The Requirement of Due Diligence in the Role of Customer and Supplier in Outsourcing

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Outsourcing agreements are often long-term partnerships, and the services outsourced, whether IT or business processes are often essential to the customer’s organization’s future operation. Outsourcing service to another company involves more than simply a business and economic concern. As executives entrust another firm with their organization’s intellectual property, digital footprints, and growth, they must pay close attention to the former’s working culture, IT skills, history, risks, and legalities surrounding its jurisdiction. This is why you need to perform due diligence in outsourcing!

Due diligence refers to gathering and evaluating a business transaction’s factual and legal background. It is a type of investigation of an operational business that reveals information about the company that is not readily available to outsiders but can only be discovered if thoroughly studied and probed. It is a background examination to investigate and assess all potential growth factors and risks involved in and after the transaction. It is done for the sake of both parties’ safety and success.

Due diligence in various M&A deals usually consists of the purchaser only doing due diligence on the acquisition target. However, due diligence in outsourcing should be a two-way street, with the supplier evaluating the customer’s proposed outsourcing project and the customer assessing the supplier’s capacity to offer the services. Prior to engaging in such important agreements, it is critical that both the client and the supplier conduct due diligence to ensure that both parties are clear on the customer’s service requirements and objectives and how the supplier will meet these. In this article, we look at the importance of due diligence from the perspective of both the customer and the supplier.

Watch our video below or read the article underneath to understand more!

The Importance of Due Diligence https://www.morganlewis.com/blogs/sourcingatmorganlewis/2019/02

Customer Due Diligence

The customer’s due diligence will focus on:

Its own needs: for example, the services that the customer is looking to outsource and its current and likely, future service requirements. The customer should also identify any objectives that the business would like to achieve through outsourcing: for example, is it looking to transform the delivery of the services, such as through automation or other innovative approaches? Other points to consider will include the risk of outsourcing the services (discussed further below) and any regulatory requirements.
The prospective suppliers: for example, do they have the necessary expertise to provide the services in a way that meets the customer’s requirements, and how do they propose to do this? The customer should also consider the geographical reach of the supplier in the context of the services to be provided and the financial standing of the supplier. Also important will be the commercial model proposed by the supplier, including the impact of changes in volume on charges.
Business case protection: for example, will the supplier’s solution and pricing hold for the term of the arrangement? Are there hidden internal costs or supplier costs that have not been identified that will impact the anticipated savings? In connection with this diligence, it is important to closely review the supplier’s assumptions and limitations.

Outsourcing can present risks to the customer’s business, particularly when the services being outsourced are complex and/or business critical. It is therefore important for the customer to identify the risks associated with outsourcing and develop and implement a strategy to mitigate the risks.

Supplier Due Diligence

Elements of the supplier’s due diligence mirror that of the customer: for example, the supplier will be looking to have a clear understanding of the customer’s requirements and objectives, and to ensure that it is able to meet expectations.

Where a proposed arrangement is more complex, the requirement on the supplier to implore due diligence is greater. That being said the supplier may have to implement exercises which may require relatively substantial resource investment. Therefore, in a competitive bid process, suppliers may need that they have been down selected (or are at least one of a few frontrunners) prior to undertaking such activities. Similarly, customers may be reluctant to commit the resources necessary for due diligence exercises by multiple suppliers before a down select.

The due diligence that the supplier carries out will usually focus on areas such as the services that are currently being performed (whether by the customer itself or a third-party supplier) and the service levels being achieved. Suppliers will also investigate any future customer requirements and any changes anticipated in the future; for example, changes in volumes, any improvements required to the services, and the likely cost of implementing such improvements.

Other items the supplier will wish to consider in respect of the existing services include ownership of intellectual property and the likelihood of being able to obtain licenses to use such intellectual property, ownership of relevant assets and the age and condition of such assets, and (if applicable) how its IT will interface with the customer systems.

Bottom Line

Outsourcing could be the catalyst for any company’s rapid expansion depending on the measures undertaken and adherence to a due diligence process. The due diligence aspect of outsourcing can be simple or complex, depending on the nature and size of the outsourced services. How thorough a Customer or Supplier applies themselves towards due diligence will help identify red flags, risks, and potential pitfalls.

HWAA can help you!

Are you looking to conduct financial due diligence before entering into a significant business transaction such as M&A, partnership, or outsourcing? If so, you are in the right place.

HWA Alliance of CPA Firms Inc focuses on providing high-quality services that will help you in your next steps in business. We can equip you to compile the necessary due diligence prior to your commitment to any business transaction, or outsourcing service. HWA offers a full range of other financial and accounting services to clients worldwide. Our due diligence team has extensive expertise in investigating and analyzing a diverse set of requirements and customers from various industries. We perform highly detailed and tailored financial due diligence to provide a complete investigative evaluation of a company’s financial performance and validate the prospective deal or investment opportunity of the business transaction. Our goal is to provide peace of mind to our clients by analyzing and validating all the financial, commercial, operational, and strategic assumptions made in the transaction.

If you are looking for high-quality and cost-effective due diligence services, get in touch with us today!

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