9 May 2014
Benchmarking is used to compare the performance and pricing of the services provided by one vendor against those provided by other vendors on a like-for-like basis. It provides a customer with the opportunity to determine whether a vendor’s charging methodology is in line with market standards and, if not, to seek changes that should ordinarily result in decreased charges to the customer and/or a more efficient, or higher quality, delivery of service.
Benchmarking is often heavily negotiated during the contracting phase, as vendors may be reluctant to agree to such a provision within the contract. Customers want to retain control of spending and ensure that the price they are paying is competitive with that paid by the rest of the market. Vendors, however, may be aware that their pricing is uncompetitive, or may feel that they have a unique and/or an innovative service or manner of delivery that makes it impossible for the customer to find an appropriate like-for-like comparative service. It’s where these latter circumstances are genuine that benchmarking may not be suitable and an alternative may need to be considered.
Historically, benchmarking has been negatively perceived. It has been used as an unfair negotiation tool to artificially drive down costs. Critics of the mechanics cite the difficulty in finding a true like-for-like comparative structure and argue that the process should not just focus on costs.
It can also signify “the beginning of the end,” to the extent there is (or was) a collaborative working relationship between customer and vendor. A customer is unlikely to invoke a benchmarking procedure where it is satisfied with the pricing charged (as well as the efficiency of the services being received) and, as a result of the level of transparency of charging and information sharing, trusts that it is receiving competitive market pricing and performance from its vendor.
A customer-friendly alternative to benchmarking is the inclusion of transparent pricing methodologies. The more information the customer has in relation to the services received, the method of delivery and the associated costs, the better equipped it will be to understand how the services are priced and whether, in fact, it is receiving market-competitive pricing. The use of consultants can be invaluable in assessing this information, and customers are becoming more accustomed to challenging vendors where the information is not forthcoming, or where other vendors are capable of providing more comprehensive data. In these instances, customers may favor a fixed-fee pricing structure using a cost-plus methodology to ensure certainty and pricing transparency.
Where agreements are of relatively short duration—i.e., lasting only for a couple of years, or perhaps one-year rolling terms—the parties may agree that there would be no value in taking considerable time to benchmark the service or any part of them. In such circumstances, the customer is unlikely to spend time negotiating a benchmarking provision where it has no intention of ever relying on it. However, that does not mean that the customer should be satisfied with the charges remaining the same for the duration of the term. In these instances, a customer could consider negotiating 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 roll-over of the term.
In the same way that automatic downward adjustments favor short-term contracts, an automatic renegotiation of the charges based on “new” information received by the customer can be a useful mechanic in longer-term contracts. Where a vendor has been providing service for a number of years, it should be familiar with the customer’s infrastructure and the efficiency of its service delivery should increase, causing costs to comparatively reduce.
At the start of the term, the parties may wish to agree that there will be an automatic renegotiation of the charges prior to any contract renewal. For example, one year before an agreement expires, a customer may seek to leverage management information provided by the vendor to reduce costs in exchange for a service term extension, thereby preventing the vendor from holding its services to “ransom” at the expiry of the term. Locking-in the expectation of a price renegotiation on renewal should help the customer have a better negotiation platform to ensure competitive pricing going forward.
In some instances, vendors may believe that their pricing is competitive in situations where they are utilizing a non-standard service packaging or delivery methodology as a means to differentiate themselves within the marketplace. In these circumstances, a like-for-like benchmarking may not be possible given the vendor’s unique approach.
The absence of a formal, contractual benchmarking process in an agreement should not prevent a customer from undertaking an informal benchmarking exercise.
One alternative to what could be viewed as an unfair and unreasonable benchmarking exercise is to have the vendor’s chief financial officer (or other senior corporate officer) confirm to the customer in writing on the commencement of the agreement that the pricing it is offering the customer is competitive with that offered by the vendor to similar customers for equivalent services. That certificate is then renewed and reissued every contract year. This can be a powerful tool, as no senior corporate officer should sign such a statement if known to be false. However, we would usually only recommend relying on such a statement where the vendor is a large, well-known vendor. Similarly, a senior corporate officer is only likely to be willing to put pen to paper in this way for large, multinational customers.
The absence of a formal, contractual benchmarking process in an agreement should not prevent a customer from undertaking an informal benchmarking exercise. An informal benchmarking exercise differs from the formal approach in the following principal characteristics: it is conducted solely by the customer based on information obtained by it; there is no role for the vendor, or requirement that it assist with the benchmarking process; and there are no automatic consequences or other contractual processes for dealing with the outcome of the benchmarking exercise. Despite this lack of vendor participation and contractual process for dealing the consequences of the exercise, we have seen informal benchmarking results prove to be a powerful tool in the context of renegotiation discussions. The results can also have significant weight in ongoing governance discussions.
Benchmarking is unlikely to fall out of practice, but it is not always appropriate, and alternatives should be considered. The right to benchmark should not be viewed as a negative tool to break down vendors. Drafted and implemented in a reasonable and fair manner, benchmarking should be utilized as frequently as necessary to ensure its effectiveness.
Benchmarking can be costly and time consuming for the customer, so the consequences should have legal implications or there is little point in conducting the exercise.
Benchmarking can be costly and time consuming for the customer, so the consequences should have legal implications or there is little point in conducting the exercise. Market standards anticipate that any adjustments to fees be downward only and that the costs of the exercise be shared between the parties unless the pricing variance to “market” is shown to be in excess of a certain pre-agreed threshold, at which point, the vendor would be expected to cover the full cost of the benchmark exercise.
However, where benchmarking is inappropriate due to the nature, cost or duration of the services, or where a benchmark cannot be agreed to, the methodologies set out above may be alternatives that can be used to help ensure that costs are both transparent and reasonable.