Benchmarking is a risk management tool designed to overcome the risks of fixed price long-term contracts. In its simplest format, a benchmarking process compares a contract price to a market price, and the contract defines the legal obligations of the parties as a result of that comparison.
Comparison to Market Prices: Approximation vs. Exactness
In BPO services agreements over a term longer than a year or two, the question is whether a market price exists at all. The quest for a comparable price using benchmarking methodologies leads only to an approximation of a market price. In commercial transactions, approximations may result in legally binding changes in price, provided that the procedures are predictable and objectively verifiable and thus enforceable by a court.
Benchmarking Methodology
Benchmarking provisions in outsourcing contracts require a series of decisions. For simplicity, we can list several issues in the use of benchmarking as a price adjustment technique.
- the third-party that is to conduct the benchmarking process;
- the contents of the data base that is used to refer to “market” prices;
- the process by which that data base was collected;
- the age of the data that are used for comparison purposes;
- the definition of a comparable transaction;
- the number of comparable transactions considered by the benchmarker as a fair comparison to the BPO transaction;
- the frequency of the benchmarking process;
- the legal character of the relationship between the benchmarker and the parties to the outsourcing transaction;
- the relationship of comparable transactions to the pricing structure of the BPO transaction;
- whether a change in price will become mandatory, and if non-mandatory, the process by which a non-mandatory change might occur;
- the impact of a small or negligible price discrepancy between the benchmarking results and the contract price;
- the impact of a price discrepancy, and whether the degree of price discrepancy (small, medium or large) has any binding legal impact upon the parties or their rights to change the agreement’s terms;
- the scope of the process (whether for an individual statement of work or for an entire contract);
- the financial elements of payment, timing and time frames as to which any changes will apply;
- the “due process” or “fairness” elements of the benchmarking overall.
This partial list highlights the complexity of attempting to applying an emerging market price to a long-term contract price. Additional considerations may be addressed by the relationship governance process.
Suitability of Benchmarking
Benchmarking may not be objectionable when the service provider’s price is based upon an hourly rate of its employees doing a labor-intensive BPO service. Labor rates can be readily determined.
The suitability and terms of a benchmarking become more complex and nuanced when the BPO resources require the application of unique technologies or methods of doing business that the service provider has developed as a matter of proprietary intellectual property rights. In that case, measuring what other customers paid other service provides for the same or similar services may not result in a meaningful comparison. Accordingly, benchmarking is a topic for careful review and negotiation depending on the particular configuration of services and the availability of a meaningful benchmarking process.
Pricing
As an econometric process, benchmarking requires significant work by a benchmarker to sift through data and present a “valid” result. This process may require extensive labor by highly trained personnel over a period of several weeks or months. Accordingly, the use of benchmarking may reflect not only a question of suitability, but also of cost of administration.