Make benchmarking work for you

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Make benchmarking work for you

Samitha De Silva, senior associate and outsourcing expert at international law firm Pinsent Masons

In the technology industry, where standards of quality tend to rise and costs continuously decline, companies that outsource often seek assurances that market prices and service levels will remain competitive throughout an agreed contract term. This is why benchmarking is so vital.

Benchmarking is now a regular part of any outsourcing arrangement. However, looking at the use of such arrangements it is clear that benchmarking is often not employed strategically to the best effect, and consequently users and suppliers can become disillusioned about the process and results.

Benchmarking is a process whereby the price paid by the user for a set of services performed to particular service levels is compared to a sample of prices paid by other organisations for similar services.

This process is usually carried out by an independent, third-party benchmarking organisation. The benchmarker, with its own database of information, compares the relevant information relating to the scope of services, volumes, prices and service levels. Out of that comparison, the benchmarker will report back to the parties its assessment of how the particular prices and services relate to the market.

Effectively, the purpose of benchmarking is to confirm that the user is paying a fair price and getting reasonable service. Although on the face of it this sounds sensible, why do IT suppliers tend to resist benchmarking provisions? There are usually several reasons for this.

The nature of technology generally means that the cost of providing most IT services either reduces over time or the services improve in quality and reliability. This, combined with new continually emerging technologies, means that suppliers that 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.

Also, it is not just fixed pricing elements that are affected - the supplier is most likely to have costed its variable pricing components on an assumed pricing model which will now simply not hold true.

One possible result of the benchmarking exercise is that the supplier may be forced to incur the capital expenditure of new technologies and write-off previous investments in existing infrastructure. Another possible result is that the supplier's revenue may also decline. Obviously, neither of these results is ideal for any IT supplier.

In addition, outsourcing deals often require the supplier to invest heavily at the start of the contract period, sometimes to the point of not making a profit in the early years. They rely on realising the profit later in the deal, so benchmarking the price later may not recognise the profit the supplier has foregone earlier. Unfortunately, not all users recognise this.

Another problem of benchmarking from a supplier perspective is that the process allows a user to require that the service levels and service delivery are adjusted to market level.

However, the supplier is most likely to 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 mid-stream without any additional funding from the user.

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 user.

Another tactic by a supplier is to attack the process. Who is the benchmarker - are they really independent? Is the benchmarker selling consulting services in competition with other service providers, so that its independence is questionable? 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?

This debate about the benchmarking procedure can delay the process or put the results into dispute. Ultimately, it can increase the costs of benchmarking dramatically or limit the effectiveness of the whole procedure.

For these reasons, a user 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 cooperative supplier, let alone with an uncooperative one.

So what can a user and supplier do to ensure that benchmarking works as intended? One option is to take a big-picture view of the process. Both parties should approach the discussion with the attitude that they brought to the early days of the agreement, when they were setting out to forge a strategic-based relationship.

Both the supplier and user should use the benchmarking discussion to re-introduce these strategic elements into the relationship, and not as a way to beat a certain percentage off the price.

The entire object of the benchmarking process is to obtain a true comparison between the existing pricing, services, technology and service levels, and market practices.

To do that, comparing the user with its true peers is important. Lack of comparability in benchmarking is probably the largest source of criticism and dispute in the process, and it has the potential to call the entire results into question.

Comparisons against market standards of quality and cost must be "normalised" to adjust for unique or unusual circumstances, including unusual service requirements, volumes of service and geography.

Aspects of "financial engineering'" should also be considered in the process. For example, unusual discounts, credits, "loss leaders", or other incentives inconsistent with customary notions of "fair market" pricing may be recovered through service charges, and must be accounted for to ensure fair comparisons.

An alternative to normalisation is for the user to consider asking the benchmarker to look at industry trends, not absolute amounts. These trends can then be matched to the user's contract by adjusting the current pricing, services and service levels by the demonstrated trend.

The main advantage is that if the trend in the user's industry is truly representative, it does add a degree of future proofing. The main disadvantage is that it increases the subjectivity of the benchmarking exercise.

One way of managing the risk and reducing the possibility of a dispute over the benchmarking process is to involve the benchmarker in the negotiation process. With the involvement of the benchmarker, the parties can agree a process for gathering information from the supplier relating to the services it is providing, as well as a reconciliation process between the service provider data and the benchmarker's data.

This is necessary to enable the benchmarker to take account of specific factors in the particular outsourcing contract, which are unlikely to be present in other contracts covered by the benchmarker's database.

If both parties and the benchmarker have agreed the process to be followed, it becomes more difficult for one of the parties to dispute the findings on the basis of the process used.

The downsides of involving the benchmarker in the negotiation process are time and cost, as it effectively ties the supplier and user to that benchmarker for the term of the outsourcing contract.

The benchmarker may also seek some form of up-front commitment to the number of benchmarks to be performed over the term, and this may be a commitment that the parties are unwilling to make prior to signing the outsourcing contract.

The benchmarking of outsourcing agreements is really all about re-opening negotiations. If the user is clearly not happy, 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 or quality improvements. This would be an equitable result where the market has simply moved, but the relationship is still strong and otherwise working well.

Both the user and supplier are likely to have legitimate concerns regarding benchmarking. However, whatever its limitations, benchmarking can be an effective catalyst for re-negotiations that has the potential to improve service levels and provide value for money.

The Public Sector Benchmarking Service website >>

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This was first published in May 2007

 

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