What Is an Outsourcing Agreement?

Before we define what an outsourcing agreement is, perhaps we should take a deep dive into the definition of outsourcing first. Outsourcing refers to the process of contracting with a third-party company to perform specialized work operations. Companies that make use of outsourcing can hire an outside company to assist with standard company operations such as inventory production or service completion on the company’s behalf. It could be a one-time task, such as filing taxes once a year, or a routine part of business operations, such as creating and maintaining social media accounts.

An outsourcing agreement is a legal document (contract) that is formed between a company and a service provider wherein the provider promises to deliver specified services. It will also serve as the foundation for the customer and supplier’s formal legal relationship. In comparison to other types of commercial contracts, they can be lengthy, complex, and cover a variety of issues that necessitate the advice of a specialist in areas such as data protection, pensions, and tax.

Types of Outsourcing Agreements/Contracts

Here are the different types of outsourcing agreements, all of which vary on the type of agreement that you enter with the outsourcing vendor:

Key Things That Should Be Included In An Outsourcing Agreement

Here are the key components that should be present in an outsourcing agreement:

Description of Services. The agreement must begin with a detailed description of the project and its scope. You can also include the RFP and the outsourcing service provider’s response here. This section, as the heart of the agreement, should include all service requirements, a description of each element of the required services, general service standards, such as compliance with international standards, and, optionally, a sweeping clause outlining functions not specified in the statement of work but inherent in the provided services. After you’ve defined the general purpose of the outsourcing agreement, you can get into specifics like the primary deliverables.Service Levels. A service level is a specific, measurable standard that must be met by the service provider. By defining these aspects, the service provider will be able to understand your expectations. It also informs them that they will be paid and may receive a contract renewal if they meet these milestones within the time frame specified. In this section, you can also outline Key Performance Indicators (KPIs) or other metrics relevant to the outsourced service.Fees Payment. Your outsourcing partner must be aware of the total amount owed to them for services rendered. The actual amount is determined by a variety of factors, including the project scope and job staffing requirements. In the case of offshore outsourcing, you may also need to consider exchange rate fluctuations. You should also specify whether the service provider is responsible for all tax payments in their jurisdiction (place of residence). They should ideally also be in charge of staff and independent contractor salary payments. For legal advice on changing pricing structures and payment terms, you should ideally consult a financial law firm.Contract Duration. The length of a contract, also known as the contract term, is critical to the success of your outsourcing transaction. This duration clause should ideally also outline the reasons for early termination. If you don’t, you risk being locked into a long-term contract that doesn’t benefit you. It is always recommended that you start the outsourcing relationship with a short-term contract with smaller, attainable milestones because this allows you to test the waters and extend the same contract if things go well with the outsourcing vendor.Asset Transfer. Your outsourcing partner may require you to transfer or grant them access to specific business assets in order to provide a key deliverable. To formally transfer these assets, a sales agreement is necessary. It’s important to remember that transferring certain assets, such as software licenses, may result in additional taxes and stamp duties. Ensure that these transferring costs are accounted for in your legal contracts.Representations, Liabilities, and Warranties. In general, the outsourced company represents its ability and competency to provide the required deliverables. Similarly, your company guarantees that payments will be made on time. When it comes to warranties, the outsourcing company guarantees that its services will comply with industry-specific regulations and demonstrate reasonable skill, whereas your company guarantees its assets or equipment. Finally, contractual liability specifies the liabilities for which the outsourcing company will be held liable, such as compensation in the event of data loss.Indemnification. Indemnities can refer to both compensation and a waiver of liabilities and damages. They are provided by both parties, namely you and the contractor. The indemnification clause in the agreement specifies that the contractor is solely liable for any losses you incur as a result of their negligence or failure to deliver. It safeguards your company while also stating that the outsourcing service provider will compensate you for such losses. The indemnity clause covers losses incurred both during and after the project’s completion.Intellectual Property Rights. Intellectual Property Rights are frequently a source of contention during the outsourcing process. You can request that the outsourcing service provider sign an NDA and a Non-Compete Agreement or clause to protect your company’s intellectual property (IP). The Non-Compete Agreement ensures that the service provider will not work for a competitor for a set period of time. When collaborating with another company, make sure that all of their employees who will be working on your projects sign these two agreements. This will help to protect any disclosure of your trade secrets legally.Data Protection. Outsourcing services such as customer service and payroll management necessitate access to sensitive information such as bank account numbers. To ensure information security, both you and the outsourcing company must comply with local laws. You should also ensure that you are adhering to any region-specific data protection regulations. The General Data Protection Regulation in EU-based countries is an example of one of these regulations.Provisions for Auditing and Performance Monitoring. Monitoring the progress of your outsourced team through regular audits is an essential part of outsourcing. These performance audits can assist you in taking any necessary corrective actions as soon as possible. It’s also a good business practice to keep track of reporting responsibilities, audit frequency, service delivery disruption procedures, and increased monitoring if service falls below agreed-upon standards. If, despite increased monitoring, the provider is unable to meet these service requirements, this clause allows your company to step in and take over management control. Auditing can help identify potential issues and even resolve disputes without resorting to litigation.Dispute Resolution. Things can go wrong at times. If the service provider violates your contract, you may wish to consider legal action. However, doing so may deplete necessary resources. As a result, the contract should include an amicable resolution provision to help you avoid becoming entangled in complicated legal issues. It will enable both parties to negotiate and reach an agreement about the situation.Termination Clause. If an outsourcing deal does not work out, especially if it is causing losses, your contract should include an explicit termination clause. You can regain control of the outsourced service if you terminate the agreement early. You have the option of bringing it in-house or outsourcing it to another provider. As one of the most important aspects of the agreement, how you exit the outsourcing relationship has an impact on your company’s reputation.

How to Determine if Outsourcing is the Right Move For Your Business

Here are the steps in determining if your business has everything present and is a good fit to start outsourcing:

  • 1. Determining the Core Functions

    You can begin the decision-making process by describing the products and services in which your company specializes. It is critical to first analyze your company’s operations to determine which areas need to be more efficient. This can assist you in determining which business functions can be outsourced to help you narrow your focus and lower your overall costs.

  • 2. Calculating the Department Costs

    Many businesses choose to outsource in order to save money. Determine how smoothly each department runs, how much revenue each department generates, and the employee turnover rate within each department position. You can compare your budgets and actual costs once you’ve determined which departments aren’t related to your core functions. This can be used as a guide to determine which departments are affecting your profits and which can be outsourced.

  • 3. Researching Different Companies

    Once you’ve determined which departments and functions might benefit from outsourcing, look into companies that specialize in those tasks to see how much they charge and what services they provide. You should also inquire about their hiring practices, security policies, and contract terms, particularly what happens if they fail to meet quotas. You can also seek recommendations and reviews from your network and other companies in your industry.

  • 4. Prioritizing Needs

    You can use the results of your Company Research to narrow down the list to the most suitable companies for your company. You can also use them to determine how much money you should budget for outsourcing the business process. If you decide against outsourcing, you can use this data to determine how to streamline the department and focus its functions and employees to be more efficient and productive.

  • 5. Determining the Effect on Employees

    Outsourcing may be a purely financial decision, but it is important to consider how it will affect employee morale. Surveys and interviews can be used to determine how employees will respond. Many employees are more comfortable with a transition to outsourcing if their company is open about the process and their reasons for doing so. You should also consider what severance packages or reassignments you will provide to employees who may lose their roles as a result of outsourcing.

  • 6. Looking at the Bigger Picture

    You can determine if outsourcing is right for your company once you have compiled financial data on the business function, projected outsourcing costs, and potential impacts on your company culture. You can also hire consultants to assist you in determining whether outsourcing is a good idea for your company and how to make the transition as smooth as possible.


Why is an outsourcing agreement needed?

If you have done your due diligence and determined that outsourcing is the best option for your business, then without a detailed outsourcing agreement in place, you will be handing over a function of your business with no contractual guarantees of service levels and the real risk to your business if the outsourcing arrangement isn’t fit for purpose and your business suffers as a result.

What is the difference between outsourcing and insourcing?

Outsourcing employs an outside organization’s developed workforce to perform tasks, as well as an outside organization’s resources for services and manufacturing products. Insourcing, on the other hand, assigns a project to a person or department within the company rather than hiring an outside person or company. It makes use of developed resources within the organization to complete tasks or achieve a goal.

Can outsourcing decrease employee morale?

Outsourcing may have an impact on your company culture, particularly employee morale. If your employees do not understand why outsourcing is necessary, they may believe they are being replaced. As workflows become more complicated, other employees may become frustrated, especially if the contracted company is in a different time zone.

How does outsourcing lower costs?

Outsourcing specific functions to other companies can help you reduce your company’s labor costs. The third-party organization hires the employees and is in charge of their pay, benefit packages, and training. This allows your company to concentrate its labor costs on its core employees. Outsourcing can also help you save money on equipment. Rather than purchasing new equipment, relocating, or changing processes, it may be more cost-effective to hire a third party.

When outsourcing to a third-party company, an effective and detailed outsourcing agreement should be in place with the service provider so that the risks that come with outsourcing are minimized. Having clear expectations and deliverables makes it easier for the parties involved in the outsourcing agreement to establish and maintain a professional relationship. In this article, examples of an effective outsourcing agreement are readily available for you to download and use as a reference.