How to Reduce the Risk of Your Strategic Partner Using Sub-Contractors

By Allan Watton on February 28, 2013

A chess piece.Last week we featured 2e2’s administration in an article about disaster avoidance. However, the 2e2 story offers up more than one moral that we can apply to the practice of outsourcing.

Yes — 2e2 failed as a prime contractor, which acts as a reminder of the importance of carrying out effective due diligence in any outsourcing contract. But in another circumstance, it also failed as a sub-contractor, which in turn means that the prime contractors using 2e2 failed their clients in performing their contracted service.

The simple fact is this: when it comes to outsourcing, the ‘contractual buck’ stops with your prime contractor, but the ‘operational buck’ might stop with the sub-contractor. A lot of strategic partnership and IT contracts are procured with the prime contractor intending to sub-contract key outsourced services in order to improve performance to you, but reduce costs and minimise risks to themselves. This issue is seldom correctly addressed during procurement and its inherent risk is often not duly monitored throughout the operational stage of the contract.

In this article we have partnered with Vicky Ladizhinskaya — Contracts and Service Development Manager at the London Borough of Waltham Forest — to provide you with a selection of key pointers identifying whether your prime contractor is carrying out suitable due diligence on its sub-contractors. In doing so you will take a big step closer towards full protection of the operational (not just contractual) interests of your outsourced service.

What Due Diligence Means in this Context

Please note that the purpose of this exercise is not to ascertain whether or not that the sub-contractors are fit for purpose. That is the job of your prime contractor. What you want to do is ensure that your prime contractor has the appropriate measures in place so it can assess whether or not its sub-contractors are fit for purpose to achieve your business outcomes.

Some organisations actually go as far as to select sub-contractors directly. The unfortunate (and potentially disastrous) side effect of doing so is the eradication of the prime contractor’s expert responsibilities — something you must avoid at all costs.

Getting too intimately involved in the service delivery aspects (the how) of the outsourced process defeats the object of the entire exercise. In terms of governance you should have a keen eye on the performance and long term viability of your prime contractor and by extension its sub-contractors, but at no stage (unless an unintended operational disaster strikes) should you seek to take control of service delivery areas that are not contractually within your realm.

Key Pointers for Reducing the Risk of Sub-Contractor Involvement

There are three points at which you should seek to carry out the appropriate due diligence on your prime contractor’s process (not the sub-contractors themselves) for delegating work to sub-contractors. Let’s explore each in turn.

1- The Pre-Qualification Stage

Your first step should be to ask for details of sub-contractors currently being used by the bidders for the delivery of contracted services, in addition to examples of schemes on which they have been used. You should also find out how long a prime contractor has used a sub-contractor (i.e. have they been working together for an extended period of time or is the relationship untested?).

Next you want to get a handle on the sub-contractor selection methodology and evaluation criteria used by your prime contractor — focus on the same items as you would when considering a prime contractor.

Then ensure that the prime contractor’s sub-contractor management methodology ensures mutual benefits to both themselves and sub-contractors and a robust mechanism for monitoring performance. You’re looking for the signs of a sustainable relationship in the same way that you do with your prime contractor.

2- The Tender Stage

At this point you want to get a better handle on the specifics of how your outsourced services will be delivered. Start by asking for details of all sub-contractors to be used for the delivery of the procured services (the main contractor may put forward different sub-contractors from the ones he used on prior contracts). Ask for evidence of robust financial standing and procedures relevant for your organisation  for all the key sub-contractors.

Ensure your main contract contains clauses specifying the minimum requirements for the back to back contracts your main contractor will be signing with their sub-contractors. Require the main contractor to provide you with the principle details of their sub-contractors, such as:  Do incentives and penalties built in the main contract differ in the sub-contractor’s agreement and do those variances create onerous requirements on the sub-contractor? Essentially you need to know what is at stake — what drives the sub-contractor performance and is it aligned with the performance criteria in the prime contractor’s agreement with you?

The sub-contracts should also ensure that the governance between the prime contractor and sub-contractor allows the sub-contractor to have the opportunity (or the requirement) to be present at key implementation and operational meetings with the client. This becomes increasingly important if a sub-contractor administers a particularly large proportion of the outsourced service. At the same time the clients should always bear in mind that their contractual relationship is with the main contractor and therefore any formal instructions, concerns and notices should always be channelled via the main contractor. By passing this safeguard is just as dangerous as not having a direct contact with the sub-contractor, as it is likely to create a rift with the main contractor, who will use this as a reason to negate on their contractual responsibilities, in case of under-performance (i.e. ‘I wasn’t formally/directly notified and therefore didn’t have to do anything about it’, attitude).

However, in our experience any prime-contractor that does not ‘partner’ in an open and transparent way with its sub contractors, is more likely to fail in the overall service delivery and you will not be able to achieve best value and optimal service performance from the partnership.

3- Operational Stage

Finally, it is vitally important that you have appropriate contractual powers and commercial trust in place to ensure the right business outcomes are achieved from the outsourced service. This implies that if services continue to fail, despite application of all contractual rectification measures, you have the power to demand that business outcomes are achieved within a short time period by whatever means.

If that means the vendor has to take the decision to replace its sub-contractor, so be it. But remember, that action should be the ultimate responsibility of your prime contractor. It doesn’t stop you suggesting it, but if you force it, perhaps by way of a step-in process, you’ll be removing your prime contractor’s expert responsibilities for the fitness-for-purpose of the services provided and taking on that expert responsibility yourself. That means any further service problems and costs to rectify as a result of your intervention is likely to lay at your door rather than that of the prime contractor.

The performance and financial health of sub-contractors is often as important as your prime contractor’s, depending upon how integral their involvement is to service quality and performance. Therefore the clients should be abreast with the financial and commercial standing of their main sub-contractors, through regular monitoring of profession press and published accounts.

Conclusion

Organisations are rightly under the assumption that by contracting a prime provider they pass to them the risk relating to the performance of the outsourced service. However, while an ironclad contract can go a long way towards achieving that ideal outcome, if the prime or its sub-contractors that are key to achieving your business outcomes go bust, then great written contract terms aren’t going to deliver your service for you.

So the key consideration is that complications can arise if sub-contractors down the chain go bust. In practical terms, it is not enough for the prime contractor to ‘say’ that it has a due diligence process in place to select and contract with its sub-contractors. You should be aware of how this process operates on-the-ground to ensure that their exposure to risk (and subsequently yours) is not too great and the terms under which the sub-contractors employed are fair and sustainable to ensure that you can establish good and long standing partnerships with all key partners to the delivery of your services.

Photo Credit: darkmatter

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