Often included in long-term outsourcing/managed services agreements but sometimes overlooked as a contractual right, in this post we look at benchmarking provisions, including what benchmarking is, common rights and restrictions, and other considerations for customers and suppliers.
What Is Benchmarking?
Benchmarking provisions grant the customer a right to appoint a third-party organization (the benchmarker) to undertake a review of the price and/or the level of service that is being offered by the supplier under a contract as compared to the price and/or level of service offered by comparable suppliers for comparable services.
Benchmarking provisions aim to give the customer the right to ensure that the services it receives are a “good value” (as defined by the parties in the agreement).
How Does It Work?
The exact process for benchmarking will be set out in the agreement, along with details of the thresholds that will denote whether the services offered by the supplier are deemed to be of good value for the customer.
Generally, if the benchmarker concludes that the customer could obtain comparable services elsewhere for a lower price or at a better level of service (dependent on what is being benchmarked), i.e., the current services do not represent a good value, then the supplier will be obliged to reduce the price or increase the level of service, as applicable, accordingly, or the customer shall have certain rights, such as the right to terminate the agreement (without payment of compensation).
“Good value” is often measured in percentages, with “good value” services falling within a certain percentage of the price or level of service of the comparable services reviewed by the benchmarker. The percentages or other thresholds on what represents “good value” will be set by the parties as part of the agreement’s benchmarking provisions.
Management of Benchmarking Provisions
Benchmarking provisions are often heavily negotiated. Having gone to the trouble of negotiating these provisions, it is important that the customer does not forget that it has the right to benchmark, especially given that there may be restrictions on the timing of undertaking a benchmarking exercise.
The customer should ensure that it understands its rights in relation to the following:
- When it can exercise the right to benchmark (including frequency)
- What part of the supplier’s obligations can be benchmarked
- What notice must be provided
- What benchmarkers can be used
- If there are any other procedures that need to be followed
- What the consequences are if the benchmarking report shows that the benchmarked services are better or worse than the comparable services
- Who is responsible for the costs of the benchmarking exercise
The customer should periodically review whether a benchmarking exercise should be undertaken for the services as a whole or for certain discrete services. The customer should bear in mind the potential costs (both time and money) of a full benchmarking exercise, and the fact that the negotiated benchmarking provision may have restrictions on the scope of what services may be subject to the benchmarking.
Benchmarking provisions can be an emotive subject for the parties, and it is not uncommon for one party to dispute the results of a benchmarking exercise. In order to mitigate the risk of disputes in relation to benchmarking exercises, the customer must ensure the following:
- The benchmarking exercise is undertaken strictly in accordance with the contractual provisions
- An experienced benchmarking organization serves as the benchmarker
- It keeps a clear audit trail for the benchmarking exercise
Suppliers should consider the following when agreeing to a benchmarking provision:
- Agree on the identity of the benchmarker (or a set of potential benchmarkers) up front—preferably an organization that the supplier knows has particular expertise in the relevant area and voluminous comparison data
- Agree on what data inputs shall be provided to the benchmarker
- Agree on the number of comparative deals that must be reviewed as part of the benchmarking
- Agree on the normalization factors that the benchmarker shall use when comparing all of the transactions
- Agree on the cost allocations of each benchmarking exercise
- Timetables should be realistic
- The benchmarking exercise should not be disruptive to the provision of services or to the supplier’s business in general
EU Competition Law Considerations
Across the European Union, benchmarking arrangements are generally acceptable and viewed as pro-competitive, provided that certain best practices are adhered to; for example:
- The comparison group should be made up of a reasonable number of organizations to mitigate the risks of the parties being able to reverse engineer the data to reveal commercially sensitive pricing information
- The data should be anonymized
- The data should be managed by an independent third party