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Tech & Sourcing @ Morgan Lewis


Risk is an interesting topic that can (and does) take volumes to address. Still, it’s helpful to step back and take stock of how you deal with risk in complex sourcing deals.

One way to break down how you look at risk is in terms of allocation versus mitigation. Contracts tend to focus heavily on risk allocation. The limitations of liabilities clause, for example, feels like risk mitigation, but what those limits really do is determine who is going to bear the risk that already exists.

Clearly understanding risk and allocating it appropriately is extremely important and not to be taken lightly. Still, it’s a mistake to give short shrift to thinking about how to mitigate that risk in the first place. This begs the question, what can be done to get that risk level down a bit?

It’s insightful to ask a room full of people what the riskiest thing they can do in a complex sourcing deal is. The answer is almost always about neglecting terms like “warranties” and “limitations of liabilities.” However, those terms, although important, are risk allocation terms and usually are not the most effective risk mitigators.

Reasonable people could differ, but a strong argument can be made that the single riskiest act in an outsourcing happens well before a lawyer ever puts pen to paper on the contract.

In the context of a competitive buy process, arguably the riskiest act is to eliminate the right potential partner. We have seen many instances where a rushed or poorly designed process fails to test the relationship attributes that encourage success. Once the right partner is gone, you are left with using a contract to force a good result from a less-than-good situation—never a great idea.

The next riskiest thing would be to force your vendor, through an over-leveraged buy process, to agree to transition terms that it is unable to meet. Backing that up with a contract that codifies this may help allocate the risk to the other party, but it may not provide the mitigation properties that you would like. And in the worst cases, poorly thought out transition terms can cause a transition to fail.

The old expression that you only have one chance to make a first impression applies here. If parties set unreasonable expectations, there will likely be difficulties in the transition. A blown transition can make you lose the hearts and minds of your stake holders. That in turn can wreck your change management program, which can have a multiplier effect on return on investment and do other damage that may be impossible to overcome down the road.

So, make sure you have as much risk allocation as you need to feel comfortable, but don’t neglect risk mitigation. The best way to win a war is to never have to fight it in the first place!