Many companies include the right to benchmark their contract as standard legal language in their outsourcing contracts, but few companies have invested in professional management of benchmarking processes. I consulted with colleague who is no stranger to benchmarking. His finance background and prior experience in a sophisticated Strategic Sourcing organization make him an ideal manager of this important role within his company’s technology organization. Over the years he’s learned a few things about benchmarking, which I’d like to share with you.
According to Wikipedia (http://en.wikipedia.org/wiki/Benchmarking) Benchmarking is the process of comparing the cost, time or quality of what one organization does against what another organization does. The result is often a business case for making changes in order to make improvements.Also referred to as “best practice benchmarking” or “process benchmarking”, it is a process used in management and particularly strategic management, in which organizations evaluate various aspects of their processes in relation to best practice, usually within their own sector. This then allows organizations to develop plans on how to make improvements or adopt best practice, usually with the aim of increasing some aspect of performance. Benchmarking may be a one-off event, but is often treated as a continuous process in which organizations continually seek to challenge their practices.
- Difficulty identifying comparable arrangements
- High direct costs and resources to execute
- The potential to for conflict between the customer and service provider
Before including a benchmarking clause in your outsourcing contract, the first thing to give some serious thought to is whether data is readily available for comparison. Benchmarking large, complex technology environment and services is a good idea because there is such a large volume of data that is readily available for analysis and comparison. Complex business process outsourcing relationships are more difficult to benchmark because they are still relatively nascent and difficult to find comparables. Regardless, since costs in business process outsourcing contracts are normally concentrated in employee costs, why spend the money? Competitive intelligence on pricing is relatively easy to obtain. You may choose to buy it at a relatively small cost from an outsourcing advisory firm. They can give you all kinds of useful data of location desirability, including the cost of labor.
According to PWC (http://pwc.com/home/document.aspx?token=it_overview), benchmarking can help helps chief information officers (CIOs) and information technology (IT) managers examine 46 performance measures in 5 key areas:
1. Cost. Compare a series of cost measures beginning with the total cost of the IT function down to the cost of each IT user.
2. Staffing. Assess the optimization of staff, in addition to programs used to retain staff.
3. Structure and support. Understand the degree of centralization within the IT organization and determine user satisfaction.
4. Systems. Examine the usage of enterprise resource planning systems, as well as software utilization.
5. Control and security. Understand documented policies and procedures and methods used to safeguard data, compared with those of the benchmark group.
Conducting a cost/benefit analysis is an important step. A formal benchmarking exercise can cost $200,000. and you can spend about 2 months gathering the necessary data. The data is all about the quantifiable metrics in the environment and operations, not invoice-level data. and the whole study can take about 3 to 4 months to complete. This will influence your decision to move forward, and the frequency of benchmarking studies.
A best practice is to establish a process by which the benchmarking firm is selected, not limiting yourself by naming specific benchmarking firms in your contract. Most major outsourcing relationships have long terms, and this will provide flexibility as companies and their capabilities change of time. Also, it isn’t necessary to benchmark the whole relationship at once, especially if the relationship is large and complex. If you have built in this provision in your contract, you may prefer to benchmark one or more technology stacks each year instead.
The next step is to issue a short, crisp RFP that allows you to select a benchmarking firm that is mutually satisfactory. Ensure you select the firm on the basis of their methodology and access to data. Working with the service provider, choose the benchmarker together, and then work together closely. Make sure that you and your service provider both sign off on the input data before proceeding with the study. This will help you avoid disagreements with the outputs without slowing down the process. And once you’ve hired them, let the benchmarking firm do their job.
Benchmark studies are fact-based reports. One of the most important things to understand about benchmarking is that despite the fact that it is data driven this is not a perfect science. No two relationships are identical, and it may be difficult to find a statistically valid sample size. A good framework for the benchmark is to specify in your contract that the benchmark is the average of the best five performers (quality and price).
In the words on our expert, you have to be mature about the findings and how you address them. If benchmark pricing is within a 10% range, it isn’t likely that action should be taken. If the range is 10 – 15%, look at the findings carefully and be cognizant about the potential for imprecision in the study before advocating action. If the range is greater than 15%, it is likely a good foundation for a change in your pricing or contract terms.
The reason why company’s benchmark is to ensure that pricing remains competitive over time. Most benchmarking clauses include require the service provider to lower their price immediately if the benchmarking study shows they are over benchmark pricing. But is this the only solution? Or what if you can’t agree? Outsourcing relationships by their nature are symbiotic That means that benchmarking findings shouldn’t be used a stick. If the benchmark pricing means the service provider is not making any margin or even losing money, think about whether it is in your best interest to insist on a price reduction. The goal may not be to invoke a change in pricing, it may be to improve service performance, make changes to the environment, or a number of other improvements. Like any good “interests based” negotiation, there are usually many things to trade.
But if price reduction is your goal, circle all the way back to the beginning of the relationship. Good contracts make good relationships, just like good fences make good neighbours. Establishing a process by which to select the benchmarker keeps the customer and buyer in alignment. And the formal dispute resolution and cure process baked into the contract is there for a reason. One way to soften the blow of invoking a price reduction clause is to award new business to the outsourcer.
Like any other profession or interest, there are associations you can join to learn more. One such group is the Benchmarking Network Inc., which claims 140,000 members from a wide range of verticals, each with their own interests group. http://www.benchmarkingnetwork.com/
Benchmarking is a quickly evolving best practice. According to Robert Osborn Jr. in his article “The Strategy Alignment Model” (http://www.siteselection.com/issues/2002/may/p303/) ”Benchmarking should be used to achieve competitive advantage rather than to simply copy and catch up”. By effectively balancing the art and science, it’s a great tool in the outsourcing governance toolkit.
Linda Tuck Chapman is an outsourcing advisor with Ontala Performance Solutions Ltd. She can be reached at ontala@rogers.com