Outsourcing Contracts : What You Need To Know (+Free Format)

Not having a solid outsourcing contract can cost your company a lot of money!

Don’t believe it?

Below I’m sharing a true incident to help you see why it’s so important to make a proper outsourcing contract.

Many companies have made the same mistake as the tech company mentioned in the story. They team up with a software outsourcing company but only give them vague ideas about what they need. They don’t pay enough attention to creating a solid contract.

Most IT outsourcing companies have standard contracts and terms of service that can be adjusted for each new project. Before you sign any contract, it’s important to pay close attention to the details and terms in the agreement.

Continue reading to learn everything you need to know about outsourcing contracts.

Must-Know Basics About Outsourcing Contracts

If you are thinking about outsourcing some of your business tasks, there are important questions about outsourcing contracts that you should be able to answer.

• What is an outsourcing contract?
• Why do I need a contract for my outsourcing project?
• What types of outsourcing contracts are there?
• What are the key parts of an outsourcing contract?
• What does a good outsourcing contract look like?

You don’t need to search many blogs and websites to find answers to these questions. This article will provide all the information you need to understand and create clear and transparent outsourcing contracts.

What is an Outsourcing Contract?

Outsourcing contracts are basically legal documents that outline everything you expect from the company you are hiring to do work for you.

This agreement is signed by both companies involved in the outsourcing project—the vendor (the company doing the work) and the buyer (the company hiring the vendor).

The contract includes details about what work needs to be done, quality standards, deadlines, costs, and any rewards related to the project. It also covers important legal matters like ownership of ideas and non-disclosure agreements (NDAs).

Types of Outsourcing Contracts

Now that you understand what an outsourcing contract is and why it’s important for any outsourcing project, it’s time to learn about the different types of contracts used for product development outsourcing. Knowing which one is right for you is crucial.

Let’s learn about the various types of outsourcing contracts!

1. Time & Material Outsourcing Contract

Let’s talk about a popular and long-lasting way to outsource work called the time & material outsourcing model. This model is used for software development projects that last a long time, especially when it’s hard to predict how long the project will take or how much it will cost.

In this type of contract, you can’t estimate the costs ahead of time. Instead, it depends on the IT services or products needed and the time it takes to finish the work.

This type of outsourcing contract is well-liked because it offers flexibility, making it easier to complete long projects. The time & material contract continues until all of the client’s needs are met and the final product is delivered.

When Should You Use a Time & Material Outsourcing Contract?

• When you need flexibility for your project
• When it’s hard to clearly define what the project should include because it’s complex or new
• When you need to use new technologies to complete your project
• When your idea is too creative or unique to estimate costs in advance
• When you want to keep control over your project while letting an outside team handle some of the work

2. Fixed Price/Managed Project Outsourcing Contracts

One common type of outsourcing agreement is the fixed price outsourcing contract. In this arrangement, a company that wants IT services from places like Bangladesh creates something called a Request For Proposal (RFP), and the outsourcing company submits a bid in response.

This setup is similar to a managed project. The company’s needs are clearly stated in the RFP along with the estimated costs. As the name suggests, there is a fixed price that needs to be paid for a specific service.

This type of contract limits how much you can change the project and how involved you can be. Typically, the outsourcing company will assign a project manager to oversee the project and make sure that the final product is delivered on time and within the agreed budget.

To make this work, you need to have a clear understanding of what you want from the project and explain it clearly in advance.

When Should You Use a Fixed Price Outsourcing Contract?

• When you’re okay with giving control of the project to the company using the managed project approach.
• When you know exactly what you need and can explain it well to the outsourcing company.
• When the project can be completed in a shorter time frame.
• When you understand that the project is straightforward and won’t require many changes once it’s done.

3. Dedicated Team Outsourcing Contract

One type of outsourcing contract you can choose is hiring a dedicated team. This means you bring on a group of people who will focus only on your development work.

When you hire this team, the contract will clearly outline the goals and details ahead of time. This team will work as an extension of your own in-house team and can tackle any project you assign to them.

In this kind of outsourcing contract, you don’t have to worry about an exit strategy because your partnership with the remote team might last for a long time.

When Should You Create a Dedicated Team Outsourcing Contract?

• When you’re looking to grow and need a skilled team of developers focused only on your project.
• When your project is complicated and needs ongoing changes and updates.
• When you want to build a long-term relationship with the development team.
• When you want to have control over the tasks assigned to the remote team.

Key Parts of an Outsourcing Contract

While outsourcing can save you a lot of money, not having a well-defined outsourcing contract can lead to unexpected costs and complications.

Now, let’s talk about the most important part of writing an outsourcing contract. When we discuss outsourcing contracts, especially for IT services, we can’t forget to mention the key components that should be included.

Below are the main parts of an outsourcing contract:

1. Detailed Project Scope

The first important part of an outsourcing contract is the detailed project scope. This section explains what services your company needs. You can also add the Request for Proposal (RFP) here, along with the response that the software outsourcing company submitted when they were bidding for the project.

It’s really important to clearly state the final project scope and services so that the offshore teams can understand it well. This will outline the main deliverables that the outsourcing company will provide to the client.

2. Service Level Agreements (Benchmarks)

Service Level Agreements, or SLAs, are important documents that help you get a guarantee of service from an outsourcing company. They set clear standards for the quality of services that the company will provide. SLAs also encourage remote developers to work hard and help meet your company’s expectations.

In the SLA, you can specify the level of performance you expect and include rules that could penalize the company if they fail to meet those expectations.

It’s a good idea to make SLAs as detailed as possible. You should include essential service levels, key performance indicators, and other measurements to track how well the company is performing.

3. Transfer of Assets

When a company decides to outsource, there are different IT assets that need to be transferred. These assets can include things like phone equipment, computer hardware, leases for equipment, and software licenses. To officially hand over these assets to the outsourcing company, a formal sales agreement is necessary.

When it comes to transferring software licenses, there might be additional costs or fees involved. Also, transferring these assets might come with taxes or stamp duties that you need to consider when figuring out the total cost of the outsourcing contract. It’s important to make sure that your outsourcing contract covers all these extra costs related to the transfer.

4. Warranty For The Product/Project

Outsourcing development to companies in other countries can come with a lot of uncertainties and risks. The company you hire might not follow the contract, which could lead to legal issues that can be very expensive and take up a lot of your time and effort. It’s a good idea to prepare for the worst. This means you should clearly state how to recover any losses in the contract.

5. Ownership or Governance Of Product

Every company wants to own the intellectual property and final product completely. However, in some outsourcing contracts, the ownership of the software created can be shared between the vendor and the company that is outsourcing the IT services.

This often happens when the outsourcing company is customizing its existing software or adding to it for the client. Whether you are getting new software developed or updating an old application, it’s crucial for the company to clearly outline who owns the software in the outsourcing contract to prevent any disagreements later on.

If you don’t have complete ownership of the product, your operations could be disrupted. The customer should have access to the source code and control over modifications to avoid problems in IT operations, especially if the outsourcing partnership ends suddenly or if there is a breakdown in the relationship.

6: IP Protection Clause

A major concern for clients is the fear that their ideas and intellectual property (IP) might be stolen when they share them with an outsourcing company. When outsourcing software development to places like India, China, or anywhere else, it’s crucial to include clauses that protect your IP in the contract.

When writing an outsourcing contract, make sure to include a Non-Disclosure Agreement (NDA) and a Non-Compete Agreement. Also, think about including legal terms for licenses and rules about sharing information.

It’s important to have a legally sound relationship to fully protect your IP. Here are a few ways to legally protect your IP:

• Copyright your intellectual property
• Get a trademark for your software or products
• Keep certain information as trade secrets
• Apply for patent protection

7. Cost & Payment Structure

This part is especially important if you are using a fixed-cost outsourcing model. The contract should clearly outline the pricing, payment methods, and overall payment structure. It should explain when payments are due, how they will be made, and who will handle them.

Both parties should agree on a price that includes all the services provided, software license fees, taxes, and any other costs. There should also be a section that talks about possible cost renegotiations over time, considering changes in technology. The contract should detail fixed and variable costs and any changes in pricing in the future.

8. Duration For Completion

In many situations, especially with fixed-cost models, the project’s scope is clear, making it easier to set a deadline. It’s important to specify how long the contract will last. The duration of your contract can greatly affect the success or failure of your outsourcing project.

For example, the BBC signed a 10-year contract with Siemens Business Services in 2004 to outsource its IT services, which ended up costing them a lot because they wanted to work with other companies but were stuck due to the long-term contract.

That’s why it’s a good idea to establish smaller milestones in your contract. It’s better not to sign a long-term contract right away. Instead, start with a shorter agreement and extend it as you go along.

9. Dispute Resolution Section

When you hire a team outside of your company to get work done, there’s a good chance that disagreements might come up. To protect yourself from legal issues, you need to be prepared for these disputes.

It’s a good idea to include a third-party person or an arbitrator in your outsourcing contract to help resolve any conflicts that arise.

10. Subcontracting Clause

One common question that people who outsource work often ask is whether the services will be provided directly by the software outsourcing company or if they will hire other developers to help. While many outsourcing companies want the option to subcontract, it’s really up to you to decide if you want to allow that or not.

If you do agree to let the outsourcing company subcontract, make sure to specify how much subcontracting is allowed. It’s also important to ensure that the main company is still fully responsible for the work done. You can ask them to tell you about the people who will be working on the tasks.

11. Indemnification Clause

There can be a lot of legal issues in outsourcing contracts. An indemnification clause makes sure that if the outsourcing company makes a mistake, only they will be responsible for it. This protects your company from losing money during or after the project.

12. Exit Strategy

How do you end your relationship with the outsourcing company? Will it negatively affect your business? Will you still have complete ownership of the software? All of these questions should be answered in the exit strategy part of your outsourcing contract. The software development companies you choose should agree to your exit plan.

Even though this is the last component, it’s one of the most important parts to include in your outsourcing contract. You need to be very clear about how to end the relationship. Make sure to answer these questions in the exit strategy:

• What items will be returned to the service provider and what will you keep?
• Who will own the rights to the software?
• How quickly will the items be returned?

Signing the Contract

Your signature is the most important part of your outsourcing contract. When you sign the contract, it means you have read and agreed to everything in it. Once you sign, you are legally bound to follow the contract, so you should never sign one without understanding it fully. Knowing how to make an electronic signature is also important for this process. Here are some things to remember when signing an outsourcing contract:

• Make sure you understand the services being provided and their details.
• Double-check the payment plan and the total cost.
• Ensure that the exit strategy allows you to leave if needed.
• Review the terms and conditions related to your intellectual property (IP).
• Look for any clauses that could limit your options.

Outsourcing Contract: A Good Format

When creating an outsourcing contract for any business process, it’s important to use a clear and organized format. Once you know how to get outsourcing contracts, make sure your contract includes all necessary information.

You can also find templates for IT outsourcing that can help you create your own contract. Here’s a suggested format to follow for your outsourcing contracts.