A White Paper On Engineering Design Services Outsourcing

By

Baker & McKenzie Peter George Michael Stoker Sameer Desai

Booz & Company Vikas Sehgal Sunil Sachan Sreedhar Vangavolu

September 26 2008

ENGINEERING AND DESIGN SERVICES OUTSOURCING 1 Companies, including engineering and construction contractors, have long been engaging engineering and design firms and professionals for specialized services, particularly where unique expertise was required that companies either did not have in house or did not want to bring in house. On the other hand, routine functions were handled with internal resources. The transaction costs of engaging engineering or design firms to perform those routine functions outweighed the benefits of having that work performed by them. Moreover, the pool of domestic talent available to perform routine engineering and design tasks was sufficiently affordable to justify hiring and keeping that talent on staff. With advances in communications technologies and a flattening world, things are changing. Today, companies reviewing their internal operations are considering their engineering and design functions on par with other internal business support functions that may have been or are in the process of being outsourced. This examination moves past traditional contracting structures for professional engineering and design work towards a more tightly integrated and highly leveraged use of strategic relationships to discharge a higher volume of such work on a more routine basis. 2 Engineering and design services are becoming ripe for outsourcing transferring responsibility for the performance of an in-house task or function, usually routine in nature, to a third party for some period of time. What are the business and legal issues that must be addressed with respect to the outsourcing of such functions? Outsourcing began with data centers but now extends to a variety of business functions. Whatever the function, basic issues remain the same scope of service, performance standards, pricing, transition, intellectual property and remedies, among others. Many risks also remain similar to other types of outsourcing, including poor (or merely mediocre) performance, excessive costs, security, late delivery, regulatory compliance

This article was prepared in collaboration by Peter George, Michael Stoker and Sameer Desai of Baker & McKenzie LLP and Vikas Sehgal, Sunil Sachan & Sreedhar Vangavolu of Booz & Co. This article is based primarily on their combined experience in the outsourcing and off shoring space, which includes considerable attention to the unique business and legal issues raised by multijurisdictional transactions. The authors would like to thank Michael Mensik, George Kimball, Samuel Kramer and Ganesh Panneer for their valuable contributions to this white paper. 2 Engineering Outsourcing The Next Growth Frontier, hotoutsourcing.net, Nov. 10th, 2007.
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and others. Open any outsourcing contract, and the table of contents recites a familiar litany; but behind the captions lie some important, occasionally subtle differences. This paper examines some distinctive features of contracts for outsourcing of engineering and design services like computer aided design (such as architectural drawings, systems layouts, 3D modeling, preparation of production drawings), data modeling, materials compatibility, finite element analysis, stress analysis, risk and failure analysis, technology scouting and a number of related activities. This article also considers the unique legal challenges raised by moving the delivery of these outsourced functions offshore. This paper ends with a checklist summarizing key business and legal issues related to outsourced and offshore engineering and design services. I. Market Demand for Engineering Off shoring:

In 2007, the Global Engineering R&D spend by private corporations in high-cost locations (primarily North America, Europe & Australia) was estimated to be around U.S. $560 Billion. This spend is projected to increase to U.S. $886 Billion by 2020 with hi-tech industry leading the way.
High Cost Engineering Spend By Vertical
2007

High Cost Engineering Spend By Vertical

2020

Other 16%
Co nst .& I 8% ndust rial s Consumer Goods 8%

Hi-Tech 25%

Co n

Other 15%
st. & I 7% ndus tria l

Hi-Tech 30%

Consumer Goods 8% Auto 19% Aero 8% Pharma 15% Total = $560 Billion Total = $560 Billion

Aero 8%

Pharma 16%

Auto 17%

Total = $886 Billion Total = $886 Billion

Source: Booz & Company Engineering Spend database, Booz & Company Resilience Report; World Investment Report; UN Developing Countries Report; Booz IC

The demand for engineering off shoring across the globe is expected to grow to ~U.S. $150 Billion by 2020. As shown in the figure below, India alone is expected to get ~U.S. $40 Billion, or between 20%-30% of the total. Currently, the bulk of this business i.e. ~60%, comes from the U.S., 30% from Europe and remaining 10% from the rest of the world. While this scenario is expected to change in the years to come, currently

companies in the U.S. are under relentless pressure to save costs and improve efficiency due to global competition. There are additional factors that make U.S. companies the #1 outsourcers of engineering activities. Some of these factors are: Continuous pressure from Wall Street to cut costs and improve efficiency; Drive growth by tapping into emerging markets (especially BRIC countries); Less stringent labor laws (than Europe); Increasing confidence in supply base; and Positive reputation of low cost engineers in the U.S.

India is currently the dominant choice for engineering outsourcing and off shoring. Key drivers for this choice include presence of a large independent vendor base, access to one of the largest pools of engineers and scientists, English speaking capability, significant labor arbitrage, low macroeconomic risk and proximity to some of the fastest growing economies (China & India) in the world. However, it is the success of many of these Indian suppliers in the provision of business process and information technology outsourcing services that has provided the required confidence to companies in the western markets to start sourcing engineering services from Indian suppliers as well. Hence, it is fair to say that many of the vendors, with a few exceptions, are known in the western markets for their business process and information technology outsourcing capabilities but have since successfully ventured into developing their engineering capabilities and delivery of off shore engineering and design services.

Off-shored Engineering Services (2010)

Aerospace 2-3% Auto 4-5% Const. & Ind. Mach 0.2-0.5% Utilities Other(1) 0.2-0.5% 3-4%

Off-shored Engineering Services (2020)

Hi-Tech/ Telecom 16 - 20%

India 20 - 25%

Other countries 75-80%

Hi-Tech/ Telecom 13-17% Auto 6-8%

Aerospace 2-4% Const. & Ind. Mach 0.5-1.5% Utilities 0.5-1.5%

India 30-35%

Other countries 65-70%

Other(1) 6-8%

Total = $60 Billion Total = $60 Billion Total = $150 Billion Total = $150 Billion

Europe: Russia, Poland, Hungary, Czech Republic, Romania, Ireland, Turkey Asia: China, Philippines, Malaysia, Thailand, Vietnam Africa: Nigeria, Morocco South America: Brazil

Source: Booz & Co. database; Booz & Co. IC; Industry Interviews

II.

How is Engineering Different Than Other Outsourced Functions? The opportunity for labor

Companies generally outsource in order to save money.

arbitrage in the offshore provision of engineering services is significant. Indian and Chinese engineers cost less than similarly trained and qualified U.S. or European engineers. 3 In addition, engineering service providers can specialize in the delivery of engineering services and leverage that specialization across a larger customer base than just a single customer. This leverage may also provide opportunities for cost savings. Accuracy, competency and compliance are, of course, crucial, and outsourcing may be an agent of transformation, through consolidation or process changes; but saving money is usually the sine qua non. In light of the current demographics around the availability of skilled engineering labor, the outsourcing and off shoring of engineering and design functions will likely continue to be a source of cost savings going forward. 4
Globalization Value Drivers (Current & Future)
Lower cost will be less important in future (96% for 2005; 70% for 2010-2015)
70% 66% 63% 56% 45% 56%

100%

96%

80%
Percentage of Respondents

60%

40%

36%

33% 27%

20%

17%

15% Current 6% 6% Future

0% Lower Cost Market Access Quality of Supply Time to Market Support Customer/ End-user Footprints Increasing Productivity Growing Capacity

Note: Based on forward-looking time period: 2006 - 2015 Source: Booz & Duke University survey

In the context of engineering and design services, there may be other reasons, such as access to skilled labor pools, access to emerging markets, capacity growth, lowering time to market, driving innovation, and increasing productivity and quality. Engineering services are different, though, as compared to other services, like business process
3 Lori Simpson, Engineering Aspects of Offshore Outsourcing, Washington Internships for Students of Engineering at page 14.

outsourcing or information technology. There are unique constraints on engineering services that make these services less amenable to outsourcing or off-shoring than other functions. Understanding these differences is important to not only realizing the expected efficiencies and savings from outsourcing but also for the long-term health of the companies engaging in it. The key differences between engineering and other services can be summarized across the following multiple factors. Product Uniqueness: Engineering services tend to be unique. Processes and sub processes vary by company, industry and the products supported by the engineering services. For example, the process to design an automotive component will be different than that of designing a paper rolling machine or packaging layout for a cell phone. The sequence of steps and testing requirements are different and often unique for each product-line. Comparatively, one can expect synergies in processes relating to financial transactions. For example, bill payment processing or the process for completing a customer service call through a call center may offer greater opportunities for leverage than many engineering functions. Back office business process functions tend to have more common steps across customers and industries. Once such a process has been established, barring minor tweaks, it can often be replicated across a customer base. Engineering services, on the other hand, require focused skill sets and capabilities from suppliers. As an illustration, a supplier that is proficient in designing automotive components might not be proficient in designing or calibrating paper press rollers. Collaborative Nature of Engineering: Unlike other 0utsourced services that may fit within particular organizations, engineering in most companies is a collaborative effort between various functional areas. Product development and research engineers work closely with sales, marketing, business strategy, procurement and information technology groups, for example. These functions work together in order to successfully deliver products to customers. This aspect of engineering is an important factor to be assessed before a decision for outsourcing or off shoring is taken. In contrast, many business process or information technology outsourcing activities can be segregated to a single function or an entity within an organization. The impact of changing the source of

While exact numbers are in dispute, India and China graduate more engineers per year than the United States. Vivek Wadhwa, Where the Engineers Are, Issue of Science and Technology, Spring 2007, University of Texas at Dallas.

engineering services is felt across the company, and the cross-functional synergies and coordination required are highly complex.

Working Relationships b/w Different Functions

Strategy

Finance

Sales & Marketing

Vision

IT

ERD

Business Strategy

HR
Long Term Plan
Source: Booz & Company IC; Booz & Company client engagements

Sourcing
Strong linkage Tertiary linkage Competitive Positioning

Domain Knowledge: Due to its critical requirement for technical knowledge and expertise, engineering requires special training and background. In the context of designing and analyzing products, in addition to fundamentals of engineering, tribal knowledge or domain expertise plays a very important role. There are many aspects of engineering that engineers can only learn by doing. For example, consider the application of just the right constraints while performing a Finite Element Analysis (FEA) versus over-constraining the computer model - both approaches might give identical results in the area of failure to pass the analysis, but the latter approach also delivers multiple spurious failures resulting in over-designing and increased costs. Defining the difference starts to look more art than science. The more exposure an engineer gets towards designing, analysis and testing within a particular environment, the more knowledge that engineer gains about engineering within that environment. Similarly, like gaining knowledge through hands-on work, the development of best-practices and the transfer of expert knowledge to successive generations of engineers adds to the complexity of externally sourcing engineering

functions. These attributes of engineering also place limits on the tasks that newly minted engineers can perform. While business process and information technology outsourcing may require specialized training, domain expertise may not be as critical in the context of these other services as it is for outsourced engineering services. For example, while an IT programmer requires knowledge of specific software or computer languages and programming experience in order to succeed, that programmer probably does not need to acquire as substantial a domain knowledge of the companys business or industry as a product development engineer. Back office functions like payment processing and call center operations may not even require a college degree. In contrast, specific degree credentials may be required for the performance of outsourced engineering services and the performance of these services requires extensive and in-depth knowledge of the customers business and industry. Market Demands: The requirements of customers for outsourced engineering services are different across various regions of the world. For example, left-hand versus righthand drives in automobiles, sizing of products, packaging requirements and consumer safety standards differ across North America, Europe and Asia. Products need to be engineered differently for these different markets. In addition, the processes, subprocesses and testing criteria required to introduce products into the market vary. Differences between various markets are less significant for other services, like business process outsourcing, primarily because an average consumer doesnt touch and feel the deliverable. A typical consumer neither knows nor cares about how a credit card transaction is processed. On the other hand, customers can touch and feel the products derived from outsourced engineering. Vendor Capability: Due to these unique factors and the importance of domain knowledge, the capability to provide engineering services is not easy to find in off-shore locations. It takes a long time to develop strong engineering capability for service providers with delivery centers in emerging markets. This is partly because the needs of the customers in emerging markets are very different than in mature markets. As a result, these service providers are at the lower end of the learning curve than their compatriots in mature markets. Further, government regulations that are geared

towards preventing global competition in fact prevent the growth and maturity of a local engineering supply base in some emerging markets. Other Factors: Other factors like language, quality of education, ability to scale-up resources, local regulation and respect for intellectual property, etc. take on different levels of significance in the outsourcing of engineering services than other types of outsourcing. For example, intellectual property related issues tend to be more important for engineering services than for business process functions that do not give the customer a competitive advantage in the market. Also, the ability to be able to scale-up resources plays a crucial role in the successful execution of off-shoring the source of engineering services. III. How to Identify Engineering Processes For Outsourcing / Off shoring:

In Section II, we discussed what makes outsourcing engineering services unique. It is critical for companies to conduct a thorough analyses of their internal engineering processes and sub-processes before determining whether or what to outsource or move off-shore. Key factors that will help in this analysis are: 1. Transferability; 2. Maturity; and 3. Risk. Transferability: Before deciding about outsourcing an engineering activity, each and every process must be analyzed for its transferability to, and the ability to perform the process without need for face-to-face interactions by, a third party. Processes that need extensive interactions with company, its engineers or other parts of the companys organization must be weeded out since these processes are not good candidates for outsourcing or off-shoring. Such processes run the risk of not capturing the latest requirements from the customer and/or modifications performed by other functional groups within the company organization. Additionally, if the process involves very frequent judgment calls being made by the engineer performing the work, then it is highly inefficient to outsource such an activity because the service providers engineer will be required to check with the companys engineer every time a decision has to be made.

Also, it is very difficult to remotely administer engineering processes that require handson assessment and the physical presence of engineers at the companys facility. Sourcing such processes to an off-shore location poses logistical problems for administering and managing the work. Engineering processes must be assessed for their transferability before a decision can be made to outsource or off-shore them. Maturity: For an engineering process to be successfully outsourced or moved off-shore, it has to be well defined, process-mapped, documented and standardized. A mature engineering process typically does not require a combined decision-making from multiple functional organizations within the company. However, a process with poor documentation typically means that there may be more than one way of performing the process and the data or information required to complete the task might be resident with multiple sources within the company. If extracting the required information is a laborious process if done internally, expecting a provider to extract that information is dubious. Also, if no set standards exist for performing a process, the process may be performed with varying results each time it is done. If the process-mapping is poor, then it is likely the steps and sequential tasks required to perform the process are stored in some engineers memory and not on paper. Sourcing a third party to perform that function requires extracting the steps and sequential tasks from the engineers memory. Each one of these characteristics makes a process less communicable to an engineering service provider and reduces the possibility of successful results from sourcing that function externally. More often than not, outsourcing of an immature process leads to disappointing results. Risk: Engineering processes that are outsourced or off shored should also be evaluated for risk. The most prominent risk is the risk of loosing intellectual capital both hard intellectual property and know-how. Given the unique nature of engineering, companies outsourcing their engineering functions have to be careful to protect their intellectual capital. Additionally, engineering processes that are very complex raise significant transition risk. For example, an engineering process that has the potential to take-up a

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significant portion of an experienced engineers time, for a prolonged period of time, in order to transition that process to a service provider raises significant transition risk. Other risks include liability for poorly engineered or defective projects, warranty commitments to third parties and reputational risks associated with poorly engineered products or processes. Based on the risk and maturity of the processes, an analysis similar to the figure below should be conducted to understand the process. The X-axis represents the risk associated with the engineering process and the y-axis plots the process maturity.
Process Maturity & Risk Assessment
Process Sheets

High

3.0

IST ST EL LE L I MP Medium Term AMP L SA S

Short Term Database

Management

Geometric Design & Tolerance

2.5
Jigs & Fixtures CFD CAE

Conversions Competitive (Catia V4 V5) Benchmarking (Non-Teardown) Technical Documentation CAD & Translations Engineering Change Management Homologation & Regulatory Affairs DMA

Process Maturity (Readiness)

2.0

Core/ Advance R&D (e.g., materials, etc)

Value Analysis (VA) Technical & Plant Simulations

E-BOM Management

Component Design

1.5
BIW Design

Sub-Assembly Integrated Teardown Design (Low System Design Complexity) (e.g., Climate Control) Module Design

Virtual Testing

Surfacing

Low

1.0 1.0

Long Term
1.5 2.0 2.5 3.0

High Implementation Risks

Low

Balancing the risk and maturity, engineering processes are then typically identified for off shoring. Without this prioritization, a party considering outsourcing or off shoring engineering services will not have a firm basis for determining what engineering functions would be good candidates for outsourcing.

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IV.

Considerations Used to Determine Captive or Vendor:

As shown in the figure below, there are many different business models used in practice by companies that outsource or off-shore engineering functions. There is no one best solution that would fit all companies. The business model should be tailored to fit the strategy and the needs of each company. The long-term and short-term strategies of the company, the types of engineering activities being sourced, and the suitability for outsourcing those functions all play a key role in determining the right business model for sourcing that function. For example, the business models would be different if the long-term strategy of a company is to find the equilibrium in engineering activities to serve the high-cost regions from the off-shore location versus a long-term strategy of developing a regional engineering footprint to serve local markets. Also, business models vary based on the nature of the engineering activities off-shored (e.g., highly mature but subject to intellectual property risks; versus immature but little intellectual property risk.) A sample way to think about outsourcing and off shoring engineering activities is explained below. Highly mature processes are typically the best candidates for outsourcing and off shoring since, by definition, they are well defined, standardized and documented. There is very little, if any, variation and ambiguity associated with their execution. Of the mature processes, if there are processes that contain proprietary procedures information or data linkages, then such processes may be deemed high risk and best candidates to be executed in an off-shore captive center of the company. A captive center is typically 100% or majority owned by the company that is outsourcing the engineering activity. Engineering processes that are mature and low-risk are best candidates to be outsourced and off-shored to engineering service providers (i.e., third party vendors). Figure mentioned in the previous section helps identify such processes.

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Landscape Of Engineering Offshoring Business Models

100% Pure captive Captive with staff augmentation Parent Company Involvement ReverseBOT Closed JV Tripartite Open JV

50: 50 Joint venture

Open JV BuildOperate Transfer (BOT) ODC

Pure vendor 0% 0% Purchased Services Partner Involvement 100%

Source: Booz & Co. client engagements, Booz & Co. IC and analysis

V.

Key Pointers to Selecting the Right Partner for Providing Engineering

Off shoring Services: Once engineering processes have been identified for outsourcing or off shoring, companies should take time to evaluate the capabilities of the vendors that will best suit their strategy. It is important to critically evaluate the vendor base before finalizing a partner. While this step might seem obvious, there are numerous examples of failed relationships and disappointed companys and vendors because companies have been too eager to chose a vendor and start the outsourcing process, without having first done a capability analysis. The following five step process is indicative of the methodology that companies may want to use to select a service partner. Step-1: Evaluate the capabilities of the vendor and short-list the potential candidates that have some experience in the industry / relevant product expertise.

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Step-2: Give a pilot test(s), that is/are representative of the problems that would be solved during the performance of outsourced services, to the short-listed vendors (from step-1) and evaluate their performance. Further refine the list of capable vendors that met pre-defined success criteria. Step-3: Visit the operations centers of short-listed (step-2) vendors, i.e., the location where the proposed activities are to be executed, to diligence the vendors capabilities and review their facilities first-hand. Step-4: Request an RFQ for the engineering activities that are planned to be outsourced or off-shored from the short-listed vendors and evaluate them. Step:5 Pick the right vendor partner based on assessments conducted in steps 1-4. VI. Key Contractual Differences Between Engineering and Other

Outsourced Services: Lets now turn to some key contractual issues where engineering and design may differ from other outsourced functions. Scope of Service Successful outsourcing requires a clear definition of scope. What, exactly, must the service provider do? What responsibilities will the company retain? These questions have particular importance with engineering and design outsourcing, where an entire function or set of tasks is rarely transferred to a service provider. Outsourcing of engineering operations requires complex interactions between the service provider and the company. For example, even in well established and long standing outsourcing relationships, companies typically outsource only discrete tasks or projects to the service provider and retain control over the aggregated function. 5 Demarcation lines and points of interaction must be clear.

See explanation in Engineering Services Outsourcing, www.engineeringservicesoutsorucing.com, which explains the iterative nature of engineering services and provides a discussion of the various tasks composing an engineering project.
5

14

Allocations of responsibility between service provider and company inevitably vary from one project to the next. As in other spheres, strategic functions tend to remain inside the company organization, along with operations that deal directly with customers. 6 Routine transactions are often good candidates for outsourcing, along with middle-tier operations that use standard processes. Since companies retain substantial responsibilities, the usual sweep (or general scope) language customary to other types of outsourcing may be less sweeping. When, years ago, companies began to hand off data centers to outside service providers, the scope of service included not only the statement of work, but everything else done by displaced staff or within the IT budget. In effect, the service provider agreed to do whatever had been done inside the companys data center. When discrete or selected engineering or design projects are outsourced, but control over the entire engineering or design process remains with the company, such sweeping language may not be appropriate. Instead, the scope of work for outsourced engineering services tends to be defined on a project by project basis. In addition, the scope of work is often described more from the perspective of the work-flow processes common to a particular type of project than as a matrix allocating responsibility for a particular set of tasks. The work flow process describes the steps that should be followed for a particular type of outsourced engineering project. For example, if the project being sourced is the production of red line drawings or process diagrams for a particular product or machine, the statement of work might describe or set forth the process steps and expected deliverables associated with development of production drawings. When allocating responsibility for completion of a specific production drawing project, the company and the service provider use the service description as the starting point for estimating the work that will be required to complete the project. The parties may vary this work allocation as necessary based on the requirements of a particular project. The precise scope of work for each project is then confirmed in the documentation for that particular project. Different types of engineering or design services usually have different work flow processes associated with them. These processes may reflect the companys internal policies or procedures for discharging the work to be outsourced. Or, the process may reflect the service providers process. Usually, the process will be a composite based on
6

Call center services, however, are obviously one exception.

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the service providers best practices and the companys specific business requirements related to a particular type of engineering work being performed. Complex projects may combine multiple work flow processes from various types of engineering assignments. The key requirement for successful project management and discharge is the clear demarcation between the work the service provider is expected to perform and the work that the company retains. As engineering outsourcing matures, it may become more common for parties to move away from these process based statements of work to the task allocation matrixes more common to traditional forms of outsourcing, like data center management. This is particularly true where parties are interested in transferring the entire responsibility for an engineering function to a service provider. An example of such a function might be management and maintenance of design archives. Rather than allocate responsibility for archiving and maintaining design drawings on a piecemeal or project-by-project basis, a company may transfer the entire set of obligations related to archiving and maintaining an inventory of design drawings to the service provider. In that case, the statement of work would likely detail the tasks associated with that scope of work (e.g., checking in design drawings, checking out design drawings, backing up the archive, etc.). In addition, the parties may agree that even if a task is not identified in the statement of work with respect to that function, if that task was performed by the companys personnel that were responsible for archiving and maintaining drawings, then that work is in the scope of the service providers work. Transition Transition refers to the process of transferring responsibility for performance of a task from the company to the service provider at the inception of an outsourcing agreement, and from the service provider back to the company, or to an alternative supplier at the end of the outsourcing agreement. In the context of outsourced engineering and design services, work is often outsourced on a project by project basis. Consequently, outsourced engineering services raise interesting transition issues. First, how much initial knowledge transfer is required and how much knowledge transition should be incorporated into any particular project? Second, how do the company and the service provider ensure that transitioned knowledge is retained by the service provider and

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disseminated to available service provider staff? And third, how does the company protect its interest in retaining access to such knowledge within its organization as the scope of the outsourced engineering services expands? The knowledge generally transitioned as part of an engineering outsourcing engagement includes functional and technical information about the companys products, services, plant and equipment. It also includes a detailed understanding of the companys engineering standards, procedures and policies. In this respect, engineering and design outsourcing may offer significant challenges. Where these standards, procedures and policies are not written down or where they vary considerably from one facility or department to another, transitioning this information may be very difficult. Documenting and consolidating such standards, policies and procedures is one exercise that companies considering outsourcing of their engineering or design function may want to undertake in advance of the outsourcing in order to make the transition to an outsourced delivery model more efficient. Requiring service providers to document such standards, policies and procedures as part of their service delivery obligations may also help ensure that such knowledge remains accessible to the company even as the scope of the outsourced services expands. As discussed above, one transition strategy commonly employed in outsourced engineering services is to begin the relationship with proof of concept or beta projects that are sufficiently scope contained to permit the service provider to deliver the service without a transition of all the engineering standards, policies and procedural information that would be required for a full scale outsourcing. Typically, companies can prepare a scope of work package for such proof of concept project with the applicable engineering standards or policies included. Alternatively, service provider personnel may job shadow company personnel in their performance of a typical project in order to identify the standards and policies applicable to a particular type of work. Such a transition process may be effective where the company does not have documented engineering standards or policies or where such documented standards are not readily accessible to potential service providers. Job shadowing may raise immigration issues where the service provider intends to staff the project with foreign nationals. For example, how do foreign nationals gain entry into

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the U.S.? Under what visa programs are they permitted to work in the U.S.? What restrictions apply to their visas? With which requirements must the company comply? Some service providers have available staff already in the U.S. to manage the transition. Others may request assistance from their clients in obtaining visas and work permits. Where timing is critical, it is important for clients and service providers to consider whether visa issues will delay transition. Companies should verify with the service provider that the service provider is responsible for compliance with all applicable immigration laws. Human Resources Another approach to transition that may be useful in the engineering space is the transfer of engineering staff from the clients organization to the service provider. In some jurisdictions, such a transfer may occur by operation of law. In such jurisdictions, if engineering or design work is transferred from a company to a service provider (with or without assets related to the performance of that work), the engineers that were providing that work may have a legal right to transfer with such work to the service provider. 7 Transferring the people that were performing the work to the service provider is an effective way to ensure that knowledge is transferred to the service provider. On the other hand, such a transfer of personnel may impact other business goals of outsourcing. Because employment laws vary by jurisdiction, companies and service providers should understand the impact that local employment laws may have on the outsourcing agreement. Where multiple facilities are impacted across multiple jurisdictions, the effect of local employment laws will likely result in different impacts. Service Levels In outsourced engineering and design services, as in other outsourced operations, quality and performance command attention. Companies seek consistency, accuracy, reliability and accountability, and desire appropriate consequences to deter poor performance. In addition, unlike many other forms of outsourced services, mistakes may lead to property damage, production or line delays and even physical injury. Safety must be the paramount concern. While contractual remedies are important, the need to perform

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appropriate due diligence on the service providers safety and performance record cannot be underemphasized. Service providers understand this in the context of outsourced engineering services and go to great lengths to develop and protect their practices and reputations with respect to the safety and quality of their solutions. In addition to diligencing the service provider, companies will seek contractual remedies to address quality issues that fall below expected standards. Often, these contractual remedies take the form of quality metrics or service levels relative to project performance. These service levels generally break down into two categories, project specific service levels and aggregate project service levels. In the former category, project specific service levels will depend on the quality of service delivered for each outsourced project. For example, in the context of design drawings, the metric might measure the percentage of design drawings completed correctly and on time against the total number of corrections requested. On the other hand, the aggregate project metrics might measure the percentage of projects during the quarter that were completed within budget against the total number of projects initiated in that time period. Similar to other types of outsourcing relationships, a percentage of the service providers fee may be at risk pending the satisfaction of such service levels. However, service levels alone may not be sufficient in the context of outsourced engineering services to provide companies with adequate comfort that the outsourced engineering service provider is bearing sufficient risk to ensure that it has taken appropriate level of care to avoid mistakes. This can be particularly true where the company is entrusting the service provider to deliver a result that may have significant impact on the companys business. For example, if the company is outsourcing the delivery of a material capital project, mistakes or delays could have an impact on production that cannot be adequately addressed through service levels. A design flaw in a production drawing could give rise to liability issues that cannot be adequately addressed through service levels. Determining how to allocate these potential liabilities between the company and the service provider raises questions that may not be addressed through the liability allocation methodologies applicable to other forms of outsourcing.

See e.g., European Acquired Rights Directive (Council Directive 2001/23/EC of March 12, 2001).
7

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For these reasons, companies may determine that the complexity of establishing and measuring service levels outweigh the benefits of including them in project based outsourcing services contracts. Setting initial service levels poses challenges, since comparatively few companies have measured their own performance as comprehensively or rigorously as they propose for the service provider. performance, service providers are reluctant to Without records of past specific performance make

commitments. Consequently, establishing service levels can be problematic. Measuring performance against service levels once set may also be difficult. Unlike other forms of outsourcing, there may not be readily available tools to measure performance. Also, unlike other forms of outsourcing where an entire function is transferred to a single provider, engineering outsourcing engagements can be structured such that project tasks are competitively bid to multiple qualified service providers. By structuring multi-source relationships, companies may use competition to keep pressure on price and performance quality. If quality starts to diminish, companies can turn to an alternative service provider for the next project. This competitive pressure may provide a better incentive for performance quality than a service level regime. However, companies, in fairness, insist that some things, such as aggregated project performance against budgets or timelines must be measured and reported. Even if price reductions are not associated with failure to meet certain minimum standards, such information is useful in managing the outsourcing relationship. This information is also useful in identifying issues for improvement. Often, this information is beneficial to both parties in determining the root cause for performance failures so that those issues can be resolved. Quality Warranties Quality warranties play an important role in engineering and design outsourcing. Like their predecessor professional services agreements, engineering outsourcing service agreements must contemplate at least two different approaches to quality: quality of service performance and quality of deliverables or the results of performance. This dichotomy in quality warranties raises interesting issues with respect to professional

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services agreements. 8 This is especially true in the context of professional services agreements where a significant component or outcome of those services is the supply of goods or capital. Given the nature of outsourced engineering functions, this dichotomy will continue to raise issues when those professional services agreements are structured as outsourcing relationships. Is the service provider responsible for achieving a particular result or is the service provider merely responsible for performing in a professional manner? Or both? The former is a strict liability standard for achievement, the latter is not. 9 In light of this dichotomy and the need to avoid ambiguity as to the parties intent, engineering outsourcing service agreements should specify what quality standard(s) apply. Given the wide variety of services provided under an outsourcing agreement, these quality standards may include: Performance warranties (e.g., performance in a professional and timely manner in accordance with highest industry standards); Warranties of specific results (e.g., delivery of a work product that is suitable for a particular purpose or installation of capital equipment meeting certain specifications by a certain date); Staffing warranties (e.g., performance by duly qualified and experienced staff).

Absent express agreement on the nature of the applicable warranties, warranties may be implied by court. In the context of engineering outsourcing services, a court may imply a performance warranty which would require the service provider to meet the same standard as other professionals with respect to its performance of the services. This warranty would not require achievement of any specific result. outsourcing contract. The warranties that the company and its agents make to the outsourcing service provider also merit special consideration. In some instances, the company makes express warranties to the service provider. For example, a company may warrant that it has the right to transfer to the service provider design drawings under the companys control.
8

So if delivery of a

particular result is expected by the company, it should be clearly stated in the

Justin Sweet and Marc M. Schneier, Legal Aspects of Architecture, Engineering and the Construction Process, Seventh Edition, Section 14.07, page 255.

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The company may also make implied warranties to the service provider, which are effective unless disclaimed by the company. For example, a company may make implied warranties that the design drawings provided to the service provider are suitable for the construction of a particular piece of equipment. In that case, if the service provider complies with the design drawing, the company may bear the risk that the equipment under construction will achieve a particular result. If the company does not intend to provide such warranties, these implied warranties should be conspicuously disclaimed. Because the company does not generally control the service providers staffing decisions (controlling such decisions makes the outsourced relationship look suspiciously like coemployment), companies may seek warranties of minimum staff qualifications from service providers. These warranties are intended to guarantee quality levels by requiring educational, training and experience levels for the service provider staff that will be performing outsourced services. In the context of offshore outsourcing, it is important to consider how such minimum qualifications may be impacted by differences in educational systems and demographics. It is also important to consider what licenses, if any, should be required for in-scope staff. These requirements may vary considerably by the type of function being outsourced, the jurisdiction involved and even by the particular project being sourced from the service provider. Pricing Because people are the primary cost input, engineering and design outsourcing services are often priced based upon headcount (generally expressed as numbers of full-time equivalents or FTEs) or some headcount equivalent (such as hourly rates). Pricing may also be based on time and materials. Typically, the parties will establish a budget estimate for a particular project based on the complexity of the project, the personnel requirements and the expected timeline of the project. Service Providers may include materials costs in their budget estimates, materials may be procured by the company, or materials may be pass through expenses to the company. Even in situations where headcount is expected to comprise a significant portion of the fees, parties should clearly allocate financial responsibility for materials.

Id.

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Where charges are based on headcount or hours, the parties should determine up front how to allocate responsibility for correcting mistakes. Is the time spent fixing an erroneous deliverable chargeable? Or should such time be non-billable? How is such time segregated from billable time, if it is not chargeable? What records must the service provider maintain to validate headcount charges? delivery organization. In very mature situations where a function is being transferred to a service provider or where services are closely tied to transaction volumes, services may be priced on a pertransaction basis price per design drawing, for example. This pricing model requires well established baselines and fairly predictable demand requirements, which may not be typical to most engineering environments. Charges then fluctuate with levels of activity. Ideally, service provider costs, charges to the company and service volumes are effectively synchronized. Pricing metrics must be chosen with care, however, to For example, multiple revisions to correct prior correspond with value delivered. Working through these issues is particularly important where the company has little visibility into the service providers

mistakes should not be chargeable to the company. Likewise, in very mature situations, fixed pricing may be appropriate. Service providers generally require fairly detailed scope descriptions and change control procedures before accepting fixed price projects. Where projects tend to be repetitive and quantifiable, fixed pricing may be attractive to both, companies and service providers. In such situations, though, service providers should have incentives to continue to drive costs out of their delivery organization. fixed fee model. Compliance With Laws Engineering and design services involve laws and regulations affecting companies generally (such as OSHA) and the particular companys industry (such as FDA, HSA or other regulatory bodies). Regulatory responsibilities cannot be delegated, even if operations are outsourced, but companies can and do seek indemnification and other protection from outsourcing service providers. Supposed distinctions between laws Maintaining competitive pressure through sourcing models using multiple suppliers is one means of maintaining such incentives even in a

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affecting one side or the other are rarely neat, since a great many laws affect both the company and its service provider (sometimes in somewhat different ways). To sort through this maze, a matrix of legal requirements and responsibilities is often helpful, so that the parties proceed from a common understanding to sensible allocations of responsibility for monitoring, compliance and, in the event of difficulty, liability based upon their particular competencies and ability to monitor legal developments and manage risks. Where compliance responsibility rests with the company (as it must in many regulated industries), the parties can protect themselves by developing detailed written procedures, approved by the companys lawyers that the service provider must follow. Service Providers who (understandably) decline to give legal advice will generally accept that they must comply with the companys procedures, and be accountable for failures to do so. Most also recognize obligations to be familiar with and abide by laws of general application affecting many or most companies, as well as local laws in the countries where they operate service centers. Outsourcing engineering and design services to offshore service providers may raise export control compliance issues, particularly where information or materials within the scope of the outsourced function are subject to export restrictions. Under U.S. law, providing foreign nationals with access to such controlled products within the United States is deemed to be an export. Consequently, offshore service providers may be prohibited from accessing controlled information without a license even if the information itself never crosses a border. To address such export control issues, parties may structure delivery solutions to prevent exports or deemed exports of such information by restricting work on such projects to approved service provider personnel. Alternatively, parties may obtain the licenses necessary to permit the export of such information to authorized personnel and comply with the requirements of such licenses with respect to any export or deemed export of such controlled information or materials. Security and Confidentiality Providers of outsourced engineering and design services may be privy to some of their clients most sensitive business, financial or technical information, such as costs of

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production, emerging product strategies and even trade secrets, all of which may be very valuable to competitors and which, if disclosed, may cause significant damage to the client. Companies therefore must pay close attention to security arrangements and to such things as the risk that service provider personnel assigned to the companys account may perform services for competitors. 10 No company wants the service providers account executive transferred to the account of the companys competitors, at least not immediately, or its data commingled with competitors in a way that could inadvertently lead to unauthorized disclosures. Neither does a company want to discover that the solution provided by the outsourced engineering staff may be tainted because those engineers were working on a competitors project. On the other hand, dedicated staff or separate, secure working areas within the service providers facility are likely to add cost. There are a number of ways of dealing with security and confidentiality issues in engineering outsourcing service agreements. First, it is essential for the company to perform due diligence on the service providers confidentiality and security practices. Established service providers will expect such diligence and should be able to provide clear evidence of the commitment to confidentiality and security. Also, at a minimum, the outsourcing agreement should include clear and unambiguous covenants from the service provider that confidential customer information will be treated as confidential and that the service provider will use, at a minimum, reasonable efforts to protect that information from unauthorized disclosure. Where the information is particularly sensitive, the company may want to attach minimum security and confidentiality policies which set forth the technical and operational procedures that the service provider and its agents (including subcontractors) must follow with respect to the performance of the services. In the context of offshore engineering services, where the service provider staff will have access to highly confidential information or the risk of misappropriation is high, companies may want to put non-disclosure agreements in place directly with service provider personnel. Obtaining such non-disclosure agreements directly from service provider personnel can be administratively burdensome. Service provider staff may turn

10

One benefit of outsourced engineering services is the ability to leverage a pool of resources across a broader customer base than can be achieved by captive sourcing. However, in the outsourced engineering space, this benefit must be weighed against the risk of loss of trade secrets.

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over frequently, so maintaining agreements with current staff can be challenging. On the other hand, maintaining such agreement with service provider staff can be useful in protecting companys confidential information in the presence of such frequent turnover in staff. Individual non-disclosure agreements may also be useful in pushing down customer security requirements directly to those persons accessing sensitive information. When services are being delivered from offshore facilities, particularly if the offshore delivery center is a subcontractor to the service provider, the company may want to have a separate non-disclosure agreement with the subcontractor that directly protects the companys confidential information from disclosure. Having such an agreement in place may simplify the companys ability to seek injunctive relief directly against the subcontractor in the foreign jurisdiction. Such enforcement may be facilitated by choosing the local law of the offshore jurisdiction as the governing law of such nondisclosure agreement. Of course, prior to selecting local governing law, local counsel should be consulted to confirm that the non-disclosure agreement is enforceable and compliant with local requirements. Non-Compete In addition to due diligence and contractual restrictions against disclosure of confidential information, companies may want to preclude service providers from serving direct competitors or from entering into particular market segments after having access to confidential information. One rationale for such non-compete obligations is to protect the companys confidences from inevitable disclosure. A key disadvantage of such restrictions, however, is the negative effect such restrictions have on the service providers ability to leverage expertise across different companies and to allocated experts to protected accounts. Where such restrictions are agreed, the non-compete is typically limited to restrictions against re-assigning in-scope staff to competitor accounts for some period of time. In other cases, the restriction may apply only to a limited number of high level personnel. With respect to offshore delivery centers, local employment laws and practices may make non-compete agreements with particular individuals unenforceable. In those instances,

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covenants from the service provider not to reassign particular resources to competitor accounts may be a companys best protection against inevitable disclosure of confidential information. Where parties agree that experts should or must be permitted to work for competitors, companies may require that information flows to such experts be limited to avoid, where possible, disclosure of customer confidences. Compliance Controls and Audit Unlike other types of outsourcing (e.g., information technology infrastructure management and finance and accounting administration services) which may have a direct impact on financial reporting systems, the focus on internal control compliance and audit with respect to engineering and design outsourcing is focused mainly on quality, accountability, safety and timeliness. Such controls are usually based on the companys engineering standards, industry standards or the service providers best practices. These controls are important in the engineering and design outsourcing space because they provide the agreed constraints around which the service provider must deliver services. These constraints offer the company a source of control over delivery, which otherwise is ceded to the service provider. In some instances, it is useful to map these controls against the service providers processes. Through this mapping procedure, the company can establish that its control objectives will be achieved, even if the controls are based on the service providers practices as opposed to those of the company. As discussed above in the scope of work section, engineering controls may be specified in the service description and may take the form of mandatory checkpoints (or gating activities), customer reviews, licensing requirements, permit requirements, service provider reviews and testing procedures. Companies will often impose clear record keeping obligations on the service provider to document that such controls are in place and being followed. Companies should use their due diligence investigation of the service provider to review the service providers control environment and its history of compliance with such controls. Companies may also require ongoing testing and reporting to document that controls are operating effectively. In addition to well-defined controls over engineering and design services, companies should retain the right to audit, either directly or through third parties, service providers

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conformance with such controls. In some outsourcing contexts where delivery platforms are highly leveraged, service providers may provide third party audit reports of control compliance to companies as part of their service offering. With respect to generic controls over security and confidentiality procedures, obtaining and sharing audits of such procedures at no additional charge is becoming an increasingly expected component of the service providers offering. Requesting access to such audits as part of the companys due diligence may be helpful in identifying reputable service providers. Intellectual Property Allocating ownership rights in intellectual property arising out of engineering and design outsourcing agreements is critical. Both companies and service providers have an interest in work product. Companies may expect ownership of the intellectual property generated from a project, particularly where that project has strategic importance to the companys business and where such company is fully funding the engineering or design work. However, because the engineer working on the project is a service provider employee and not a company employee, depending on the scope of the engineering or drawing assignment, there is no guarantee that ownership of such intellectual property will inure to the company upon creation. Instead, under applicable law, the service provider may retain ownership rights in such intellectual property absent an express agreement by the parties to the contrary. In some cases, it may be advantageous to both parties for the service provider to retain ownership in intellectual property created through the performance of the outsourced engineering or drawing services, so long as the company obtains broad and unrestricted licenses to use such work product. The service provider may be better positioned to leverage that intellectual property in ways that do not negatively impact the company. This may be the case where the engineering services being outsourced are standardized and do not provide the company with any market advantages. Of course, in other circumstances it will be critical for the company to retain ownership over intellectual property rights. For example, where the service provider is designing a component to a machine that will provide competitive advantages to the company, precluding a competitor from obtaining license rights in or to that design may be a company

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imperative. Protecting the companys ownership of the intellectual property in the design may be a company imperative. 11 For these reasons, contracts for the provision of engineering and design outsourcing services must provide clarity around ownership of intellectual property rights. In some instances, this may require express assignment of intellectual property rights from the service provider to the company. In other instances, particularly where services are delivered from offshore locations, such assignments must be made in writing following creation of the intellectual property. To accommodate such requirements, engineering services outsourcing agreements often include further assurance clauses pursuant to which the service provider agrees to execute any assignments necessary to achieve the contractual allocation of intellectual property rights, for no additional consideration. Where services are delivered from offshore delivery centers, companies must also be cognizant of the broader implications of international variations in intellectual property laws. Intellectual property law is strictly territorial. As a consequence, the law governing ownership of intellectual property is usually the law of the jurisdiction in which the intellectual property is developed, as opposed to the law of the jurisdiction where the company resides, or even the governing law specified in the contract. Some jurisdictions have default provisions as part of their background intellectual property law regime that differ from principles of U.S. law. 12 Understanding the issues raised by such background legal principles is essential in order to properly structure the engineering services outsourcing contract to achieve the intellectual property allocation intended by the parties. In addition to a clear allocation of rights, in the context of engineering services outsourcing, it is important to consider the procedures that the parties will put in place to properly identify patentable inventions that may be created during the provision of engineering and design services. This process should provide for the capture, retention and transfer of applicable technical notebooks, research findings and other related information. Otherwise, particularly where services are provided offshore or from
11 For instance, Section 102 of the U.S. Copyright Act provides that copyright protection subsists in architectural works, which is defined to include a design of a building. See 17 U.S.C. 101 and 102.

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remote locations, the allocation of intellectual property rights may not be practical to enforce. Companies may find it challenging to actually implement the further assurances clause if they are not aware of the service providers invention. IP Disclosures For outsourced engineering services to be effective, companies and service providers must be positioned to share large volumes of information, much of which will typically be protected by intellectual property rights. To facilitate sharing this information, each party will likely need to grant the other limited rights to use, reproduce, transmit and create derivative works of such information. In some cases, service providers may want to incorporate pre-existing service provider technology or third party technology in a deliverable. Where ownership rights in such pre-existing or third party technology will not be transferred to the company, the company must be granted sufficient rights in and to such service provider or third party technology to exploit the deliverable for its intended purpose. Without properly structured cross licenses, companies may find their ability to use or divest deliverables restricted. Likewise, service providers may find their rights to transfer customer intellectual property to offshore subsidiaries or subcontractors restricted. Companies may also find it necessary to provide their service providers with intellectual property licensed to the company by third parties. In such cases, consents to permit or sublicense to the service provider use of such intellectual property may be required. The outsourcing contract should clarify which party is responsible for obtaining such consents. At times, the company may be in the best position to obtain such consents. In other circumstances, the service provider may be better positioned. In any event, identifying and allocating responsibility for obtaining such consents is typically a necessary task to initiate the outsourced services. Where such intellectual property will be transferred offshore or will be accessible by foreign nationals, third party providers may require that special steps be taken to protect such intellectual property. Consequently, companies are encouraged to start this review early in their due diligence process.

For example, in India, assigned inventions that are not put into practice within a certain period of time may revert back to the inventor. See The Copyright Act, 1957, Sect. 19(4).
12

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Subcontractors Like other forms of outsourcing, subcontractors often play a large role in the delivery of outsourced engineering services. Where services are delivered offshore, it is not unusual to find that the service provider subcontracts significant delivery responsibility to a captive subsidiary in the offshore location. Such a delivery structure is often expected by both parties. In other cases, the service provider will subcontract delivery to unrelated suppliers in offshore locations. In either case, the service provider must remain responsible for service delivery, confidentiality and intellectual property rights. Given the sensitive nature of outsourced engineering services, companies generally demand visibility and approval rights over subcontracts, at least where such subcontracts are for material portions of the services being delivered. De minimis administrative procedures may be subcontracted without approval, unless performance of such services provides the subcontractor with access to customer confidential information. Taxes With engineering and design services, as with other outsourced services, both sides must consider the impact of possible taxes upon the services, of taxes that may be withheld from payments and of the risks of creating taxable permanent establishments where none may now exist or be intended. Depending on the jurisdictions in question, tax costs could play a material role in determining the total cost of outsourcing engineering and design services. Contract structures, delivery solutions, and invoicing arrangements should be constructed to minimize the overall effective tax cost of the transaction, but must also be balanced against the companys and the service providers pre-existing or future tax plans. The administrative burden of different contract structures must also be taken into account. In some instances, tax planning may require the transaction to be structured to permit local-to-local invoicing. In other cases, the transaction should be structured regionally or through a single client or service provider entity. While there is no single tax advantaged structure for outsourced engineering services, close attention to the tax impact of the transaction can provide both parties with opportunities to reduce the total cost of outsourcing.

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Assists One aspect of engineering services outsourcing that is often overlooked is the impact that the procurement of engineering services from offshore may have on the custom valuation of imported goods. Where a party outsources engineering services to an offshore provider, the value of that offshore work may be considered an assist that must be added to the custom valuation of the product when it is imported into the U.S. While assists may not apply where the offshore engineering services are being used to develop products that are manufactured onshore, they may become a significant issue where the engineering work for products being manufactured offshore is also procured from an offshore provider. Termination Rights Engineering and design outsourcing contracts generally provide the usual panoply of remedies, up to and including termination, both for breach and convenience. Often, the most contentious issue is the termination charge payable for a convenience termination (surely a misnomer, for termination is supremely inconvenient). In practice, these rights to terminate without cause, are most likely to be exercised when the company is dissatisfied, but lacks either sure grounds to claim default or the stomach for unpleasant proceedings. Companies naturally prefer lower termination charges in order to minimize the pain and expense. Service Providers hope to be made whole, and interpose an expensive deterrent. Termination charges commonly include shutdown costs (such as severance and relocation), unrecovered investments in facilities and equipment, and perhaps some allowance for unearned profit on the remainder of the term. However, since engineering outsourcing transactions usually do not involve major investments in technology or infrastructure made for a particular company, termination charges should be lower than other outsourcing situations.

Disaster Recovery Ugly events in recent years, such as the September 11, 2001 terror attacks, Hurricane Katrina, or the 2008 earthquakes in China, have focused attention on the risks of

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calamities risks that distance may compound when operations relocate to India, China or the Philippines. Good outsourcing contracts address these issues in two ways: through force majeure clauses that excuse performance and may permit termination if service is not restored, and disaster recovery arrangements, which plan for the continuity of delivery in the event of a catastrophic event. With engineering outsourcing services, the essential thing is, if possible, to put knowledgeable people back to work as soon as reasonably possible. Immediate recovery may not be necessary, so long as essential functions are restored within a reasonable time. Skilled staff need places to work, ways to get there and access to information. Good plans assure that they have all three. Engineering and design outsourcing contracts require such plans, regular updates and periodic testing of such plans. VII. Conclusion:

This article examined outsourcing of engineering and design services. This review included consideration of the nature of the outsourced engineering market and the typical issues that must be resolved with respect to outsourced engineering services. These issues range from service descriptions and transition provisions, to delivery requirements and warranties, through remedies and termination. The issues raised by outsourcing of engineering services have some similarities to other types of outsourced services, but the differences are pronounced. This paper is intended to highlight those differences. In closing, the paper also provides the following matrix of key business and legal issues raised by outsourced engineering services. The matrix is not exhaustive, but is intended to provide a high level overview for consideration. Each outsourcing engagement has unique aspects that must be considered in their own right. However, we trust that the attached issue list will be helpful. Next to each issue is a column identifying the contractual and non-contractual approaches the customer and service providers may use to address the particular issues raised.

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Engineering Outsourcing Risks And Liability Allocation

Type of Risk Risk Non-Contract Risk Mitigation Contract Risk Mitigation / Liability Allocation

Business Risk Quality Ensuring that quality of engineering services and deliverables meet or exceed required quality standards for use by the business Due Diligence Process Definition Specifications Testing (where retained by the Customer) Specified Delivery Centers Required Engineering Standards Defined Engineering Processes Warranty that Deliverables Conform to Specifications Covenants re Service Performance Minimum Staff Qualifications Testing (consequences of testing failures) Quality Service Levels o o o Defect Rates Rework Percentage Other

Cost Ensuring that the cost of the services fall within expected budgets. Ensuring that the prices for the services be the lowest available for comparable quality, type and scope of service

Dual Sourcing Model Pilot Projects Alternative Sources of Supply

Milestone Payments Rework Pricing Project Specific and Aggregate Performance to Budget service levels Governance Most Favored Customer Pricing Benchmarking

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Type of Risk

Risk

Non-Contract Risk Mitigation

Contract Risk Mitigation / Liability Allocation Forecasting Project Specific and Aggregate Timeliness service levels Governance

Timeliness Ensuring that the timeline for service performance will meet the Customers expectations.

Dual Sourcing Model Pilot Projects Alternative Sources Supply Dual Sourcing Model Alternative Sources of Supply

Availability Ensuring qualified, trained staff available for projects.

Forecasting Knowledge Transition Retention and Availability service levels Rework Qualified Staffing Covenants Restrictions on Contract Staff Competition Retention and Availability service levels Work Flow Process Governance

Forecasting Ensuring that the Company can provide accurate and timely forecasts for planning purposes.

Internal Governance Demand Management

Legal Risk Personal Injury Risk that a person may be injured by a defective product, equipment or process. Due Diligence Safety Policy and Procedures Training Staffing Qualifications Policy and Procedural Compliance Quality Covenants Indemnification for Third Party Claims Staffing Qualifications Policy and Procedural Compliance Quality Covenants Indemnification for Third Party Claims

Damage to Property Risk that property may be damaged by defective product, equipment or process.

Due Diligence Safety Policy and Procedures Training

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Type of Risk

Risk

Non-Contract Risk Mitigation

Contract Risk Mitigation / Liability Allocation Staffing Qualifications Policy and Procedural Compliance Quality Covenants Indemnification for Third Party Claims Intellectual Property Rights Allocation Confidentiality Protections Security Protections Restrictions on Work for Competitors

Negligent Design Risk that providers design will be negligent.

Due Diligence Safety Policy and Procedures Training

Misappropriation of Intellectual Property Risk that the service provider will misappropriate the companys intellectual property and use it for unauthorized purposes.

Due Diligence Service Provider Reputation Governance

Intellectual Property Infringement Risk that a third party will bring a claim of infringement against the company for work product or deliverables created by service provider. Legal Compliance Risk that Services are not performed in compliance with applicable laws and regulations.

Due Diligence Service Provider Reputation Governance

Warranty of No Knowledge of Infringement Indemnification for Third Party Claims

Due Diligence Internal Compliance Analysis Service Provider Reputation

Conformance with Customers Engineering Standards Compliance with Law Related to Performance Matrix of Compliance Tasks and Task Allocations Indemnification for Claims Arising from Breach of Compliance Obligations

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Type of Risk

Risk

Non-Contract Risk Mitigation

Contract Risk Mitigation / Liability Allocation Governance Allocation of Direction/Control over Contract Staff Indemnification for CoEmployment Claims

Co-Employment Risk that under local law, provider employees can claim coemployment benefits from the company.

Do not Manage Service Provider Staff Do not Direct Service Provider Staff Govern at Manager to Manager Level

Sourcing Risk Transition Risk that the companys process/knowledge not effectively communicated to service provider. Pilot Engagements Prior History Dual Sourcing Model Retained Organization Governance Transition Plan Availability and Performance service levels Transition Assistance upon Termination/Expiration IP Ownership Provisions Data Control Provisions Transition Assistance upon Termination / Expiration Contract Management Governance Dispute Resolution

Knowledge Retention Risk that the company loses institutional knowledge.

Relationship Management Risk that the relationship breaks down.

Due Diligence Dual Sourcing Model

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