Benchmarking clauses have been included in long-term IT services agreements from their inception. However our experience with the use of these arrangements shows that benchmarking is often not used strategically to best effect, and therefore seldom delivers what customers expect.
The rationale behind benchmarking
Benchmarking is the ability for a customer to go to the market (usually through employing an independent third party analyst) to test the pricing / services / service levels under their current services or sourcing contract, against what is generally available at a given point in time.
The pricing / services / service levels are then adjusted, or a process is entered into to agree a path to reset the contract to a market level.
It is usually argued that customers need to have this right in long term services and sourcing relationships, as the deal that was signed three or more years ago is unlikely to keep pace with current market practice. Changes to technology, to the customer's business needs and even to the supplier's risk profile (as the supplier will now know the customer's environment and requirements intimately), may mean that the original pricing for services to be delivered, and/or service levels (including any service credits) and/or general delivery of the services themselves, should be revisited.
Effectively, it is the ability for the customer to re-open the contract and adjust certain levers to keep it market-competitive.
Benchmarking problems
This potential re-opening of the pricing of existing arrangements is the foundation of problems that arise where benchmarking is used inappropriately.
The dynamics in technology generally mean that the cost of providing most IT services either reduces over time or the services improve in quality/reliability. This coupled with new technologies continually emerging, means that suppliers who have developed a cost structure and pricing model to provide certain services, usually find that the market (especially with new entrants or technological advancements) now has a lower cost base or improved service offering over time. It is not just fixed pricing elements that are affected - the supplier will have costed its variable pricing components on an assumed pricing model which will now simply not hold true.
The supplier is faced with a dilemma. Do they incur the capital expenditure of new technologies and write-off previous investments in existing infrastructure?
Not only will the supplier be left with their existing cost structure (plus the additional cost to move to new technologies to provide lower costs/increased quality/improved functionality), but the revenue will also decline if the benchmarking exercise results in the supplier having to lower their pricing.
Another problem is the re-opening of service levels or service delivery. Again, the supplier will have developed and costed a method of delivery to a certain standard. This will involve assumptions over staffing numbers, skill sets and refresh cycles. If this is then 're-calibrated' to market, the supplier is then faced with a requirement to significantly change its operational model midstream - again without any additional funding from the customer.
Supplier behaviour
A benchmarking approach that requires a supplier to bear all of these legacy infrastructure costs and to bear the cost of investing in new technology to receive less money, or simply reshape their delivery or quality of service without compensation, is fundamentally flawed and doomed to failure. In those circumstances, it is in the supplier's interest either to delay the benchmarking process itself (so the customer loses interest) or attack the components of the process (how the benchmarking is actually conducted).
Benchmarking requires both parties to work together - even if only to discuss or implement the end results. Suppliers can drag the consultation or implementation process on for months (even years) to effectively wear down the customer.
Another tactic by a supplier is to attack the benchmarking itself. Who is the benchmarker, are they really independent? Is the benchmarker in fact an organisation that sells consulting services in competition with other suppliers, so their independence can be questioned? Is the benchmarking taking into account all relevant factors? Legacy infrastructure is often inherited or special service or operational circumstances exist that need to be considered by the benchmarker. Is the result a true 'like for like' comparison? Very few complex environments can be easily mirrored elsewhere.
This debate about the benchmarking procedure can delay the process or put the results into dispute - increasing the costs dramatically or limiting the effectiveness of the whole procedure.
Customer behaviour
For these reasons, a customer that wants to use benchmarking simply as a mechanism to drive down price or improve service delivery will find it a costly and frustrating process. Benchmarking is expensive and time consuming even with a co-operative supplier, let alone with an un-cooperative one.
Exercising a benchmarking right in these circumstances is a sign that the customer is dissatisfied with the services or wishes to be reassured as to value for money. That is, the parties are already diverging. In our experience, few if any customers do not already have a good idea of whether equivalent or better services can be obtained in the market more cheaply.
The answer?
Benchmarking is expensive and time consuming.
An automatic adjustment following benchmarking simply will not work for any supplier with a committed or inherited cost base. It is also unlikely to be agreed to in any event.
A simple 'agreement to agree' statement means nothing - and having a third party impose solutions in the event of a dispute just replaces one benchmarker's opinion with another.
Benchmarking is really all about re-opening negotiations. Clearly the customer is not happy, and a commercial solution should be jointly worked on. If the parties cannot agree, then those 'uncompetitive' services should be provided elsewhere or brought back in-house. If the services simply cannot be 'pulled apart', then termination may be the only option.
Alternatively, the parties could agree to share jointly any variations in price, or jointly fund any service delivery/quality improvements. This would be an equitable result where the market has simply moved, but the relationship is still strong and otherwise working well.
In our experience, benchmarking rarely delivers what it promises. We have seen many situations where customers have exercised their market power to renegotiate the relationship - whether through mid-point reviews or just out of the need to re-shape the deal to meet business requirements.
Benchmarking has in many instances produced results that are controversial. This detracts from the real message of the need to have a general review and re-open the foundations of the relationship.
Maybe it is time to own up to the fact that benchmarking simply is not guaranteed to work for technology services contracts.
Quentin Lowcay
Senior Associate
T +61 2 9296 2080
quentin.lowcay@mallesons.com