to holdup 13risk also increases once it has made a large transaction-specific investment. Therefore, contracts governing such an arrangement should include measures to mitigate the risks to both parties. Even though contracts that govern complex ITO arrangements can be lengthy and specify decision and ownership rights, the measurement system, pricing provisions, incentive clauses, and numerous other provisions, they are still incomplete.

Contract Structure in ITO

A large outsourcing contract typically contains many components. The followings four broad categories provide an overview of the contract components that are most important in developing a successful contract.

1. Monitoring provisions
2. Dispute resolution
3. Property rights allocation/protection
4. Contingency provisions.

Monitoring provisions

1. Reduces contractual risks by specifying procedures.
2. Review procedures to be followed
3. Establishes the governance framework for observing and recording the vendor’s performance
4. Detects underperformance or noncompliance of the parties.

Dispute resolution

1. Establishes the processes to be adopted when disputes arise
2. Provisions conditions that constitute grounds for a more formal lawsuit.
3. Property rights
4. Specifies the ownership and rights to control
5. Associates provisions for security and confidentiality
6. Covers ownership or copyright, title and licensing rights, patent protections, data security and confidentiality terms
7. Rights to access the source code (in case of software development).

Contingency provisions

1. Refers to built-in provisions for variation or modification
2. Allows the specification of parties’ obligations in case of a foreseeable event happens
3. Allows an adaptive capability or flexibility to unforeseen contingencies necessitates.

Summary

This report summarizes the role and performance impacts of contractual mechanisms of ITO in large outsourcing arrangements where assets essential to service delivery are transferred to the vendor. Clearly, clients outsource IT services to achieve better delivery outcomes. However, vendor ownership of the assets introduces complex tradeoffs into the outsourcing arrangement. We know from PRT that asset ownership by the vendor provides it with the crucial incentive to continue to invest in these production assets that are necessary to improve the outcomes of IT service delivery. On the other hand, the transfer of critical service delivery assets to the vendor raises the likelihood that one or both parties will engage in post-contractual opportunism. It is then apparent that outsourcing arrangements with asset transfer must incorporate additional contractual mechanisms to alleviate the danger to both parties. Vendors must provide guarantees to their clients via contractual features that they will not exploit their ownership of the key production assets. Clients must provide their vendors with incentives to continue to invest in the assets.