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Outsourcing as a Tool in Exiting a Failing Business: National Australia Bank’s Acquisition of Shares in Rival AMP Ltd.

October 9, 2009 by Bierce & Kenerson, P.C.

Outsourcing can provide a unique benefit in preserving the value of a declining line of business.  Consider an industry where many major players are suffering operating losses, where “ill-timed” acquisitions have resulted in write-offs and loss of shareholder value, and where there are no buyers or where the assets impaired by recent losses cannot be sold for what has been the historical valuation.  In such cases, outsourcing offers to management the “breathing room” to maintain a customer base while waiting for either a recapture of the same outsourced business in a future up-market.  This principle applies to international as well as domestic markets.

We take a case study in the financial services industry in Australia and the United Kingdom as the backdrop for some “lessons learned” in the use of outsourcing as a tool for exiting, or preserving value, in a failing line of business. The case involves National Australia Bank and AMP Ltd. (formerly named Australia Mutual Provident).  The lessons apply to any business that has been challenged by recession or by failed over expansion through failed acquisitions.

Background.

AMP Ltd. and National Australia Bank are both Australian financial services companies that entered into the UK life insurance market as part of a diversification strategy. They compete in Australasian banking and insurance  markets as their principal markets. Both concentrate on insurance and funds management services.  AMP has about A$235 billion in funds under management, compared to NAB’s A$65 billion, as of August 2003.  AMP’s crown jewel is its network of about 1,900 financial planners in Australia.

AMP and Its Demerger Strategy for Unlocking Shareholder Value in a Declining Market.

AMP, whose shares are owned by about 1 million Australians, experienced financial troubles and a steep decline in the price of its stock from 1999 to 2003. In response, in late 2002, the company adopted retrenchment measures, including closures of certain lines of business, a new board of directors, reductions in costs and in risks and a demerger, announced on May 1, 2003, that it would “demerge” its UK and Australasian businesses.  The demerger announcement asserted that each new entity would benefit by having distinctive strategies, customer bases and growth prospects, and would operate in simpler, more transparent structures.  As restructured, AMP Banking will focus on Australian markets for mortgages, retail deposits and retail financial planning services.

NAB and its Rolling Acquisition Strategy.

National Australia Bank operates in 15 countries and is one of the 50 largest banks in the world by revenue.  NAB made an informal offer in 1999 to purchase AMP for A$21 a share, less than one third the A$6 per share that it offered in August 2003.  On August 28, 2003, NAB announced that it was offering to acquired a small 5.4% stake in AMP for A$6.00 per share.  When NAB “waded in” to make an initial purchase, AMP was trading at A$5.40 per share.  While NAB’s 2003 share purchase did not involve a tender offer for control, it clearly put AMP’s shares “in play” for a potential tender offer, which would give NAB a dominant position in the Australian funds management industry.

Role of Outsourcing for Both Financial Institutions.

Outsourcing played a role in the business strategy of one of the two financial services institutions.  Both experienced hard times from one of the worst bear markets in UK history. Their strategies differed. AMP sought a split-off, or demerger, of the UK and Australasian lines of business.  NAB decided to continue in both markets as a distributor of third-party services, rather than as an integrated seller of life insurance.

Outsourcing by NAB.

NAB used outsourcing to drop losing lines of business without losing customer goodwill and without losing the opportunity to cross-sell customers using service products that it did not “own” or produce directly.  By outsourcing, NAB positioned itself to retain customers and, one may presume, the legal right, on expiration of the outsourcing agreement, to recapture the outsourced services or find another service provider.  After the outsourcings, NAB can now focus on distribution and customer relationship management.

Outsourcing of Life Insurance Underwriting.
Facing tough competition and an economic downturn in England, in early August 2003, NAB closed down its life insurance underwriting business in the United Kingdom and appointed Legal & General Group as its “alliance partner” to underwrite life insurance for retail customers of NAB’s three UK bank subsidiaries.  NAB’s announcements in the press did not specify any material details.  In a bid to persuade its retail customers that a brand name was better than an affiliated “house” name, NAB praised Legal & General’s status as a leading life insurance underwriter.  The Australian Financial Review called this an “outsourcing deal.”

Outsourcing of Insurance Administration Services.
NAB also formed an “alliance” with Junction, a part of the UK’s Budget Group of Companies, to provide product and administration services for its home and motor vehicle insurance operations.

Outsourcing by AMP.

AMP used outsourcing to drop its own losing lines of business, but only as a means of termination and liquidation of a dying business.

Insurance Business.
As part of its cost cutting, AMP discontinued its reinsurance and direct insurance businesses.  AMP hired another insurance services company, Cobalt, to “manage the runoff,” or claims processing for the eventual expiration of all pending policies written by such AMP lines of business.

Investment Operations Outsourcing Services.
AMP was apparently in such dire straits in 2002 that it had to sell off a crown jewel, its Cogent subsidiary in the UK, to BNP Paribas Securities Services.  For BNP Paribas, which had extensive operations in serving mutual funds and providing custodian banking, AMP’s sale was an opportunity to relaunch its position in the United Kingdom by expanding further into outsourced support for mutual funds and private equity funds.

Legal Issues in the Acquisition Strategy.

Use of an outsourcing strategy to reduce corporate capital investment in operations and accelerate an acquisition campaign poses legal hurdles. The “big payoff” will not be available if the acquisition violates antitrust or competition rules.  But the outsourcing strategy pays off anyway because it deals with an inherent problem instead of closing out a business.

Lessons for Corporate Strategists, Investment Bankers and Shareholders.

When a company hires an outsourcing services company, the engagement can signal an exit in the line of business.  In the case of AMP, it signaled a total exit for the closed lines of business.  For NAB, it signaled a chance to retain customer loyalty while shifting to Legal & General Group the business of managing a life insurance underwriting operation.

From a corporate strategist’s viewpoint, we think outsourcing (or some variation such as “strategic alliances” or subcontracting) can provide significant advantages in different types of markets. In this case, the markets had suffered significant declines in customer purchases.  The loss of gross revenues in 2001 opened opportunities for creative strategic responses using outsourcing techniques

• Outsourcing as a “Least-Worst” Alternative to Closing a Line of Business.
  Outsourcing can be a viable exit strategy for a line of business.  When a business is closed, its assets are lost.  By preserving the semblance of continued operations, the goodwill associated with the line of business can be preserved.   The goodwill can continue to generate shareholder value without permanent impairment. Even where the business is actually closed, hiring someone else to manage the “runoff” of expiring business obligations (in this case, life insurance policies) allows an immediate closeout of the business operations, thereby allowing management to focus on other business needs.

• Outsourcing as a Tool for Cost Containment.
  Outsourcing can contain costs.  The extent and predictability of such cost containment depends on how the outsourcing is structured and managed by the enterprise customer.  In the case of NAB, the “strategic alliance” dramatically reduced the costs of the UK bank subsidiaries for valuable products.

• Outsourcing as a Tool for Customer Retention Strategy.
  Outsourcing can increase customer retention for services and products that the enterprise cannot viably deliver at competitive prices or terms. By shifting from a proprietary service suite to an outsourced service suite, NAB’s UK bank subsidiaries can argue that they have improved the quality of service by a “strategic alliance” with a “best of breed” life insurer.  In the process, NAB retained the full line of service, so that customers will continue to view it as a “full-line” service provider in its field, financial services.  And NAB can be seen as a distribution company, retaining goodwill.

• Outsourcing as a Tool for Risk Mitigation.
  Outsourcing can mitigate the risks of continuing a business in a highly challenged marketplace.

• Outsourcing as a Tool for Nimbleness in Mergers and Acquisitions.
  Outsourcing can allow management the time to focus on strategic mergers and acquisitions.  In Australia, NAB had already offloaded the underwriting function to Legal & General Group and could easily integrate and expand that outsourcing to accommodate the AMP UK life insurance business as well, if NAB were to acquire or merge with AMP.  In doing so, NAB position its self to either swallow AMP as a “full fledged fish” with a poorly performing life insurance underwriting business, or it could elect to offer only to acquire the crown jewels of AMP, its financial management services business.

• Outsourcing for Renewed Focus in a Down Market.
  As management guru Peter Drucker once said, companies have two purposes: to innovate and to market.  By outsourcing effectively to avoid loss of market share, NAB is able to focus on its core business and contemplate the possibility of acquiring its chief rival in Australia.  If it acquires AMP, NAB will reportedly have a 52% market share above that of its nearest rival, Commonwealth Bank, in the institutional investment funds management industry.

• Failure to Outsource.
  In selling its Cogent subsidiary in 2002, AMP chose to sell a line of business rather than outsource it and keep the customer relationships.  One may second-guess this decision as a precursor to a financial and strategic restructuring of AMP.  In making “sell vs. outsource” decisions, management should consider both. If management has to raise cash to pay off debt, the “sell vs. outsource” decision becomes skewed towards a simple sale.

Vetoing the Legislation Against Outsourcing in California

October 9, 2009 by Bierce & Kenerson, P.C.

Politics and Outsourcing

Quite evident in the recent presidential campaign, as well as in numerous legislative campaigns across the country, was the issue of outsourcing and whether curbs should be placed on this business practice in both the public and private arenas. In the months leading up to the elections, the media filled hours of air time and reels of newsprint (and pages of cyberspace) reporting on and debating about the latest outsourcing initiatives and trends, and their effects, real or imagined, on the US economy in general and on the plight of the American worker in the industries, businesses and practices being, actually or potentially, outsourced.

In addition, in the run up to early November 2004, numerous state legislatures, as well as the US Congress, debated bills introduced during the prior legislative calendars that focused on trying to prevent or limit outsourcing in some form or other, particularly with respect to public contracts and services.  Most state proposals will never be enacted, at least in their current forms.

Perhaps in no state was the interplay of the current political and business agendas over outsourcing more evident than in California. In the last days of the state’s 2003-04 legislative session, Governor Arnold Schwarzenegger faced a number of proposed bills that were aimed at controlling the off-shoring of California jobs and services and that would become law without the Governor’s veto.

Mix of Focuses and Arguments

These “anti-outsourcing” efforts generally encompassed three broad categories:

• Requirements that state contracts be performed within U.S., by U.S. citizens and/or by authorized workers in U.S.;
• Preferences or incentives to businesses restricting outsourcing activities; and
• Restrictions on the transmission of personally identifiable information abroad.

The arguments against enacting them similarly centered on three main themes:

• Protectionist public policy invites retaliation;
• State outsourcing restrictions may unconstitutionally impinge upon the federal government’s role in regulating foreign commerce; and
• Outsourcing limitations may violate existing trade agreements.

Therefore, without analyzing in detail the history of the various bills seeking to limit certain types of outsourcing initiatives in California, it is nonetheless interesting to review, in light of the above categorizations, the reasoning stated in Governor Schwarzenegger’s issuance of three vetoes of such bills that came before him for signature at the end of the legislative session in late September 2004.[1]

Proposals and Vetoes

Governor Schwarzenegger vetoed three bills.

• SB 888 (prohibiting the off-shoring of essential state homeland security work);
• AB 1829 (prohibiting state agencies or local government from contracting for services to be performed by workers outside the U.S.); and
• SB 1492 (prohibiting health care businesses from transmitting personally identifiable information outside the U.S. without authorization).

The intended prohibition of each vetoed bill mirrored generally the three types of efforts to limit outsourcing taking place around the country. Expressing apparent distaste for restraints on business, the wording of the Governor’s vetoes similarly echoed the broader category of positions against  arguably unconstitutional bills that create artificial barriers to economic growth and unnecessary hurdles for businesses and government.

Existing Laws and Regulations

The veto of SB 1492 (medical information) was short and to the point. “Existing [state and federal] laws prohibit the sharing of an individual’s medical information. [and] provide mechanisms to protect the confidential information and remedies against those who violate the acts.” The veto message did not touch on the issue of outsourcing per se.

A more measured explanation addressing the topic was given for the veto to AB 888 (homeland security).While describing that bill as “unconstitutional under the commerce clause” and “overly broad,” on a more practical point the Governor’s veto noted that there is “no guarantee” that the performance of the essential homeland security work will be somehow less safe if performed in another country. He concluded that the implementation of adequate security measures to protect sensitive information in this area is the appropriate requirement. Also, by placing additional restrictions on contractors, the veto indicated that the bill “will, ultimately, result in higher prices for services without increasing homeland security.”

Restriction and Competition

The most significant address of the outsourcing issue came in the veto of AB 1829 (state contracts). The bill would have required contractors to certify that work on state contracts would be performed in the US.

Gov. Schwarzenegger first noted that California, with its innovative and entrepreneurial businesses, are a part of “the global marketplace,” which benefits both California citizens and those of the rest of the world. Then, in vetoing, Governor Schwarzenegger stated that “our focus should not be on erecting artificial barriers that thwart” such economic activities. Indeed, in announcing the veto, the Governor determined that rather than saving jobs, the bill “would actually be detrimental to our economy and the creation of new jobs in this state,” as well as negatively impacting state and local competition, implementation of more efficient government purchasing systems, and prices paid by government entities for services.

Arguing that the bill would “restrict trade, invite retaliation or violate the United States constitution and our foreign trade agreements,” the Governor sought to make clear that his veto was against “punitive policies restricting [the] ability [of businesses] to make decisions on how best to perform and provide goods or services for state government and our consumers.” Finally, in stating that continuing California ‘s position in the global economy was necessary to “create new opportunities and better jobs for our citizens,” and after earlier noting the hundreds of thousands of jobs created in California from foreign investment, the Governor surmised that “[t]hese restrictions will drive business out of California.”

Future Legislative Efforts

Based on earlier raised arguments and pronouncements, perhaps there was nothing really unexpected in the content of the vetoes issued for the “anti-outsourcing” bills in California. There was certainly a public pronouncement of the state Republican administration’s path and reasoning in the face of legislative efforts to curb the outsourcing trend, at least in the public contracts arena. No doubt there will be further legislative efforts undertaken, in California and elsewhere. Perhaps it will require approval of additional federal legislation in the future to create a toe hold from which the state legislatures may hang their efforts with more success.

Litigation: “Spoliation of Evidence” Where Records Are in the Hands of Service Provider

October 9, 2009 by Bierce & Kenerson, P.C.

Principle decision: A customer’s failure to identify the existence of, or provide, business records held by a service provider constitutes spoliation of evidence and justifies a directed verdict in favor of claimant suing the Customer.

Customers, especially government bodies, can be classic deep-pocket defendants in personal injury tort litigation.   If the customer fails to produce records of its maintenance and custody of facilities that it is legally liable to maintain, a court could find that the customer engaged in spoliation of evidence.   Such spoliation warranted a decision that the customer inexcusably prejudiced the claimant, and that the customer’s answer to the complaint was stricken, resulting in a directed verdict for the injured claimant.

In a New York decision in July 2002, the court noted that, if the customer (The City of New York) had named the service provider during the discovery phase of the injured third-party claimant’s litigation, the claimant might have been able to sue the service provider or at least obtain records that could be used in suing the customer.  In this case, the service provider, an engineering firm, had contracted to manage the City’s traffic control detectors, and the plaintiff alleged injuries sustained while riding a bicycle into a traffic control detector.

Lesson #1:

Customers need to be aware of the contractor’s management of facilities and must disclose, in litigation, the service provider’s role in facilities management.    Amankwaah v. The City of New York, ___ NYS2d ___, NYLJ July 1, 2002, p. 31, col. 5 (NY Supreme Ct., 2nd Dept. 2002).

Lesson #2:

If the parties expect that the service provider will have to defend against claims of third parties, in the outsourcing agreement they should allocate the financial and legal liabilities of such claims.

Lesson #3:

The outsourcing contract should also have provisions governing records maintenance and management.

International Outsourcing: Legality of Xenophobia in Outsourcing

October 9, 2009 by Bierce & Kenerson, P.C.

Summary:

In the United States, layoffs during the downward economic cycle following the dot.com bubble and then the 9/11 attack have had a severe impact on the local economies.  In the resulting legislative debate over the impact of outsourcing, some state legislators have proposed a reversion to the “Buy American” principle that conflicts with international trade under the World Trade Organization.  This issue underlines an emerging internal public policy debate on the desirability of international outsourcing.

NOTE: Posted in 2003, this seminal article could be updated for more recent manifestations of xenophobia in outsourcing.

“Buy American” in State Government Contracting.

In March 2002, a New Jersey State Senator, Shirley Turner, introduced a bill that would impose a “Buy American” rule on all purchases in the state.

N.J. Sen. No. 1349, 210th Legislature, intro. Mar. 21, 2002, passed in the Senate (40-0), Dec. 16, 2002.

The bill was inspired by the fact that “Recent published reports have indicated that telephone inquiries by welfare and food stamp clients under New Jersey’s Families First Program were being handled by operators in Bombay, India after the contractor moved its operations outside of the United States as a cost-cutting measure.”  The bill was intended to ensure that State funds are used to employ people residing in the United States and to prevent the loss of jobs to foreign countries.

As a “mini-Buy-American” Act, this legislation does not provide any exception for:

• a determination that a domestic procurement is “not in the public interest,”
• a determination that the cost of a domestic procurement is “unreasonable,” or
• a determination that the particular goods or services being procured are not available in such commercially available quantities or quality as are available abroad.

All of these are exceptions under the federal “Buy American” act.

If enacted, such laws would apply only to government procurement.  But such legislation could have repercussions on the image of offshore outsourcing throughout the United States.

The bill does not address issues of cost, or availability of local American services in the particular procurement.

Legality for Governmental vs. Private Purchases of Foreign Services.

As a matter of law, “Buy American” (or “Buy Local”) laws are illegal under the World Trade Organization’s General Agreement on Trade in Services (“GATS”) when they relate to purchases by private buyers.  But for governmental buyers of services, the GATS allows such favoritism to local service providers.

Impact on International Outsourcing by Private Customers.

Legislation limiting government procurement to local service providers should not have any impact on the right of private companies, as customers, to hire any service provider worldwide to render any service.

• Freedom of Contract.
  In our view, nothing in the various laws of individual states in the United States that currently are in consideration could validly overcome such freedom of contract.
• War.
  In case of a war involving Iraq or other country, the United States federal government could validly adopt rules to safeguard its economy from foreign interests.   As discussed below, this raises risks for contracting parties, but such risks may be surmounted through customary technical means for security, business continuity planning, redundancy and disaster recovery.

Buy American – Revival of the Past.

The “Buy American” legislation was originally adopted by the Federal government as a means of promoting local business.  This legislation, at 41 U.S.C. 10a, is limited to the purchase of goods:

This law has been rendered largely moot by the Government Procurement Agreement adopted at the Uruguay Round of the General Agreement on Tariffs & Trade.  See Agreement Establishing World Trade Organization, Annex 4, Plurilateral Agreements, Government Procurement Agreement.

More recently, state legislatures in the United States have considered imposing some restrictions or prohibitions on the use of foreign service providers for contracts involving payment of  state or local funds.  In New Jersey, State Senator Shirley K. Turner introduced a bill that would prohibit any contracting or subcontracting to foreign service providers where the work could be done by American citizens or lawful permanent resident aliens.  Similar legislation is reportedly under consideration (as of February 2003) in Connecticut, Maryland, Missouri and Wisconsin.

Policy Debate: Validity vs. Wisdom of Xenophobia.

As a matter of public policy, we must distinguish between law and policy.  Would such legislation be lawful?  Under the World Trade Organization (WTO) General Agreement on Trade in Services (“GATS”), it would appear valid for government procurement of services.  As a “beggar-thy-neighbor” policy of keeping jobs at home, such legislation would help generate employment at a time of economic decline, reducing the costs of public welfare and other social costs.

Would such legislation be good public policy?  Such legislation would deprive local governments of purchasing services at the cheapest price.  It would hurt local taxpayers as consumers of government services.

World Trade Organization: No “Non-Tariff Barriers” for Private Trade.

Free trade under the World Trade Organization (formerly known as the General Agreement on Tariffs and Trade, or GATT) is based on certain fundamental principles:

• national treatment of foreign suppliers of goods and services, where each member state must “accord to services and service suppliers of any other Member, in respect of all measures affecting the supply of services, treatment no less favorable than that it accords to its own like services and service suppliers.”   General Agreement on Trade in Services, Art. XVII(1), MTN/FA II-A1B, p.19).
• transparency of the laws and regulations governing international trade (subject to the supervening principle that disclosure is not required where it “would impede law enforcement or otherwise be contrary to the local public interest or would prejudice the legitimate commercial interests of particular enterprises, public or private.”   See, e.g., Agreement on Trade-Related Investment Measures, Art. 6, MTN/FA II-A1A-7, p. 3.)
• non-discrimination.

Market Access to Foreign Services Providers under GATS.

The WTO’s General Agreement on Trade in Services embodies the principle that, in sectors where a member state undertakes to grant market access to service providers from another member state, that market access cannot be restricted either nationally or regionally.    Specifically, it is a violation of GATS for a member state to impose any restriction on market access in any of the following forms:

• Number of Service Providers: limitations on the number of service providers (such as in the form of numerical quotas, monopolies, exclusive services providers or the requirement of a “economic needs” test as a condition of market access).
• Value of Service Transactions: limitations on the total value of service transactions or assets (in the form of numerical quotas or the requirement of an “economic needs” test).
• Quantity of Services Provided or Service Operations: limitations on the total number of service operations or on the total number quantity of service output expressed in terms of designated numerical units, in the form of quotas or the requirement of an “economic needs” test.
• Number of Employees: limitations on the total number of natural persons who may be employed in a particular service sector or that a service provider may employ and who are necessary for, and directly related to, the supply of a specific service in the form of numerical quotas or the requirement of an economic needs test.
• Type of Legal Entity or Joint Venture: measures that restrict or require specific types of legal entity or joint venture through which a service supplier may supply a service.
• limitations on the participation of foreign capital in terms of maximum percentage limit on foreign shareholdings or the total value of individual or aggregate foreign investment.

General Agreement on Trade in Services, Art. XVI(2), MTN/FA II-A1B, p.18.

Exceptions to GATS Protections.

Several exceptions expressly permit a member state to disregard its obligations on trade in services.
Services Supplied in the Exercise of Governmental Authority.

By definition, the GATS does not apply to “services supplied in the exercise of governmental authority.”  General Agreement on Trade in Services, Art. I(3)(c), MTN/FA II-A1B, p.14). In some countries, “governmental authority” involves the performance of functions that are considered commercial or otherwise not “in the exercise of governmental authority.”

In the United States, for example, in November 2000, President George W. Bush’s administration adopted regulations requiring that all governmental functions be evaluated and classified as governmental or non-governmental, and non-governmental functions are to be contracted out to outsourcers (or possibly even privatized).

National Security.
National and international security considerations take precedence over trade in services under GATS. In particular, member states may take actions that they may deem necessary to protect “essential security interests” relating to services for provisioning military establishments, nuclear fuels or their materials, or any other action “taken in time of war or other emergency in international relation.”   As a procedural matter, the member state must notify the WTO’s Council for Trade in Services when such “security exceptions” have been adopted and when they have been terminated.  General Agreement on Trade in Services, Art. XIV bis, MTN/FA II-A1B, pp.16-17.

War.
As a “national security” measure, a member state might impose an embargo on trade in services with one or more other WTO member states during a time of war.  The exception applies “in time of war.”

This “war” exception leaves open a number of vital questions about the legality and viability of discrimination, trade embargos and other acts normally prohibited by GATS.  The “war” exception does not specify that the embargo must only apply to another member state that is at war with the buying member state.  But it is not clear whether the right to impose an embargo applies to a country that is perennially in a “state of emergency” or has never entered into a formal cessation of armed hostilities with a particular other member.

In a sense, this exception could arguably serve as the basis for a member state’s attempt to circumvent the WTO principles of free trade in services.  In our view, such an attempt could invite trade reprisals and dispute resolution before a WTO dispute tribunal.

Deceptive and Fraudulent Practices; Contract Default and Enforcement of Rights.
Under GATS, member states may adopt and enforce measures of a general, non-discriminatory nature relating to “the prevention of deceptive or fraudulent practices or to deal with the effects of a default on service contracts.   Accordingly, laws governing enforcement of rights and remedies under contract breach are not subject to GATS rules, so long as the laws are “not applied in a manner that would constitute a means of arbitrary or unjustifiable discrimination between countries where like conditions prevail, or a disguised restriction on trade in services.”   General Agreement on Trade in Services, Art. XIV(c)(i), MTN/FA II-A1B, p.15.

Data Protection.
Similarly, under GATS, member states may adopt and enforce non-discriminatory laws for “the protection of the privacy of individuals in relation to the processing and dissemination of personal data and the protection of the confidentiality of records and accounts.”  General Agreement on Trade in Services, Art. XIV(c)(ii), MTN/FA II-A1B, p.15).

Safety.
Laws governing safety are also generally exempt from the rules of GATS, except if they are discriminatory or disguised trade restrictions.  General Agreement on Trade in Services, Art. XIV(c)(iii), MTN/FA II-A1B, p.15.

Collection of Taxes.
Laws for the “equitable or effective imposition or collection of direct taxes,” or for the avoidance of double taxation under a tax treaty, may be somewhat discriminatory against foreign service providers.  General Agreement on Trade in Services, Art. XIV(d) and (e), MTN/FA II-A1B, p.15).

Government Procurement.
Exceptionally, under GATS, the WTO principles of most-favored-nation treatment, market access and national treatment do not apply for governmental procurement of services. General Agreement on Trade in Services, Art. XIII(1), MTN/FA II-A1B, p.14). (The other principles, such as the “transparency” duty to publish applicable laws and regulations, remain unaffected.)   The Government Procurement Code, adopted prior to the GATS, relates to trade in goods and does not require any treatment different from GATS.

Safeguard the Balance of Payments.
This exception allows a government to escape from GATS requirements to open its economy to free trade in services in order to safeguard the country’s balance of payments “in the event of serious balance-of-payments and external financial difficulties or threat thereof.”  General Agreement on Trade in Services, Art. XII(1), MTN/FA II-A1B, p.12). This exception is not directed at measuring bilateral trade imbalance between two countries that are trading partners.  Rather it focuses on multilateral trade and generalized imbalances in the balance of payments.

Conclusions for Outsourcing Services Providers.

If you are promoting the sale of your services from a foreign country, you should focus on the practical economic benefits of your service.  This may include:

• abundant labor supply.
• rapid deployment of a large pool of skilled workers for early completion of a complex project.
• high quality standards, such as the Software Engineering Institute Capability Maturity Models for both software and services.
• low cost to the taxpayers whose governments are acting as purchasing agents.
• local presence in the host country, and the role of the host country employee pool for the service provider.

Conclusions for Purchasers of Transborder Services.

There are undoubtedly substantial risks of force majeure in outsourcing.  But the WTO principles of national treatment for private-sector transactions and other fundamental protections of international trade in services are well established.  Legislation by state legislators is not likely to have any impact on your ability to procure services at low cost under a clear outsourcing contract. Despite the risks and problems, using technological methods as well as legal contracts, you can protect your investment in foreign services.

Conclusions for National Governments.

The opening of borders to “free trade” under WTO principles leaves everyone exposed to the risk of loss of value of their knowledge in a rapidly changing information economy.  Governments should focus on building a workforce that is skilled in knowledge tools.

Case Study in “On Demand” Computing: American Express Company

October 9, 2009 by Bierce & Kenerson, P.C.

Motivations for an “On Demand” Computing Deal.

American Express Company is the world’s largest issuer of credit cards and provides financial services. Why did American Express Company decide in February 2002 to sign a $4 billion seven-year deal with IBM, the world’s largest information technology company, that the two companies hailed as “on demand” computing? The announcement says little about the structure of the deal, but is clear as to intentions.

American Express Company’s Cost Savings.

American Express calculated that this deal will save them “hundreds” of millions of dollars.

American Express Company’s Internet Initiative.

After 2001, Chairman and CEO Kenneth Chenault began pushing American Express to Web-enable its operations as much as possible. In a Web conference with investors on February 6, 2002, he noted that, “given the compelling economics of online servicing across all our businesses, several initiatives last year focused on shifting customer transactions to the Internet.” He asserted that self-service Web-enabled applications allowed the company to handle 78% of their customer transactions – from payments to disputes — via the Internet, with over 5.5 million U.S. cardmembers enrolled in this program, generating over 83 million logins in 2001, resulting in unit cost reductions of up to 60% for certain transactions, reduced rates of credit problems of credit card fraud (by up to 96% at certain merchants and overall by over 25% in 2001) and of customer disputes (by up to 50%). Other administrative chores have been permanently shifted to the Internet, such as employee and financial advisor processes.

American Express Company’s Restructuring Initiatives.

Due to a sharp decline in travel and in demand for financial services after September 11, 2001, the company accelerated its then current focus on cost cutting and restructuring. In 4Q2001, the company eliminated 5,500 to 6,500 travel-related jobs and took a restructuring charge of $240 to $280 million. In a news release on December 12, 2001, the company note that “reengineering initiatives being implemented or considered by the company include cost management, structural and strategic measures such as vendor, process, facilities and operations consolidation, outsourcing, relocating certain functions to lower cost overseas locations, moving internal and external functions to the internet to save costs, the scale-back of corporate lending in certain regions, and planned staff reductions relating to certain of such reengineering actions.”

Prior and Ongoing Business Relationships.

Announced in February 2002, MarketMile, an e-procurement service provider founded by American Express Company entered into an “e-business on demand” “alliance” with IBM to deliver to American Express’ customers the “benefits of e-procurement” and management of “indirect expense spending via the Internet. This service will be based on IBM’s “Leveraged Procurement Service,” IBM’s program for Web-enablement of a customer’s proprietary applications and supply-chain integration of the customer’s supplier network and customers. In March 2002, IBM and American Express announced an agreement to jointly develop a Web-based expense reporting and reconciliation software tool for reporting travel and miscellaneous business expenses and reconciling corporate purchases, to be marketed by American Express and hosted by IBM.

Interlocking Boards of Directors.

Good friends make good business, it seems. IBM’s Chairman Louis Gerstner from 1993 to March 2002 was formerly Chairman and CEO of American Express Travel Related Services from 1985 to 1989. American Express Company’s Chairman and CEO Kenneth Chenault is a member of IBM’s Board of Directors. This unusual bilateral interlock spanning 15 years of common business experience shows how aligned the interests of the companies have become. Could anyone say that this was the reason why IBM got the deal? (Or was it because of superior acumen, customer service and solid technology?)

IBM’s Investment in Changing Technology.

The selection process for a transaction of this size involves more than board-room and golf-outing relationships. IBM’s position as a manufacturer of computers gives it unique leverage in pricing. IBM’s “Project eLiza,” to deliver self-managing systems technology (including configuration, optimization, fixing and self-protection) across the company’s entire e-server product portfolio by 2007, offers customers the comfort of being with a market leader in hardware that supports e-business.

IBM Global Services: Are they the only game in town?

The promise of “on demand” computing requires a services provider to provide a “total smorgasbord” of services, even for third-party equipment, third-party software and third-party telecommunications. Who else could meet this challenge? Is this a challenge that makes sense for other services providers? Could a meaningful outsourcing contract be drafted that would overcome the inherent limitations of a narrow-scope services provider? Do equipment manufacturers (such as IBM, HP, Compaq and Dell) offer better terms than pure services companies? Or could a narrow-scope services provider compete effectively by becoming a better manager of third-party services than IBM? This deal opens these issues.

Deal Terms.
American Express will pay IBM Global Services about $4 billion over seven years to host its Web site, network servers, data storage, and help-desk support. According to IBM, this contract is IBM Global Services’ largest for utility-based service delivery. Payments are adds are based on actual usage of IT services rather than a flat fee. American Express projects “hundreds of millions of dollars” in IT savings during the life of the contract.

As part of the agreement, American Express will also move about 2,000 employees worldwide to IBM Global Services. The employees will continue to work out of American Express’ data centers in Phoenix and Minneapolis, as well as locations in England and Australia. In March, IBM will begin taking over American Express’ transaction-processing operations.

Utility Computing /On-Demand Computing.

While the concept of on-demand access to IT resources has been in the market for a few years, few large companies such as American Express have committed to it. Essentially, the services provider takes over responsibility for making all purchases, managing the technology and delivering technology as a service “on demand,” when and where needed, in scalable volumes. As a legal contract, however, the degree to which any service can be “on demand” involves prior agreement on the customer’s current and future technology plans, as well as any financial risks that the customer must shoulder to deal with changing customer needs, changes in technology and changing market conditions. The customer still remains responsible for IT strategy, planning and ensuring that it gets what it contracted for.

Frequently Asked Questions For Employees

October 9, 2009 by Bierce & Kenerson, P.C.

A) “Outsourcing” does not mean the automatic loss of your job.

It may improve an employee’s career opportunities by opening the door to new environments for providing service. Indeed, with the technical training that an outsourcing service provider gives its new employees, being “outsourced” can be a ticket to personal growth, improved opportunities for lifestyle change (e.g., telecommuting, or flex time), and backup to avoid being burned out as the only, “indispensable” employee supporting a business operation. For the employee, the challenges create opportunities. But, because the external service provider will be held accountable for agreed service levels, the employee will also be guided by new measurements and standards of performance.

B) “Outsourcing”: Same Threat to Your Job as in a Merger?

Employees in a company or department that is being targeted for outsourcing normally feel threatened by the uncertainty. This is similar to the fear, uncertainty and doubt experienced by employees in a merger. Yet the outsourcing decision is quite different. Indeed, in an outsourcing, management elects to maintain and effectively deploy all useful resources. External services providers typically do not want to hire someone just to fire them later. By hiring an employee whose job is being outsourced, the outsourcer (external service provider) assumes many responsibilities. Such responsibilities generate high costs in recruitment, training, transitioning in and transitioning out (including outplacement and severance, if applicable), pensions, labor law compliance and other legal and economic obligations. So the outsourcer will normally plan to maintain certain employment levels and efficiently use all personnel whose jobs are being outsourced.

The threat is not the same as in a merger. In a merger, attrition and job terminations are generally one of the compelling reasons to marry the two companies. So your job is more at risk in a merger than in an outsourcing.

C) Can We Avoid Outsourcing?

Yes. When a work group – however large and complex – has been mismanaged through neglect, lack of vision and poor processes, outsourcing might not be the only answer. Improvement of business processes before outsourcing can avoid those outsourcings that occur based solely on “cost savings.” But even good management and leadership cannot escape the compelling advantages of certain types of “strategic outsourcing” that adds a strategic benefit beyond mere cost savings.

D) Should Service Level Agreements Be Used only for Outsourcing?

No. In fact, today’s well-managed businesses often establish “service level” commitments from internal “in-house” staff. Indeed, some information technology departments propose “service level agreements” as a means of setting realistic expectations for business users. Studies have found that frequently, an in-house service department may suffer from criticism by frustrated in-house clients. After going through the process of asking what the in-house clients expect, and showing the costs of fulfilling those expectations, the in-house staff can compare itself to the “best of breed.” The process of defining internal service levels will help harmonize expectations of users and reduce stress by in-house service providers.

E) When Should We Outsource a Function?

Within a globally competitive environment, outsourcing could be useful, or it could unbalance a well-managed organization. The key is to find and maintain one’s balance. Rebalancing involves a candid reassessment of organizational strengths, weaknesses and the threats from the marketplace. Confronting this constant challenge, management must determine what functions fit within the core competencies of the organization, retain those and seek ways to minimize investment and risk in areas that do not add as much value to shareholders – and other stakeholders – as the core competencies.

F) What Alternatives Exist?

Outsourcing is one of a wide range of possible management strategies. Considering “in-house” strategies include:

• Inaction:
  Do nothing. We’re doing a great job already.
• Cuts Projects:
  Eliminate wasteful projects (especially those that require an excessive investment).
• Cut Jobs:
  Eliminate jobs. Load more work onto existing staff.
• Reallocate Resources:
  Shuffle personnel to new, more effective tasks. (Training may be required. Transitions could be bumpy.)
• “Strategic” initiatives include:

• Competitive Departments:
  Make each department into a separate cost-center and allow it to compete for customers both in-house and in the market. General Motors follows this practice.
• Shared Services Subsidiaries:
  Form an alliance of similarly situated customers of the same service, and transfer the “generic” workload to a jointly owned “shared services subsidiary.” (This “shared services” subsidiary might compete in the market as well.) This requires some submission of control and political alliances with outsiders. Experience proves that a jointly managed subsidiary, without independent management of its own, can lose its way and flounder. In this case, outsourcing has been shown as an effective alternative to a failed experiment.
• Joint Ventures with Services Providers:
  A joint venture involves a sharing of risk and rewards. (Outsourcing involves shared responsibilities and possibly shared risks, and rarely involves shared rewards). Joining forces with a services provider can be useful where the functions performed by the joint venture do not require you to promote, directly or indirectly, the cannibalization of your own core business. The services provider, as your joint venturer, will undoubtedly expect a rate of return on its investment by selling the joint services to others – including your competitors – in the marketplace.
• Other Paradigms:
  Organizational management includes a panoply of other paradigms for speed, skill, technological competency and other goals. The authors of this Website would be pleased to explore such other paradigms with you, and to receive your comments on the effectiveness of outsourcing in relation to other possible paradigms.

Outsourcing Law & Business Journal™: July/August 2009

August 22, 2009 by Bierce & Kenerson, P.C.

OUTSOURCING LAW & BUSINESS JOURNAL (™) : Strategies and rules for adding value and improving legal and regulation compliance through business process management techniques in strategic alliances, joint ventures, shared services and cost-effective, durable and flexible sourcing of services. www.outsourcing-law.com. Visit our blog at http://blog.outsourcing-law.com for commentary on current events.

Insights by Bierce & Kenerson, P.C., Editors.  www.biercekenerson.com

Take Our Survey!

We invite you to participate in our survey of the services and information offered on www.outsourcing-law.com and in the Outsourcing Law & Business Journal (™). You may be asking yourself, should I participate? Let us answer some of those questions you may be thinking in considering taking this survey:

Why this survey? We would like your input to help us redesign our website, outsourcing-law.com, and to include more relevant articles in our e-newsletter, Outsourcing Law & Business Journal (™). Currently the website offers legal resources and information on global sourcing to the “newbie” as well as the experienced practitioner. This survey will provide us with the data we need to provide you with the information you need to meet today’s challenging economic climate and its impact on global sourcing.

Who is being surveyed? This survey will encompass a large group of industry professionals and non-professionals, including business executives and managers, consultants, attorneys, government representatives and those interested in global sourcing.

How long will it take? It should take no more than ten minutes, time enough for a quick coffee break.

Why participate? We are confident that your input will help us make our website and newsletter a more effective resource for you. As an additional incentive a randomly selected participant will be given a $100 American Express Gift Card.

Who is conducting the survey? The survey is being conducted by Bierce & Kenerson, P.C., an award winning international law firm providing legal advisory and transactional support for clients to create and preserve stakeholder value in business, technology and investment and the editor of www.outsourcing-law.com and the newsletter Outsourcing Law & Business Journal (™).

Let’s get started. Click here for the link that will take you to our survey. Thank you in advance for your time and participation, your feedback is greatly appreciated. And good luck in the drawing for the $100 American Express Gift Card! The deadline for survey responses is September 15, 2009. The drawing will be held on September 16, 2009.

All responses will be kept confidential.

Vol. 9, No. 7 (July/August, 2009)
___________________________

1.  Outsourcing as a Restructuring Strategy for the Distressed Enterprise.

2.  Humor.

3.  Conferences.
___________________________

1.  Outsourcing as a Restructuring Strategy for the Distressed Enterprise. A global recession reduces the demand, and thus the supply, for consumer goods and services. Companies struggling with adverse economic conditions and recurring quarterly losses search for new strategies to reduce the number of employees and capital costs and to free up capital for investment in product development and customer support.

Outsourcing offers an opportunity for phoenix-like rejuvenation for distressed companies and even for government infrastructure services
When should a company consider outsourcing the management of the “infrastructure” of its business operations? Is there any magic in outsourcing when the company is in financial distress? What business and legal considerations apply where the company has lost money for several quarters, faces a continuously depressed economic climate and has been losing customers?

For the complete article, click here.

2. Humor.

Clauses–“Change in Control” (1) a provision governing termination of the relationship when the other party changes from Dr. Jekyll to Mr. Hyde; (2) dissociative identity disorder; (3) changed business relationship due to auditory hallucinations of the personalities inside their mind, depending on who is observing (the customer or the provider).

3. Conferences

July 27-29, 2009, IQPC’s 7th Annual Procure-to-Pay Summit, Boston, Massachusetts. Join Procurement, Accounts Payable and Sourcing professionals at the 7th Procure-to-Pay Summit to discuss new initiatives for procurement including e-procurement and consortium bidding as well as AP optimization approaches like Centralization, Outsourcing and Automation. The program has a new emphasis on Strategic Sourcing and Global Procurement, in addition to discussions on the latest sourcing and purchasing strategies. For more information, please click here.

September 22-23, 2009, American Conference Institute’s 7th Annual Advanced Forum on E-Discovery and Document Management, Philadelphia, Pennsylvania. Be a part of the leading cross-industry e-discovery and information management forum for corporate counsel, litigators, and technology professionals. At a time when most companies are striving to reduce costs and trim staff, the burdens of e-discovery can be crippling. What’s more, court-imposed sanctions for e-discovery failures could very well place you on the losing side of bet-the-company litigation. Given the complexity, variety, and evolving nature of information management and communication technologies, it comes as no surprise that corporate and outside counsel often find themselves at a loss as to how to manage the e-discovery process. Thus, it is imperative that you take the lead in ensuring that your company is well-positioned to manage the demands of e-discovery. For more information, please click here. Newsletter subscribers receive a $200 discount when they reference discount code “OutsourcingLaw.com” when registering.

September 28-October 2, 2009, IQPC and SSON 13th Annual Shared Services & Outsourcing Summit, Chicago, Illinois. Join us at the 13th Annual Shared Services & Outsourcing Summit this fall, the can’t-miss event for all professionals involved with shared services and outsourcing, at every stage of adoption. This customizable program provides the key strategies that you can bring back to your organization, with areas of focus in:

• Innovation & Governance in BPO
• The Behaviors of a Good Partner
• Improving Offshore Performance through Robust Governance
• Standardizing Terms and Finding Continuity
• Negotiation Strategies for Contracting Success

Our Shared Services series attendees agree: the content from just one event vastly accelerates experiential learning and provides the necessary networking opportunities to benchmark against peers. Visit the website for more information, including webcasts, podcasts, articles and other resources. Use “special code” to receive a 20% discount when you register.

October 6-7, 2009, American Conference Institute’s Software Licensing Agreements Event in San Francisco, California. Companies on both sides of the table in software license negotiations are being increasingly confronted with challenges relating to the use and licensing of proprietary products that contain or otherwise incorporate open source code. Coupled with the other core challenges presented by the negotiation of software licensing agreements: IP infringement, warranties, limitations on liability, indemnification, revenue recognition, product development and maintenance, and contract termination, it is imperative to a successful negotiation that one has a process in place to preemptively anticipate, address and quickly resolve these issues when they arise.

To provide you with specific insights into how to confront these and other contentious issues, ACI has assembled an exceptional faculty, including in-house representatives from the major players in this industry who will provide you with the tactical and strategic insights you need to negotiate more lucrative, airtight agreements—whether acting as the licensor or the licensee. For more information, visit our website.

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FEEDBACK: This newsletter addresses legal issues in sourcing of IT, HR, finance and accounting, procurement, logistics, manufacturing, customer relationship management including outsourcing, shared services, BOT and strategic acquisitions for sourcing. Send us your suggestions for article topics, or report a broken link at: webmaster@outsourcing-law.com The information provided herein does not necessarily constitute the opinion of Bierce & Kenerson, P.C. or any author or its clients. This newsletter is not legal advice and does not create an attorney-client relationship. Reproductions must include our copyright notice. For reprint permission, please contact: publisher@outsourcing-law.com . Edited by Bierce & Kenerson, P.C. Copyright (c) 2009, Outsourcing Law Global LLC. All rights reserved.  Editor in Chief: William Bierce of Bierce & Kenerson, P.C. located at 420 Lexington Avenue, Suite 2920, New York, NY 10170, 212-840-0080.

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