High school graduates In European and Asian countries notoriously outperformed their U.S. counterparts on basic knowledge tests, especially those covering universal topics such as science, mathematics, literature, and world history.

U.S. education analysts have long lamented the gap between U.S. high schoolers and their international peers, but they could always bask in the superiority of American higher education.

No longer. Higher education around the world has caught up with the United States in terms of quality of education and intensity of ongoing research programs.

Once a major drawing card for scholars from around the world, U.S. higher learning no longer occupies the top spot in several important categories.

During the height of the Cold War, the Soviet Union launched the Sputnik satellite, sending shockwaves across the American educational landscape.

Fear of being outdone by Soviet scientific and technologic advances, the United States focused new resources on educational achievement, especially in the sciences and math.

The threat posed today by foreign educational systems overtaking the United States is less obvious.

It has come on slowly and methodically and does not have the drama of a tiny, beeping object circling high above our heads and threatening our security.

Back then the threat was nuclear annihilation. Today, the threat is global economic irrelevance.

Statistics may help crystallize the threat to U.S. domination of global business. In 2002, about 60,000 students in the United States graduated with engineering degrees.

In India and China-the two predominant outsourcing destinations that together comprise one-third of the world’s population- more than 300,000 students graduated with engineering degrees.

Other Asian countries, such as South Korea, Japan, Taiwan, Singapore, and Hong Kong, share a similar focus on science and technical education.

Some commentators speculate that outsourcing is like a universal acid in reverse-it will continue to seep upward unabated and unstoppable into ever-higher-bevel work, including advanced research and product development.

With the overwhelming numbers of technical graduates abroad, perhaps America is not likely to lead the world in the raw numbers of technically educated workers. That is not necessarily a bad thing.

One needs to remember that much of the work done by science and engineering graduates is applied rather than basic research.

And the Asian countries that are excelling in production of technical workers will need each of them to build the next generation of roads, bridges, and telecommunications networks to meet the demands of their burgeoning populations.

The edge in education will not be gained in raw numbers of science and engineering graduates; it is far more likely to go to the country that can take advantage of that low-cost technical labor.

Basic research is dedicated to following the trail of scientific advances wherever it may lead.

This requires immense funding to enable the greatest minds available the freedom to pursue their interests without worry about commercial potential.

Of course, the goal of all federally funded basic research must be commercialization (or, at least, practical application), but that should not be the day-to-day role of those who are responsible for pushing the boundaries of knowledge.

Leadership in the coming age of worldwide outsourcing will go to those countries who produce the breakthroughs in basic research and who develop the entrepreneurs and managers skilled in commercializing the output of those research programs.

The United States continues to lead the world in basic research investment and in business/management education.

It also has the most nurturing cultural, economic, and political systems to encourage risk takers and entrepreneurs to find ways to bring new products and services no market.

The intelligent entrepreneurs today, in whatever country they may call home, will do well to recognize the incredible opportunities for rapid scalability through leveraging global labor resources.

There has been some response in higher education to help domestic companies take advantage of BPO.

The Massachusetts Institute of Technology (MIT) entertained a standing-room-only crowd in a first-of-its-kind course on outsourcing during Spring 2004.

The course is co-taught, appropriately enough, by Indian MIT professor Amar Gupta. Former clear and economist Lester Thurow is the other professor of record in this class, which is liberally sprinkled with guest speakers from the likes of Accenture and other large outsourcing consultancies.

The students run through simulations of outsourcing projects, which include occasional monkey wrenches, such as simulated terrorist threats against offshore ventures.
 

Of the approximately $1.45 to $147 of value derived from every dollar spent offshore, U.S. firms receive $1.12 to $1.14, while foreign firms receive only $0.33 of the value.

Moreover, if income taxes paid by H1-B visa holders, and software and service imports by India are considered, outsourcing provides an aggregate benefit to the U.S. economy of $ 16.8 billion.

The global economy has suffered potent shocks over the past decade: the collapse of the Japanese, Mexican, and Russian economies; the unbelievable rise and fall of the Internet economy in the United States; and the rise of terrorism that threatens nearly everyone.

These global shocks are usually “let with great uncertainty and hand wringing by tycoons, politicians, and blue-collar workers alike.

BPO has been elevated to levels of everyday consciousness that is usually reserved for more exciting business trends.

Given the pressing concern about economic recovery in the post-bubble era, and given the amplification of small issues during an election year, anxiousness about job loss from offshore outsourcing is heightened.

Despite the obvious overemphasis on the impact of outsourcing, there are clear economic implications of the trend that need to be examined and understood.

Business leaders must take stock of outsourcing from the perspective of strategy-seeking to understand how they can leverage outsourcing for their own purposes in line with the movement of the global economy.

The most significant concept that can be applied to BPO from an economic perspective is David Ricardo’s theory of comparative advantage.

Every economics student learns Ricardo’s macroeconomic theory, which states that sovereign nations should compete in the global economy on the basis of advantages that stem from their natural resources or geographic location.

For instance, Saudi Arabia could conceivably compete in the global economy by attempting to make and sell automobiles.

From the perspective of comparative advantage, however, it would not be in the Saudis’ interest to do so.

Although it is entirely possible for the nation to be an efficient source of automobiles, it is far more advantageous for them to be the source of the world’s crude oil.

Saudi Arabia happens to have been blessed by the fates to be located atop one of the largest oil reserves in the world.

Comparative advantage simply states that a nation should pursue those economic interests in which it has an advantage compared to its competitors.

To bring the concept into greater clarity, Milton Friedman used the example of the high-paid attorney and the administrative assistant.

While it entirely possible that the attorney would be a more efficient administrative assistant, it is neither to the attorney’s nor the company’s comparative advantage to divert him or her from legal to administrative duties.

Better to have less efficient administrative assistant continue in that role and allow the attorney to pursue higher-value interests.

Comparative advantage has nearly imperceptibly shifted from a theory of leveraging natural resources to one of leveraging the intellectual and human resources of a nation.

The service and information economies of our time place high value on the ability to manipulate symbols.

A decade ago, former U.S. Labor Secretary Robert Reich wrote a book titled The Work of Nations.

In that somewhat prescient work, Reich identified the new class of knowledge workers emerging in America and called them “symbolic analysts.”

According to Reich, symbolic analysts are those individuals who spend the bulk of their workday in front of computer terminals crafting original material, analyzing data, and sending and receiving electronic messages.

The level of expertise required for these individuals to perform their duties is comparatively rare, placing them among the higher strata of the U.S. socioeconomic classes.

When Reich wrote during the early 1990s, the United States was hardly threatened by international competitors for symbolic analyst roles.

In fact, Reich was fairly comfortable that America would continue to lead the world in that regard. His book was written in part to assuage the doomsayers who felt threatened by the pace of American manufacturing shifts to foreign providers.

Reich reasoned-nightly at the time-that the U.S. higher education system would enable the nation to stake out a long-term lead in symbolic analyst roles, employing the world’s labor only in the grimier, more menial tasks of physical labor.

The great shift that has occurred since Reich’s book is the upgrading of the higher education systems around the world to match their superior K-12 systems, which had been the subject of some concern for years.

Americans have long known that the K–12 system in the United States produces graduates that are comparatively weak by international standards.

Concern about the United States bagging far behind European and Asian counterparts on K–12 educational attainment had been offset in part by our vastly superior higher education system.

That edge remains, but the gap has closed markedly and likely will disappear in a very short time.

The United States no longer enjoys a dramatic comparative advantage in the critical role of symbolic analyst.

Around the world, eager young people are seeking to improve their economic status by applying the technical and analytic skills that are at world-class standards.

They will transform their nations by creating the critical middle class that has been missing.

The consumerism mindset that is necessary to drive an economy to greater levels of growth is taken for granted in the United States, where the middle class has enjoyed nearly 70 years of unabated consumerism.

Not so in the Asian and Latin American countries that are the hotbeds of offshore outsourcing.

The rising middle class that is being created through offshore outsourcing will demand products that fit their middle-class lifestyle, many of which are offered by U.S. companies.

It is likely that global demand for higher-value goods and services associated with middle-class lifestyles will increase rapidly in the coming years.

This global economic shift has a positive-feedback potential that could eventually raise all participating nations to higher living standards.

When the U.S. automobile industry turned to outsourcing to reduce the costs of producing an automobile, a great hue and dry went up to reverse the trend.

Nevertheless, on further analysis, it became clear to economists and social analysts that outsourcing some labor to offshore destinations actually helped preserve American jobs.

As MIT economist Lester Thurow put it at the time, “Either half the car is produced in Detroit and the other half in Mexico; or the whole car is produced in Japan.

By attempting to use legislative measures to tilt the balance in favor of Detroit over Mexico, one would in fact be tilting the balance in favor of Japan.

The effect of outsourcing on the professional service workers in America will undoubtedly produce short-term pain for many thousands.

In response, and especially in this election year, legislators and politicians will attempt to appeal to those displaced by outsourcing by introducing new laws and regulations that will have long-term consequences for jobs.

One possible response on the worker side is an increasing push to unionize service workers. Currently, most professional services workers are not unionized.

There has been some movement toward unionizing workers in the software industry, represented by organizations such as the IBM Employees’ Union.

If an increasing number of service workers join unions in an effort to curtail the movement of jobs offshore, their numbers could have influential political effects.

The commonly held belief that BPO leads to net job boss in America has been challenged by economic research.

The value of U.S. service exports in computer programming, telecommunications, banking, engineering, and management consulting exceeded $130 billion in 2003, up more than 6 percent from the previous year.

In the meantime, imports of such services were in excess of $77 billion for 2003, up more than 10 percent from 2002.

Thus the United States posted a net surplus in these service areas for 2003, a rarity among its current account balances.

Using government accounting standards, when a U.S. company opens a technical-support center overseas that handles inquiries from the United States, that is considered an import of services to the United States.

Nevertheless, when a U.S. service provider does work for a foreign company, that is considered an export of services.

These numbers suggest that any efforts by the federal government to restrict the flow of service imports could backfire and lead to reciprocal restrictions on U.S. service exports.

Given that the U.S. current account deficit overall hit $541 billion in 2003-a record high-it is not likely that legislation leading to curtailment of the one area of surplus is going to have an easy ride through the political system.

In addition to hiring high-level U.S. white-collar service workers, foreign companies have also increased their direct investment in U.S. firms.

In 2003, foreign direct investment in U.S. companies hit a record $82 billion-nearly double that of 2002.

In addition to the net service-industry current accounts surplus, which largely reflects the activities of large enterprises, small- to medium-sized firms are also creating jobs in the United States by using foreign labor.

For instance, Claimpower, Inc., a Fairlawn, New Jersey-based medical claims processing firm, was able to expand its domestic market share through the use of low-cost foreign labor.

The business, formerly run only by the founder and his wife, now has the capacity to expand nationally.

This will require hiring local managers and sales representatives to develop business opportunities, which will then be processed in India.

Entrepreneurs who see outsourcing as an opportunity to cost-effectively grow their firms will be able to scale their new ventures at a pace never before possible.

We predict that entrepreneurs and venture capitalists will recognize the disruptive potential of outsourcing over traditional modes of conducting business in a wide variety of industries.

Firms that are based on analyzing data as a service are going to be competing on an uneven playing field unless they find a way to leverage the booming global labor market.

Both major political parties have staked out positions on the issue in a manner that is in line with their overall economic platforms.

Democrats stand in favor of some type of regulation, although most are staunchly opposed to anything that smacks of overt protectionism.

Republicans defend free trade and hail the unimpeded flow (if goods and services around the world. They favor allowing the short-term pain to subside before leaping to any policy decisions with respect to outsourcing.

The Republican perspective on outsourcing was summarized by noted economist N. Gregory Mankiw.

Speaking in his role as Chainman of President Bush’s Council of Economic Advisers, he noted that outsourcing is a positive thing for the U.S. economy.

Of course, in the midst of some painful displacement of workers who paid a lot of money for educational credentials, the remarks rang rather hollow and created a small tempest for Mankiw.

He quickly backtracked, stating that his remarks were poorly worded. Nonetheless, it does reflect the basic conservative position that outsourcing is a component of their free-trade platform plank and unlikely to be modified.

Shortly after Mankiw’s comments, Secretary of State Colin Powell visited a group of young workers in India and assured them that the United States was not going to enact policies that would jeopardize their newly lavish lifestyles.

For their part, liberal politicians have also supported free trade over the past decade. In fact, the North American Free Trade Agreement (NAFTA) was supported by and ratified under the first term of the Clinton administration.

Still, as a matter of political leverage, there is room for inconsistency on the free-trade issue, and the growing anxiety over job security by middle- and tipper-middle-class workers is a potential voting bloc worth waffling over.

In act, a December 2003 Zogby poll noted that 25 percent of Americans earning at least $75,000 were worried about job security. That is the largest percentage in any income bracket.

Yet these risks can be estimated with some measure of objectivity, and an appropriate mitigation strategy can be developed and enacted.

Geopolitical realities around the world today have brought the threat of war to nearly every doorstep.

At the same time, reasonable assessments of the probability of war affecting a BPO vendor can be made.

Business Monitor International provides extensive coverage of the political, economic, and military risks that exist for countries around the world.

Their Web site at www.businessmonitor.com provides a starting place for assessing the war risk associated with the home country of the business process outsourcing (BPO) vendor. Another great source of country-specific information is the US.

Department of State Web site. This site at www.state.gov has extensive information for travelers and business people to determine the risks associated with regions around the globe.

The PMT can manage its own exposure to liability by utilizing objective information sources in the development of its force majeure risk management plan.

The potential for political unrest exists in many countries that are desirable outlets for outsourcing, such as India and the Philippines.

Firms outsourcing to foreign countries should plan for the possibility of war and the impact such a conflict would have on their business. Contingency plans should account for a worst-case scenario that would address issues such as the following:

• What would you do if the country were attacked?
• How would you perform the outsourced functions?
• How would you protect your facility and its contents and your intellectual property?
• Where would you relocate your business?

The recent outbreak of severe acute respiratory syndrome (SARS) affected several companies that outsourced functions, especially those based in China.

But the effects of SARS were felt in the United States, too. Companies that had employees working in China when the SARS outbreak occurred had to move those employees back to the United States or have them quarantined.

Besides, companies in the United States that received packages from China were concerned about opening them in case the disease could spread.

The SARS outbreak illustrates the importance of planning for unusual and unexpected events. Companies need to understand the flow of their business and how each function on operation could be affected by an unusual event.

If they have not already, companies that outsource overseas need to develop disaster recovery and business continuity plans.

Such plans force companies to examine possible risks, and they are crucial if the outsourcing firm wants to purchase insurance to cover property, liability, or business interruption exposures.

Also, it is a good idea to have a backup in place in case anything goes wrong with infrastructure, business partners, or distribution channels.

In addition to a backup, BPO buyers should consider drawing up a contract with the company responsible for securing the outsourcing.

Sample Language for Disaster Recovery
Scope and Definition: The outsourcer shall develop and implement a plan for the prevention and mitigation of business interruptions due to natural and other causes.

The outsourcer shall make all reasonable efforts to prevent and recover from such events to ensure the continuity of business operations.

Outsourcer Responsibilities: Make all reasonable efforts to ensure the continuity of operations through implementation of a disaster recovery and business continuity plan.

And develop a more detailed and comprehensive plan to ensure business continuity in the event of natural or other events that may cause service, supply chain, delivery, on performance interruptions.

The plan must address these activities that are necessary to resume operations at the optimal level at an alternative location within X number of days of a catastrophic event.

Source: “Touch These Bases Before You Sign to Outsource Your IT,” Contractor’s Business Management Report (November 2003), pp. 4-5.

Dire predictions of the demise of U.S. global competitiveness are balanced by enthusiastic invocations of Schumpeter’s “creative destruction” theory and the proven ability of the U.S. economy to recover from whatever shocks might come its way.

The Wall Street Journal’s Daniel Henninger calls “the global migration of human labor” the “most powerful force on the globe today.

The New York Times’ Thomas Freidman has adopted outsourcing as a personal cause célèbre, authoring more than a month’s worth of weekly columns defending and endorsing the offshore outsourcing phenomenon.

Meanwhile, over at CNN, avuncular Lou Dobbs has seemingly dedicated his entire “MoneyLine” program to warning Americans against the evils of offshore outsourcing.
Politically, outsourcing is shaping up to be an important election year issue.

It is difficult to predict how state and federal regulators are going to respond to increasing demands for action.

The AFL-CIO, as might be predicted, is strongly in favor of preventing the movement of jobs to offshore labor markets.

To counter the labor union’s lobbying efforts, business and industry trade groups have formed the Coalition for Economic Growth and American Jobs.

This pro-outsourcing lobby consists of more than 200 trade groups, including the U.S. Chamber of Commerce, the Business Roundtable, the American Banker’s Association, the National Association of Manufacturers, the Information Technology Association of America, and a host of individual companies.

As of mid-Spring 2004, dozens of bills ostensibly designed to “protect U.S. jobs” had been introduced into state legislatures and Congress.

One bill, introduced by Senate Minority Leader Tom Daschle, would require workers at telephone call centers to disclose their physical location at the beginning of each call.

The logic of the bill is that American consumers would then be able to make an informed choice about whether they wanted to continue the call, or hang up and dial again until they reached a call center worker who would be sitting in front of a computer workstation at a preferred physical location.

The irony of waiting long minutes for a technician only to be dismayed by the physical location of the person who finally picks up on the other end of the line is apparently lost on the bill’s backers.

One company that has preempted any such bills is E-Loan, which allows users to select the physical location of their home equity loan request processor merely by clicking an appropriate button on its Web page.

The total quality management (TQM) movement in the United States, for instance, was characterized by long-overdue advances in manufacturing processes.

Ford Motor Company adopted the “Quality is Job 1” mantra in the early l980s after superior-quality products from foreign automakers had already seriously eroded its domestic and international market share.

The NBC news program “Quality on Else” and the subsequent book of the same title lit a fine under American managers and business school educators, ushering in sweeping changes in business processes and educational curricula.

W. Edwards Deming was the dominant figure of the decade, sermonizing to managers across the land on the virtues of TQM until his last days.

Many companies made major advances by implementing TQM in their operations-often because their processes were in need of major improvements.

Others were less fortunate. Many TQM programs introduced into companies languished and festered, precious resources were squandered, and employee morale was compromised.

The early days of TQM were marked by a good deal of experimentation, and the popular business literature was filled with case studies of companies that did things right and gained advantages and those that did not do things right and wound up disappointed.

In the long nun, the TQM revolution resulted in lasting changes to organizations and is the forerunner to today’s better-known managerial strategies, such as Six Sigma.

People do not talk about TQM as much as they used to because it has become an expected part if doing business.

The personal computer was a remarkable business revolution in its day, but no one pays attention no a business today because it uses a PC-more remarkable would be the firm without one.

The same has occurred with TQM and the quality movement in general: It is a necessary part of business, and a business that lacks quality will stand out-usually in a negative way.

BPO is likely to cover the same business innovation trajectory as that experienced by TQM, the PC revolution, and other business innovations.

We have already stated that early pioneers have made many of the big mistakes with BPO, and there is much to be learned from their examples.

Firms such as GE, IBM, Microsoft, and other giants were the early adopters of BPO, and they agonized through the learning curve.

That they were largely successful in their outsourcing initiatives is one of the main reasons that BPO has become a common part of the daily lexicon.

In his March 21, 2004 syndicated column, noted language watcher William Safire acknowledged that the term outsourcing is here to stay.

BPO will slowly become accepted across the globe and will eventually lose its ability to provide competitive advantage.

As the TQM movement burst on the scene, early adopters were able to gain advantages over laggards.

Eventually, that advantage was eroded as increasingly more firms adopted the TQM approach. Something similar is bound to occur with BPO, but it may take years for that to happen.

Over the next five to ten years, U.S. firms should seek to take advantage of the fact that Indian and Chinese higher education systems are churning out five times as many engineers as U.S. institutions.

Large and even industry-disrupting advantages can be gained by leveraging this inexpensive and high-quality labor pool.

During the early days of TQM, failure to leap on the bandwagon and adopt quality measures within the organization led to steady losses in market share. A similar effect could occur for failure to adopt BPO.

In the long nun, TQM was a market-share-driven business innovation. The cost savings and efficiencies gained by quality management practices eventually found their way to the consumer.

Today’s early adopters of BPO can retain much of the cost savings for themselves because many of their competitors have not adopted outsourcing and have no other compelling inclinations to lower prices to consumers.

Nevertheless, it will not be long before this increased net margin luxury disappears and the savings gained from BPO are reflected in the prices charged to consumers. Early adopters get to reap the windfall. Late adopters will only level the playing field.

With the myriad uncertainties inherent in any complex BPO deal, extracting anticipated value can be a challenge.

This risk can be mitigated through several techniques, most of which center on managing the projected outcomes.

For instance, if the outsourcing deal is expected to save the BPO buyer $1 million during the first year, the project management team (PMT) should manage to that figure.

Adding additional people or hiring consulting firms may be a temptation as project difficulties mount.

This temptation can be resisted if the PMT is committed to hitting the cost savings targets established for the project.

Another technique for mitigating project value risks is to empower the PMT to constantly seek opportunities to leverage the competencies that develop between the buyer and vendor firms.

This tactic, often referred to as “pressing the value model,” will expand the reach of vendor competencies and those jointly developed through the BPO relationship.

For instance, firms that outsource payroll may find that additional advantages can be gained by turning over other back-office functions to the same vendor.

When the PMT presses the value model, it seeks to identify other noncore processes that may be suitable for outsourcing under an existing buyer-vendor relationship umbrella.

Value risks are inherent in any project as people strive to work together to achieve future organizational states.

Working with international vendors presents higher-value risks than working with domestic vendors in that the extent of potential value is often overstated by the foreign vendor and can take longer than expected to achieve.

Mitigation of these risks centers on the effectiveness of service level agreements (SLA) negotiation, implementation, and management.

The project management plan can also be an important tool for mitigating value risk because it specifies tasks and responsible parties that can be held accountable on a one-to-one basis.

Critical process flows should not be allowed to linger out of compliance for long periods without explanation and plans for remedy.

The PMT should have provisions in place for emergency meetings in the event that value goals are not being reached.

The risks associated with the vendor organization can range from business practices to authenticity of certification and reference claims.

Vendor business practices can vary greatly around the world. Practices that are clearly prohibited or considered highly questionable in the United States can be routine in the vendor’s home country.

The problems of bribes, kickbacks, on money exchanged under the table have affected U.S. businesses abroad in a wide range of industries.

The U.S. Foreign Corrupt Practices Act of 1977 is designed to domestic companies from participating in practices abroad that are proscribed at home.

Most BPO vendor companies were founded after the 1977 Act was passed and are generally managed by individuals who are sensitive to the need to conform to its strictures.

Market-based governance mechanisms also compel vendors to conform to U.S. standards.

Still, the potential for abuses is present, and the frequency of abuse may increase in the Wild West atmosphere that is shaping up overseas as increasingly more vendors seek to strike it rich in BPO gold.

Another risk concerns the potential for vendors to overstate their competencies and to exaggerate the business and technical certifications they possess and the clients they serve.

This risk can be mitigated through comprehensive due diligence that insists on objective proof of certifications and permission to talk to representatives from the vendor’s client list.

Vendors that refuse to share certification evidence on balk at client referrals should be treated with caution.

Vendor organizational risk also includes its HR practices. Many manufacturers that chose to outsource to foreign companies turned a blind eye to labor practices long banned in the United States.

Child labor, excessively long hours, and outright sexual and other forms of harassment on discrimination are not uncommon in some foreign labor markets.

Firms choosing to outsource business processes should consider the labor practices of the vendor and determine whether the risk of participating in domestically reviled practices abroad can damage domestic reputation and goodwill.

For instance, there currently are no clear legal rules governing the extent to which remedies can be extracted from a business process outsourcing (BPO) vendor in the case of a security breach on other gross malfeasance. Countries differ in their laws for foreign firms seeking damages from private enterprises.

This governing document provides a framework for the buyer-vendor relationship. Today, many law firms and, consultancies specialize in assisting BPO buyers in developing contract terms that are favorable and enforceable.

Of course, each contract must foster and promote the BPO relationship. In an offshore BPO project, the BPO buyer may have to concede some governing jurisdiction to the vendor’s home country.

That is, it may not be possible to draft contracts with offshore vendors that demand all legal conflicts be decided in the buyer’s preferred jurisdiction.

Some give and take may be required on different contract elements, with some potential areas of conflict to be decided in a domestic forum, some in a forum preferred by the vendor, and others in an international forum such as the International Arbitration Association.

BPO buyers should mix and match forums to ensure that matters of potentially greatest impact to competitive ability are decided in their preferred forum.

This can be achieved if there is a willingness to concede matters of less importance to be decided elsewhere.

One technique that has been effective for avoiding legal disputes is to split outsourcing contracts depending on different deliverables and service level agreements (SLAs).

For instance, many firms outsource software development as well as IT management to third-party vendors.

A BPO buyer would be wise to split the software development contract from the IT services contract. IT management services are generally governed by SLAs that require regular fee payments.

Nevertheless, software development fees should be payable at development milestones-with a substantial portion of the fee withheld until final acceptance of the final code.

Splitting the contract so that standard service provisions are kept distinct from software development reduces the risk of financing development of code that does not perform as expected.

Firms should also be careful no separate continuous service on transaction-related terms from those that concern development of some type of output, such as software on knowledge that is the property of the BPO buyer.

The transaction-related services are usually covered in the SLAs and are paid on a regular basis.

Development contracts should be treated separately. It is reasonable for the BPO buyer to withhold a substantial portion of the development contract fees until the final product has been delivered and tested.