For better or worse, invoking the benchmarking clause in an outsourcing contract can spell trouble. IT suppliers contend that benchmarking has been used by some customers as an unfair negotiation tool to drive down costs. And industry experts point out that creating true apples-for- apples comparisons can be difficult as outsourcing relationships are about more than cost.
“One of the key elements to a successful, collaborative sourcing relationship is governance and trust. Benchmarking can often signify the ‘beginning of the end’ to that collaborative, working relationship,” says David Bates, partner in the business and technology sourcing practice of law firm Mayer Brown. “If a benchmarking clause is exercised by the customer, it demonstrates a lack of satisfaction and trust on behalf of the customer and shows a breakdown in the governance of the relationship.”
That doesn’t mean the benchmarking clause is dead. But there are five effective alternatives that outsourcing customers can consider to determine whether their IT service provider’s pricing remains competitive with the market.
1. Transparent Pricing Methodologies
One alternative that’s customer-friendly is a transparent pricing methodology. The more information an IT organization has about services, delivery, and costs, the better it can understand pricing relative to the market.
IT service providers can be reticent to provide such clarity, however. “A supplier may be reluctant to provide transparent pricing to its customers, not wishing to give away what it considers commercially sensitive information, leaving customers in the dark as to how the costs for their services are structured,” says Megan Paul, an associate at Mayer Brown. “Consultants can often bridge this gap and educate customers in how different services are priced.”
“Consultants can often bridge this gap and educate customers in how different services are priced,” says Paul. The drawback is the additional cost of retaining those consultants. In addition, some vendors may be incapable of providing such comprehensive data. In those cases, say Bates and Paul, a cost-plus model can provide some lucidity.
2. Automatic Downward Adjustment
In some cases, such as short deals that last a couple of years or exist on rolling one-year terms, customer and supplier may agree that benchmarking makes little sense. But that doesn’t mean customers should leave prices unchecked.
They can negotiate an automatic downward adjustment based on certain triggers, such as the customer maintaining an agreed minimum volume over a period of months or the vendor failing to reach certain service levels in a given period. Such automatic downward adjustments can also apply on any extension or rollover of the relationship.
But, says Bates, “agreeing on the triggers which would lead to such downward adjustment can prove difficult. It requires a good understanding of the services to be outsourced and usually places the onus on the customer to behave in a certain manner in order to secure the reduction in costs.”
3. Automatic Renegotiation
Automatic renegotiation is a similar tactic that can be employed for longer contracts during which the environment might change impacting the cost structures of IT services.
“Suppliers should, over time, become more efficient and cost-effective at providing the services, taking advantage of synergies and lessons learned as the contract progresses,” says Paul. Both parties might to agree to an automatic renegotiation of the charges prior to any contract renewal, putting the customer in a better position to negotiate competitive pricing going forward.
However suppliers may have little incentive to agree to such a clause. “Automatic renegotiation may not be welcomed by a supplier seeking to retain those savings for itself,” says Bates. “There is little incentive for a supplier unless some sort of gain-share is agreed between the parties. This drives better behavior as both parties will ultimately benefit from the efficiencies and the supplier’s hard work.”
4. Director’s Certificate
When a vendor views benchmarking as unfair or unreasonable, an alternative is to have the supplier’s chief financial officer or other senior corporate officer confirm to the customer in writing on the commencement of the agreement that the pricing is competitive with that offered by the vendor to similar customers for equivalent services. That certificate is renewed and reissued every contract year.
No corporate officer should be willing to sign such a statement if false. However, says Bates, “the customer may not be willing to rely on a non-contractual statement from an officer of the supplier on the basis that the statement given will not be an impartial view but, most probably, drafted from the opinion of the director and therefore unlikely to satisfy the customer when it would prefer to rely on an objective, contractual promise or obligation.” And ,unless made fraudulently, there is little recourse for the customer if an officer’s statement turns out to be incorrect.
Ultimately, Bates advises relying on such a statement only with large, well-known vendors. Additionally, most IT service providers will only agree to such a stipulation for their biggest customers who are likely to be receiving the best pricing.
5. Informal Benchmarking
If there is no formal, contractual benchmarking process in an agreement, a customer can still undertake an informal benchmarking exercise. Unlike the formal alternative, the customer conducts the exercise based on information obtained without any vendor participation. And there are no automatic consequences or other contractual processes for dealing with the outcome of the benchmarking.
Nonetheless, it can be a powerful tool in renegotiation. “The timing of the exercise is important,” says Paul. “If conducted at a time before renegotiation, it can incentivize a supplier to provide competitive pricing. However, customers should be careful of the message it sends to suppliers and an open and frank discussion should be had as to why a customer feels it necessary to conduct such an exercise.”