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Outsourcing:Outsourcing:ItIt’’s Often Disguised as M&As Often Disguised as M&A
Shearman & Sterling
HRO Outsourcing Conference
July 31, 2003
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Outsourcing:Outsourcing:ItIt’’s Often Disguised as M&As Often Disguised as M&A
Why Do We Care?• M&A Tends to be Less Adversarial
– Fewer Bumps in the Road– Less Focus on SLAs
• Transactions Run More Smoothly• Different Motivations• Management has a Different View on M&A • Transaction Teams Structured Differently• View from Wall Street
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Similarities Between M&A and Outsourcing
• Size of BPO transactions rival, and sometimes far exceed, those found in M&A
• Transfer of substantial employees, systems and infrastructure from one entity to another, along with significant integration and risks
• Liabilities are assigned between the parties, with the vendor often assuming traditional buyer-type obligations
• BPO arrangements have a lengthy negotiation cycle, extensive duediligence and substantial risks of closing uncertainties.
• Transaction consideration has involved a mix of cash and securities
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Key Drivers for Traditional Outsourcing
Business Drivers• Reduce Costs• Flexibility to Add/Reduce Services• Flexibility to Add/Reduce Staffing• Focus on Core Competencies• Build World-Class Processes• Improve Overall Competitiveness• Establish Local Presence
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Key Drivers for Traditional Outsourcing
BPO Drivers• Backup, Disaster Recovery, Business Continuity• Improve Service Levels• Enhance BP Effectiveness• Supplement BP Resources• Shorten Implementation Time• Lower risk of technology refresh costs
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The Traditional Approach
The Goal - Focus on Core Business
BP Service
Customer
Customer
Core Business
Outsourcing Agreement
Core Business
AncillaryBP Service
Service Provider
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The Traditional Approach:The Customer as Caveman
Beat the Vendor into Submission• Focus on Pricing• Focus on Extraneous Legal Provisions
The Cost• Adversarial Relationship — Starts to Look Like Litigation• Do You Really Use the Remedies You Negotiated?
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The Problem with Outsourcing Deals
• Extreme Focus on Costs– What Happens the Next Morning?– What will the Vendor do to Make a Profit– Are the Parties Still Talking to Each Other?
• Lack of Motivators Beyond Cost• Adversarial Negotiations• Inflexibility to Future Changes
– Focus is on SLAs and Payment Matrix
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Who is Driving the Outsourcing Deal
• Outsourcing Usually Driven by IT, Finance Personnel, or High-level Technical Managers– Structured with a relatively narrow vision– Reducing costs, maximizing service levels, ensuring technology
refresh and transferring risk of service delivery to the vendor.
• M&A Almost Always Driven by C-Level Executive Suite
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Who is Driving the Outsourcing Deal
• Consultants and Many Vendors Developed Expertise in IT Space– Traditional motivators may apply
• Are traditional motivators primed to become the norm in Business Process Outsourcing as well?– Were these motivators ever sufficient for IT outsourcing?
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How Deals are Currently Done
What is Driving the Typical Deal• Costs! Costs! Costs!• Squeeze the Vendor
Result: Animosity
Who is Driving the Deal?• IT Managers
Result: Lack of Resolve by High Level Decision Makers
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How Deals are Currently Done
Typical Bottlenecks• Do the Parties Really Have a Meeting of the Minds?
– SLAs– Warranties– Indemnities– Termination Provisions– Service Level Credits
• Focus on Problems/Remedies
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Complex Legal/Regulatory Issues
Often Ignored• 401(k)/Benefits• HR• Taxes• Intellectual Property• Privacy — EU Directive• Data Export• Employee Rights (TUPE Regulations)
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Looking To M&A For Guidance
• Looks Very Much Like The Traditional Outsourcing Arrangement• Are the Motivations the Same?• Have We Dealt with the Same Legal Issues?
Customer/Seller
Purchase and Sale
Agreement
Core BusinessAncillary
BP Service
Service Provider
(BP Service)
Core Business
Service Provider
Vendor/Purchaser
People Equipment Facilities
BP Service
Sale of Business
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Ancillary BP
Service
Core Business
BP Service
Core Business
AncillaryBP Service
Ancillary BP
Service
Core Business
BP Service
The Spinoff
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BP Service
Core Business
Service Agreement
Core Business
AncillaryBP Service
Core Business
AncillaryBP Service Core
Business
Service Agreement
Joint Venture
Party 1
Party 2
The Joint Venture
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Motivations• Focus on Core Business• Direct Cost Savings• Exercise Control through Ownership
– Consider Unique Governance Structures• Balance Sheet Benefits• New Structure Enables Greater Focus on BP Service• Share in Future Benefits of BP Service• Retain Possibility of Future Upside — IPO (Not in this Market)• Employees are Better Protected and See Future Opportunities• Tax Benefits
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How to Improve Outsourcing Deals:Who is Driving the Deal?
• Seek Senior Management Buy-in– Board/CEO/CFO/CTO are preferable– May need to identify other motivating factors to get
management buy-in– Focus of deal will switch to motivators beyond costs– Deal will progress more quickly– Decision-makers will be on board ready to make
decisions
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How to Improve Outsourcing Deals:What is Driving the Deal?
Look For Motivators Beyond Costs• Less Focus on Technology Issues
– Flexibility– Add/Reduce Services– Add/Reduce Staffing
– Business Continuity– Tax Benefits– Spin-off?– Share Price
Create a Win-Win Outsourcing Deal
More Partnership/Less Adversarial
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How to Improve Outsourcing Deals:Guidance From M&A
M&A usually being driven by high-level management• Parties operate at a much faster pace• Many nuts-and-bolts operational issues are simply ignored in favor of
language regarding high-level business objectives
Transaction team on an M&A transaction is usually much larger • Multi-disciplinary team that can handle all issues simultaneously• Technical and/or service-related issues • Financial • Legal and Regulatory
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How to Improve Outsourcing Deals :Guidance From M&A
The view From Wall Street• Needs to be “win-win”• Focus on deal economics • Vendors are expected to obtain a reasonable return on their
investment– Not exclusively in the out years, especially when contracts are
commonly renegotiated every 2-3 years• Consider using a Financial Adviser to manage Wall Street
expectations• Advanced financing paradigms?
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How to Improve Outsourcing Deals:Guidance From M&A
In M&A , it is often easier to negotiate Service Agreement and SLAs
• Emphasis on greater shared interests• Purchase Agreement in an M&A transaction provides
warranties, indemnities and limitations on liability
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How to Improve Outsourcing Deals :Guidance From M&A
Focus on issues governed by M&A process guidelines
Use appropriate valuation techniques as employed by financial professionals
Effectively set and communicate expectations to Wall Street
Negotiating tactically (vs. from an operations perspective)
Considering the full universe of strategic and financial options
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Advanced Paradigms
Think Outside The IT/BPO Box• Holding Companies
– Special Purpose Vehicles• JVs• Strategic Alliances• Spin-off/IPO• Tax Benefits• Cross-Border Deals
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Benefits of M&A-Based Approach
May be easier to deal with Legal/Regulatory Issues — Often ignored in traditional outsourcing
• Employee Benefits/HR • Privacy• Tax
Less Adversarial• Not the Caveman Approach• Mutually Beneficial• Shared Interests• May be easier to negotiate Service Agreement
– Purchase and Sale Agreement may provide Warranties/Indemnities– Greater transaction benefits enable less emphasis on outsourcing provisions
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How to Improve Outsourcing Deals: Recommendations
• It’s Not a Litigation – Don’t Approach it as Such
• Structure the Vendor Selection Process to Create a Partnership
• Focus on Pricing, but not to Exclusion of all Else
• Structure the RFP Process to Reduce Adversarial Negotiations
• Build a Flexible Contract with the Remedies You Need