Benchmarking: How to make it work for you

Corporations, like individuals, want value for money for the services they pay for and are prone to making comparisons with others to ensure they are not paying over the odds for the level of service they receive, write Paul Barton and Hui Min Ch'ng.

Statistics show that there is currently an upwards trend for capital spending on outsourcing projects. Having outsourced a key function of your business to a service provider, you may feel that you have negotiated a good deal.

Nevertheless, in the face of ever-present cost challenges, how do you ensure you continue to receive value for money for services throughout the contract long after the ink on the paper has dried?

Benchmarking is a key contractual tool that can be used to achieve this goal. It establishes a much needed performance standard that a service provider is contractually obligated to deliver in a rapidly changing technological environment. So what are the benefits of using a benchmarking exercise?

  • It provides a reality check throughout a contract to address a key question:
    Are services being delivered for a fair price and at the appropriate level of service, particularly if business expectations have changed since the contract was first signed?
  • It delivers a clear and objective evaluation of services delivered to the customer to date by the service provider.
  • If implemented successfully, it can improve the relationship between a service provider and a customer. Benchmarking is much more than a cost saving exercise - it can examine how best value can be delivered and often leads to new opportunities for the service provider in terms of additional services or a more optimal return on its investment.

Key elements for successful benchmarking

Carried out effectively, a benchmarking exercise can lead to increased levels of performance and reduced fees for a customer's outsourcing arrangement. In our experience, successful benchmarking exercises focus on the following elements:

  • Independence: Benchmarking should be carried out by an independent third party. You should resist relying on random survey data offered by a service provider as a benchmark. A third party will inspire confidence in data gathering and undertaking comparisons as well as helping to preserve anonymity for any sensitive data.
  • Use of reliable and current data: Data used to establish a benchmark should be reasonably current and reliable. It should be based on services performed by other third parties no more 18 months prior.
  • Transparency: Benchmarking should be completely transparent. Both the service provider and the customer should have access to information regarding the reference group and the nature of any adjustments. In particular, all parties must have a clear understanding of how key performance indicators and other service measures are defined, how the pricing model operates and how adjustments are made to prices through a defined change control process.
  • Compare like for like? The benchmarker must ensure that the most appropriate comparisons are used. For example, if you are benchmarking a desktop service, use data on service levels and pricing for desktop arrangements with similar organizations with similar workloads and services.
  • Fair pricing: The evaluation of pricing structures on a benchmarking review should be based on fair market value. For example, if £2 per call constitutes a fair market price for help desk services, then you should agree to pay that rate - even if a service provider is able to deliver services for £1.50 per call. This type of stipulation is essential to motivate vendors to support benchmarking initiatives and to invest in innovation to improve their operations.
  • Executive involvement: There should be a high degree of executive involvement in a benchmarking exercise to ensure all round cooperation between the staff at a service provider, an independent benchmarker’s organization and your organization.

Flaws in benchmarking clauses

The most effective benchmarking exercises are built on clear, robust and unambiguous benchmarking clauses. Such clauses are often criticized because they lack commercial applicability or fail to cover the key aspects. Common flaws in benchmarking clauses include:

  • No flexibility: The benchmarking process often entails adherence to a rigid procedure which may have been well suited at the beginning of the contract but proves impracticable as technology shifts with time. 
  • Difficulty of execution: A benchmarking process which is difficult to execute in practice, is complicated, too process driven or takes no consideration of timings is doomed to failure. An example would be where the service provider is given a week to reduce its service charges when the benchmarker discovers that services provided fail to match market rates for equivalent services. 
  • What happens when it is over? Often, clauses contain no provision of what would happen at the end of the benchmarking exercise. Will there be adjustments in the service or performance levels or the fees or will the parties have the option to terminate? Benchmarking becomes a pointless exercise otherwise. 
  • Asking for too much: Standards for benchmarking are often set too high in the customer's favour, making it impossible for a service provider to make a profit. A service provider will not be thankful if all the customer wishes to do is to drive down its profits using the benchmarking exercise. 

Crafting the ideal benchmarking clause

Set out below are the things to look out for when considering how a benchmarking clause should be put together. Issues to consider include:

  • Frequency of benchmarking: How often should it be carried out? This will differ depending on the nature of the service being outsourced. As a matter of good practice, this should be conducted at regular intervals at least on an annual basis. 
  • Selection of benchmarker: Parties need to decide beforehand which independent benchmarker to use. Organizations such as Compass Management Consulting and Gartner Inc. often act as benchmarkers. If agreed, the identity of the benchmarker should be set out in the contract. 
  • Flexibility: It is important to ensure that the benchmarking process is not stuck in time i.e. it can be modified where parties see fit or as technologies develop and will be applicable at any point during a contract's lifetime. 
  • Principles and criteria: The parties should agree the principles and criteria for the benchmarking process i.e. how the data will be sampled and the adjustment factors to be used to align compared data with your organization's data.  
  • Consequences and remedies: The clause should specify what corrective action needs to be taken if the service levels fail to match the benchmark i.e. service providers should be invited to submit an action plan providing additional staffing, levels of training, upgrading hardware and software, amending the service, service levels or fees where appropriate. Where fees are no longer competitive, service charges should be reduced accordingly within a set time frame. Consider including a dispute resolution procedure to deal with any disagreements about the outcome of the benchmarking exercise or about benchmarking process itself. Other contractual remedies, including the right to terminate should also be included in the event that the benchmarker fails to implement the outcomes of the benchmarking process.

Conclusion

Getting a benchmarking process right requires hard work from all parties involved. However, the potential benefits often more than justify the effort required.

Although it is often perceived that the customer has most to gain from a benchmarking exercise, savvy service providers have realized that it can be used to enhance the relationship between the parties and that is something any service provider will be keen to achieve.

Paul Barton is a partner and Hui Min Ch’ng is a solicitor in the Technology Group at Field Fisher Waterhouse LLP.

September 2006