Outsourcing Contracts
November 20, 2009
In recent years organizations have undertaken to focus more on their core business functions. This has led to more and more organizations outsourcing other parts of their organizations. Contracts are a key component in outsourcing since they act as a guide between both the seller and the buyer. Outsourcing contracts should include four key issues, these are scope of services, performance standard, pricing schedule and terms and conditions.
Scope of services describes the statement of work (SOW) that will be performed by the seller. The SOW can be detailed, performance based or level of effort. A detailed statement of work describes how the work will be done exactly and the seller will follow the SOW as described by the buyer. A detailed statement of work will prevent the seller from coming up with creative and beneficial solutions to solve the buyers problem. A level of effort SOW “describes the general nature, scope or complexity of the products or services to be provided over a given period of time.” (Chen 2006)Performance based statement of work give the seller the flexibility in terms of how best to do the work. It does not dictate how the work will be done and thus the seller can come up with innovative ways to solve the buyer problem. The seller is judged by their performance, technical ability and quality of work.
Performance standards describe how the seller’s work or the contract will be judged. It describes the minimum services levels that the seller will perform, what criteria will be used to measure their performance and what are consequences of failure on the seller’s part. (Greaver II 1999)
Pricing schedules describes what the buyer will pay for the services of the seller and how this will be done. Some long term contracts might have a monthly payment schedule while others might pay per deliverable produced or at the end of the contract.
Terms and conditions describe the legal and business issues that the buyer and the seller should abide by. It deals with contract terms, billing terms, termination terms, and transition procedures. (Greaver II 1999)
There are different types of contracts and the buyer needs to know which contracts tend to expose him/her to risks and thus be able to introduce policies that will prevent exposure in terms of cost. Firm Fixed price contract allows for the seller and buyer to agree on the price of the project or service in advance. The seller must do the work for the agreed price. It tends to protect the buyer from cost overruns because the seller will have to absorb the cost overruns if they occur.
Time and materials contract involves the buyer being billed by the seller for labor and materials. “Time and material contracts provide for payment of direct labor hours at an hourly rate that includes direct labor costs, indirect costs and profit.” (Chen 2006).
Cost plus contracts are contracts where the buyer reimburses the seller for allowable expenses incurred on top of the final cost of the project. Cost plus contract are suited for projects that are not well defined or risky ventures where there is no performance track record. (Chen 2006). Cost plus fixed fee contract, Cost plus incentive fee contract and Cost plus award fee contract are some of the types of Cost plus contract.
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