Substantial and frequently changing hurdles stand between food companies and success. A company’s bottom line often is subject to increased costs brought about by economic recession, natural disasters, fluctuating commodity prices, regulatory changes and changing consumer demands, among other obstacles. The Food Safety Modernization Act (FSMA), for example, has imposed a host of food safety-related requirements on food companies that may be costly to fulfill, with more on the way come full implementation.
In an effort to counter the costs of such hurdles and to protect their bottom line, food companies of all sizes are more often outsourcing business functions (human resources, information technology, etc.) and manufacturing operations (research and development, testing, packaging, etc.). When well planned, outsourcing arrangements may prove quite beneficial.
But as with any supply relationship, changing circumstances may make an outsourcing arrangement unrewarding. Moreover, where an entire business function or manufacturing operation is outsourced, the potential risks rise for business disruption and increased costs. A failure in a critical outsourced business process or manufacturing operation may have a substantial, and potentially devastating, effect on the company’s business. (For more about the benefits and risks of outsourcing food safety testing, see sidebar “Lab Outsourcing”)
What can a food company do to adequately protect itself against risks that underlie outsourcing? In short, a food company should properly plan for the life of the outsourcing relationship. Proper planning comprises at least four considerations:
1. Thorough due diligence regarding, and preparation for, the outsourced relationship
2. Thoughtful negotiation of the outsourced relationship
3. Precise drafting of the agreement that governs the outsourced relationship
4. Vigilant management of the outsourced relationship and agreement
Each aspect of planning is complex. Moreover, given the variety and complexity of outsourcing relationships and outsourced processes and operations, unique due diligence and risk management considerations may exist and should be assessed in conjunction with a particular relationship. This article addresses outsourcing relationships generally, highlighting key strategies, issues and considerations that will help food companies plan for such relationships and avoid outsourcing errors.
Preparation for the Outsourced Relationship
Mismatched expectations between a food company and outsourcing partner make it easy for the relationship to fail. Preparation for an outsourcing relationship thus requires two assessments—one internal and the other external.
First, a company must assess how the process or operation to be outsourced fits within its overall business. It is essential to consider any issues unique or critical to that function that may be of particular concern in outsourcing. It also is essential to consider the costs to transition to an outsourced relationship and the subsequent costs to manage it.
If the internal assessment confirms that it is appropriate to outsource, the company should draft a plan that establishes its goals for the relationship. Among other things, an outsourcing plan should:
• Specify the company’s objectives, both operational and financial
• Define the scope of the function or operation to be outsourced
• Set forth any requirements and specifications of the outsourced function or operation
• Explain operational, technical and financial metrics against which to measure potential outsourcing partners
• Describe expected performance outcomes
• Assess how the company intends to manage the outsourced relationship, including consideration of necessary personnel
The plan also should spell out any essential criteria that might affect the success of the outsourcing relationship, such as U.S. Food and Drug Administration regulations, U.S. Department of Agriculture regulations, or industry best practice standards governing the particular operation. It may be more fruitful to select a supplier that understands and has experience in the food industry. In addition, the plan should take into consideration the personnel or consultants needed to assess whether to outsource, to select an outsourcing partner and subsequently to manage the outsourcing relationship. Without knowledgeable personnel or consultants to form the plan, assess partners and manage the relationship, it may be doomed from the start.
Second, a food company should use its outsourcing plan as the foundation for the matters it examines when performing due diligence on prospective outsourcing partners. In addition to assessing a potential supplier against operational, technical and financial metrics, careful due diligence also entails research into the potential supplier, including sharing of information and review of material about the supplier that would impact the efficacy of any relationship. This includes the potential supplier’s procedures, culture, accreditation, certification, food industry experience, equipment, facilities, finances and financial stability. Where feasible, both high-level businesspeople and technical personnel who know the process or operation to be outsourced should interview the potential supplier in person to determine whether the supplier understands the company’s business and industry, and to assess the potential supplier’s compatibility with the company and its culture. If a potential outsourcing partner is located outside the United States, additional consideration should be given to conditions that may be unique to that candidate’s locale, including environmental factors, accessibility, political unrest, labor pool, energy, telecommunications and transportation infrastructure, food, consumer and safety laws and pertinent other laws and regulations.
A natural tension exists between a food company’s desire to cut costs by outsourcing and its obligation to meet food safety and consumer demands. Suppose, for example, that a company’s manufacture of its food product requires microbiological testing subject to regulatory parameters or marketplace demand. Such testing may already be, or may soon become, so specialized that the company believes that purchasing or upgrading the necessary laboratory equipment and retaining trained scientists to perform the tests would be too expensive to do in-house. Nevertheless, the food company retains responsibility for compliance with the testing specifications regardless of cost. Thus, the company must perform sufficient internal and external due diligence to mitigate the risk of the outsourcing partner’s noncompliance to determine whether the company would benefit by outsourcing and whether those benefits outweigh the risks.
Due diligence also plays a critical legal function. Information gathered during due diligence will affect the content of the outsourcing agreement. That is, unless a food company first identifies its critical business needs and then assesses potential supply partners in light of those needs, it may not have enough information to perform an adequate cost-benefit analysis or to negotiate, reflect and protect those needs in an effective outsourcing agreement.
Thoughtful Negotiation and Precise Drafting of the Outsourcing Agreement
A well-negotiated, well-written outsourcing agreement is critical to form a productive outsourcing relationship. Boilerplate is almost unavoidable in formal agreements, but relying on boilerplate increases the chances of a company misunderstanding the impact of contractual terms. Thus, a company should instead carefully consider, negotiate and contract for each aspect of the outsourcing relationship. This is especially true for food companies that are particularly susceptible to the unpredictable nature of consumer perception. Even were a problem caused by its supplier, consumers are unlikely to appreciate a distinction between the food company and its outsourcing partners. A food company may not be able to recover in the eye of the consumer even if the company did not directly cause a problem.
Given the complexities of an outsourcing relationship, food companies must address a number of considerations to make an outsourcing relationship successful. The particular considerations will vary, depending on the circumstances and nature of the relationship. But generally, when effectively drafted, an outsourcing contract should, among other considerations:
• Identify precisely who is the supplier
• Specify the services, and the scope of those services, to be supplied