BOTs come in various flavors: there are the ones that crawl the web, the DIY robots that makers build and there are Build Operate Transfer setups with outsourced software development firms. Although the first kind are much used and the second more interesting to talk about, it is the third set that I want to discuss today.
What is a BOT, Where Did it Originate?
In its original incarnation, a Build Operate Transfer (BOT) was a form of project finance where the parties to the project had a number of goals that best aligned in its structure. The original BOTs tended to be for large, capital intensive projects - think bridges, power plants, rapid transit systems or toll ways - that a host entity wanted to get constructed and operating. That entity would enter into an agreement with an engineering firm to build the asset, a bank to finance it, and another entity to operate the project for a set period of time, after which it would be transferred to the sponsoring entity.
BOTs are popular in cases where the host wants to attract investment capital and technical expertise, e.g. a developing country that needs to increase power generation capacity or build a port.
There are a number of flavors of BOTs including:
- BOOT - Build Own Operate Transfer
- BOO - Build Own Operate
- BLT - Build Lease Transfer
that each provide different benefits to the participating entities.
How is This Model Applied to Software Outsourcing?
Domestic software companies figured out that, if they decide they need a captive operation in an offshore location - say one they want to grow to a considerable size - building it from scratch can be a time consuming and expensive process. So, they will often partner with a local software development firm, engaging them to build a team for them, manage it for a specified period and then transfer it to the American company.
This enables the American company to leverage the partner firm’s knowledge of local markets, it human resources infrastructure (recruiting, training, payroll) and presence, getting them much further much faster than if they built to operation on their own. Under some structures (see below) it also gives them flexibility as to if and when they take over the operation.
Like its infrastructure cousin, software outsourcing BOT comes in a variety of flavors, in a continuum from rapid separation to integration. The outsourcing partner may build the team for its client in a separate location, setting up its own recruiting, training and management functions. Or, the partner may build the team for its client within its own operation, leveraging its own services and continue to provide these after the BOT has been exercised. In the latter version, the software company is often given the option of pulling the trigger on the BOT, giving it flexibility to grow in the host country or to continue to work the with partner on an arm’s length basis.
What are the Key Deal Points in a Software BOT?
There are four key deal points to keep in mind when structuring a BOT.
First, what is the minimum team size that you and your partner will consider transferring within the context of a BOT? Your partner is unlikely to want to got to the effort of setting up parallel HR, financial and legal structures for a team that doesn’t grow beyond a few FTEs. Likewise, you should be wary of taking on the direct management of a small team in another country, which can be time intensive. Especially because members of a small team may feel isolated and when better offers come knocking, may take them.
Second, what is the minimum term that the BOT will operate before it is transferred. Your partner is unlikely to want to set up a team in a hurry and immediately hand them over to you, acting as a glorified recruiter. They expect to be able to recoup some of the costs through managing the team for a period. You shouldn’t want this either: one of the things that the partner can do for you is develop a stable vibrant work culture with your team. It needs time to do this.
Third, what team members do you identify as core - essential for the transfer - and peripheral - can be added or not, as the opportunity arises. You and your partner need to identify core FTEs and work to make those FTEs part of your organization.
Finally, and most important, how are fees for the BOT structured. You should focus on XX factors. First, what will the partner charge you for FTEs under their management, while they build the BOT? Second, What is the actual transfer fee (typically calculated as a percentage of annualized billings at the time of transfer)? And, third, how is that transfer fee adjusted for tenure of the FTEs at the time of transfer? It is reasonable for your partner to expect the transfer fee to vary based both on the length of operation prior to transfer (the longer that time, the lower the fee) and by individual FTE tenure (the shorter the tenure, the higher the fee.)
The $64 question is: what should these fees clock in at? Well, you can do some simple math around the gross margin - 15 - 18% - your partner would expect to generate if you were to run your outsourcing operation with them and not take it over, to give you a guide for what the BOT fee should be, on an opportunity cost basis. And, you can use the typical fee that local recruiters charge to put a cap on the BOT fee you would pay, once the operation has run for a few years. Finally, you can assume that your partner will invest in the partnership when setting the operation up, foregoing a good portion of its gross margin in the first year.
So, you can assume that a BOT option should be open no less than 24 months from project inception (this gives the partner an opportunity to make a return on its investment in setting up the partnership), and that a regular outsourcing gig that runs 3 - 4 years - say 42 months - is satisfactory for the partner. So, if the BOT is exercised in month 24, the partner is foregoing 18 months of margin, so a fee of 20 - 25% would be reasonable. If the BOT option is exercised in month 42, the partner has generated an adequate return on its investment and you would pay them the equivalent of a recruiting fee - 7 - 9%.
Similar math can be applied to each FTE being transferred based on their tenure at the time of transfer - you would pay a lower fee the longer the FTE had been hired by the partner for your project.
One Final Word
The best business relationships are run as partnerships, with parties to the transaction treating each other as equals, focused on building lasting relationships. This is particularly true when working with an outsourced software development partner: working steadily to a common understanding of how your BOT will work and renewing this understanding regularly, in the context of developing a deeper working relationship, will get you a lot further, and protect you in the event of difficulties, than will a very long contract agreement.