Benchmarking Clauses in Outsourcing Agreements: Keys to Success

Benchmarking clauses in outsourcing contracts are an established mechanism to gauge the competitiveness and quality of service delivery. A benchmark review can help a client and service provider determine if services are aligned with market standards for price and quality, define adjustments that can and should be made, and identify additional opportunities for improvement or innovation.

Despite these potential benefits, benchmarks have gotten a bad rap in some quarters. One reason is that, in fact, traditional benchmark reviews have often wrongly focused on the pricing of discrete slices of operational performance, neglecting the big picture of service delivery and overall business objectives. When that happens, the review process can degenerate into a standoff between the client and service provider, with one side demanding immediate price adjustments and the other challenging the validity of data and comparative references.

Effective benchmark clauses and benchmark outcomes are characterized by a transparent process involving the client, service provider, and third-party advisor, with data and comparative references agreed upon upfront. The terms of the clause must be clear, specific, actionable, and realistic.

Here are some specific keys to success and pitfalls to avoid:

  • Challenge a provider who insists on excluding a certain benchmark partner from consideration. That could indicate a past case of being “caught with their hand in the cookie jar.” All of the major players in the contract benchmarking market have well-established and defendable methodologies. Often the issue is finding the benchmark partner who best fits the client’s scope, scale and complexity. Since only a finite number of deals are reviewed each year, no single benchmark firm can have the deepest insight into all environments.
  • Insisting on a specific “percentile” outcome may in fact not be reasonable based on the scope, scale and complexity of the deal. Do not let the partner dictate the process used to execute a benchmark, as this is not their core competency.
  • Since the deal’s original intent often gets lost with time, changing business pressures and current operational or strategic needs, early documentation must be preserved for consideration in future benchmarks. Regardless of the alignment of the agreement, determine what will be benchmarked: the contract, the services being requested by the client, or the services being delivered by the service provider.
  • Use the benchmark results to define clear, actionable and time-boxed activity. Resist attempts to soften the next steps by inserting “best effort” language, as that can effectively leave you with no clear way forward.
  • Do not put the onus on improvement solely on the service provider. Rather, identify potential actions for the client organization as well. For example, are client processes inefficient and cumbersome, and can they be rationalized to allow the service provider to leverage economies of scale? Are the client’s reporting requirements unnecessarily cumbersome and can they be streamlined?

Applied in this manner, the contractual benchmark can be a win/win for both parties.

John Lytle, Consulting Director, ISG