Benchmarks Still Count: Keys to Effective Use of Contractual Measurement Clauses


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Benchmarks Still Count: Keys to Effective Use of Contractual Measurement Clauses

  1. 1. BENCHMARKS STILL COUNTKeys to Effective Use of Contractual Measurement ClausesBy Lawrence Kane, Sr. Leader, IT Infrastructure Strategy, Sourcing, and Asset ManagementExecution,
  2. 2. INTRODUCTIONRapid advances in technology, improvements in operating processes, andincreased competition are all driving declining market prices for IT services. Inthis environment, predicting the fair value of services to be provided in thefuture can be difficult. Options to ensure that prices for outsourced IT servicesremain competitive over time may include negotiating short-term contractsand frequently re-bidding, or negotiating long-term contracts andbenchmarking competitiveness of prices on a regular basis.Long-term contracts need to be structured to anticipate expected changes intechnologies and reflect expected efficiencies in forward pricing. Whilebenchmarks can address this need, many service providers today tell theircustomers that benchmarking clauses in outsourcing contracts have outlivedtheir usefulness. Benchmarks provide limited value, some say, creatingcontention, damaging the relationship, and distracting both parties frommore important business issues. Indeed, compared to five or seven years ago,relatively few contracts today include clauses specifically mandating periodicreviews of pricing and service quality.For many businesses, however, executing benchmark clauses that assesspricing in the context of competitive market standards remains an essentialfoundation of an effective outsourcing negotiation, contracting, andmanagement strategy. Many top-performing global businesses employbenchmarks as a core element of their operational philosophy, assuringcontinuous competitiveness of in-sourced and outsourced operations,leading-edge contracting practices, and ongoing operational efficiency.This ISG white paper, guest-authored by a senior IT leader at Boeing,examines how benchmark clauses can be applied to ensure competitiveness,drive continuous improvement, gain insight into performance drivers, andfacilitate a positive relationship between customer and service provider.BENCHMARKS STILL COUNT ■ LAWRENCE KANE 1
  3. 3. HIGH SUCCESS RATEA pioneer in the use of comparative analysis, Boeing first For some organizations and in certain situations, theemployed benchmark reviews of IT outsourcing contracts “soft” approach has proven to be effective. Organizationsmore than a dozen years ago. The fundamental objective have had success using the “soft” approach to help framewas—and remains—to ensure and maintain the their negotiating position, most often when going into acompetitiveness of outsourced services over the life of a sourcing new activity, or renegotiating at the end of ancontract term. Given the dynamic nature of technology existing agreement. Enterprises value insight thatinnovation and market trends, Boeing recognized that an benchmarking of (potential) sourced services canagreement that was competitive on day one could provide, compared to a simple current cost to marketquickly fall out of alignment with rapidly changing market price comparison. Often this type of softer approach canstandards. Periodic and rigorous benchmark reviews be viewed as a “proxy bid.”were therefore considered the most effective way to For many, however, clearly defined, binding andvalidate and, if needed, adjust pricing, service levels, or actionable terms are imperative to a successfulcontract Terms and Conditions over time. By enabling benchmark initiative. In Boeing’s view, undertaking aadjustments, benchmarks were also seen as way to keep benchmark process that does not result in specificrelationships on track and avoid contentious consequences essentially defeats the purpose of therenegotiations or costly and time-consuming re- initiative. While some argue that a binding benchmarkcompetitions. clause is likely to produce contention between the twoSince 1999, Boeing has conducted dozens of benchmark parties, Boeing has found that clearly defined terms can,reviews of IT infrastructure outsourcing, business process in fact, facilitate long-term relationships.outsourcing, and IT application outsourcing contracts. In By structuring contract negotiations to includethe majority of instances, the analyses resulted in benchmarking milestones, service providers competingcontractual price reductions, cost reductions through for Boeing’s business know the rules of the gameinternal process improvements, and/or implementation entering the agreement. While a benchmark analysisof improved practices. Even after benchmarking each might consume time and resources, both parties benefitservice area in eighteen month to two-year intervals for when independently vetted data either confirmsover a decade, recent studies have yielded approximately competitiveness or points to specific changes that musta 5 : 1 return in direct cost savings, with indirect benefits be made. Without these studies, it is challenging to pen a(e.g., improved Service Level Agreements, industry long-term contract with any assurance that IT canleading practices) far exceeding that. demonstrate a commitment to competitiveness for itsBeyond quantitative benefits, the benchmarking process customers.inspires confidence by validating how services are being Moreover, an effective service provider can use thedelivered in a comparative context using an independent benchmark results to demonstrate the value they deliver,third-party benchmarker. In addition, this analysis not just from a pricing standpoint, but in terms ofprovides a valuable reality check that assesses additional benefits around service quality and processcontractual Terms and Conditions against the day-to-day improvement. For example, while Boeing and the servicereal life of the environment – a perspective that can provider typically share a benchmarker’s fees, someinform additional improvement both from the service suppliers have voluntarily paid the entire cost of a studyprovider and within the customer organization. in order to provide facts and data that could lead to a renegotiation rather than re-competition at expiration ofBENCHMARK STRATEGIES their contract. Such decisions are by no means guaranteed, but this behavior not only demonstratesOrganizations take a variety of approaches when goodwill but also faith in the benchmarking process andemploying benchmark clauses. One consideration is credibility of the results.whether to use the benchmark findings as a non-bindingguide or to make the analysis results “actionable.” In the When benchmarking is characterized by a stringentformer the findings form a basis for further negotiation process that assures participants their competitivenesswhereas in the latter the service provider is contractually will be fairly evaluated, when it yields actionable results,obligated to adjust pricing anomalies revealed during theprocess.BENCHMARKS STILL COUNT ■ LAWRENCE KANE 2
  4. 4. and when all parties share a willingness to use the data high degrees of process discipline along with thefor decision-making, the exercise can be much more than contractual freedom to implement their tools and/ora “stick” wielded by the client. Rather, it has the best practices, but can pose risks for both the buyer andpotential to become a win/win proposition that delivers seller. From a buyer’s perspective pricing might be front-inherent value for both parties. loaded, asynchronous with the marketplace, or simply not competitive. On the seller’s side, profitability could be at risk if the projected rate of improvements is overlyHOLISTIC VS. GRANULAR optimistic or the state of the current environmentAnother consideration in implementing a benchmark insufficiently known.clause is determining the appropriate level of detail to A “step-down” pricing approach, while complementarypursue. Some organizations favor a high-level analysis to a benchmarking program, has not proven to be anthat presents a general overview of the environment. adequate substitute. Without the fact-based analysis of aWhile this approach is relatively inexpensive and benchmark, providers can artificially inflate pricing inoftentimes easier to implement, it typically offers little year one in order to show a decline over time. Moreover,insight into where performance issues lie, in part the step-down pricing can be a numbers game, and evenbecause ensuring apples-to-apples comparisons where when suppliers can predict realistic savings, a benchmarkall complexity factors have been accounted for presents is still needed to quantify improvements and assessa challenge, but largely because aggregated data tends to those improvements against the market. Similarly “mostmask underlying problems. The value of such studies, favored pricing” clauses which assure competitive servicetherefore, lies less in stand-alone results and more in offerings are also a good supplement, but only reflect theidentifying areas to look and “firing orders” for doing so. service provider’s comparison with itself, rather thanThe alternative is a more detailed and rigorous— and with the entire marketplace for like services and servicemore costly and time-consuming—analysis that drills levels.down to identify specific anomalies and root causes ofperformance issues at a granular level. This perspective IMPLEMENTING IMPROVEMENTSenables an organization to not only understand what’scausing problems but to formulate specific and The implementation approach must be considered earlyappropriate corrective action. Importantly, while an in the procurement process, so that selected suppliersoverall service offering might be competitive, at the know what kind of deal they are getting into. This affectsgranular level areas for improvement are almost always how the service provider implements the changesfound when the proverbial onion is peeled back. needed in order to achieve improvements mandated by the analysis.For Boeing, the investment a detailed analysis requireshas yielded significant dividends. As a defense In cases of most “utility” IT services, pricing tends to becontractor, the company must demonstrate pricing paramount and customers are relatively unconcernedtransparency and assure government auditors that rates about the “how” of service delivery. So long as servicepaid to service providers are market-competitive. level requirements are met, the provider has significantFurthermore, a granular approach avoids the trap of leeway to manage the supply. In the majority of suchbundling, whereby highly efficient services subsidize low instances automatic, oftentimes retroactive priceperformers. In cases where technology or process adjustments are an appropriate contractual mechanisminvestments are needed to reduce risk, improve for implementing the benchmark results.productivity, or meet service expectations a benchmark While it’s all about price for utility services, not all dealscan oftentimes help justify any additional expenses. fall into this category. In some cases the relationship between customer and supplier is more transformative,ANNUAL BUILD-DOWN perhaps even a true partnership. In such instances, risk and market-competitive pricing must be balanced alongAs an alternative to regular benchmarks, some with other factors such as innovation and time-to-marketorganizations opt to incorporate an annual mechanism to ensure that the “shared destiny” of the two parties isthat automatically adjusts pricing to reflect ongoing not adversely affected. A more complex benchmarkchanges in the market, typically building a pre-defined clause may be appropriate here.year-over-year reduction percentage into the contract.This model can be effective when services suppliers haveBENCHMARKS STILL COUNT ■ LAWRENCE KANE 3
  5. 5. BENCHMARKS AND MULTI-SOURCING organization being analyzed. Benchmarking consultants must have superb communication skills and experienceWhile benchmarks may have grown out of traditional in dealing with customer employees whose jobs may besingle-source solutions, they are even more important in affected and supplier employees whose profitabilitymulti-sourced arrangements, whether multiple providers might be impacted as a consequence of the benchmarkplay in any technology or service area or not. While a results.multi-vendor approach is oftentimes ideal for leveragingthe unique capabilities of various providers, it also tends While the benchmarker can run the entire process,to raise retained governance costs for contract Boeing has found that the best results are achieved whenmanagement, integration, and oversight. In such a dedicated, autonomous benchmark “core team” leadsinstances, benchmark analysis results can demonstrate the activity as a primary interface with the benchmarker,not only competitiveness of individual suppliers, but also with customer and supplier service delivery expertsthe effectiveness of the entire governance model gathering the data. Up front planning and(assuming the customer’s retained organization is part of communication is essential.the analysis).Multi-sourcing governance assessment plays a key role in CONCLUSIONensuring not only delivery of services within the context In a successful benchmark, both customer and supplierof the in-scope agreement, but may also highlight agree that the results are accurate and fair, even if theyweaknesses across an organization’s many sourced do not like them. Customer and supplier executives,relationships. Hand-off of Change, Incident and other IT management, and employees have a good understandingInfrastructure Library (ITIL) processes are critical, often of the benchmarking project and process, which isthe cause of real or perceived weaknesses by the end- performed with transparency and proactivecustomer in service delivery. Benchmarking can often communication throughout. Results are actionable andhighlight where the initial negotiation may have implemented as planned. In this fashion, the projectweakened critical process interaction. virtually always has a positive impact on the relationship between customer and supplier.HIRING AN EFFECTIVE BENCHMARKER Benchmarking has proven to be an effectiveBenchmarking is clearly a good thing, but only if management tool for many global organizations, andimplemented “correctly.” Vital to implementation is a central to a culture of continuous improvement. Even asbenchmark service provider with a proven methodology, organizations that benchmark over the long termstrong process discipline, robust database of comparable experience some diminishing returns in terms of hardpeers and skilled consultants who can interpret the savings, the insights gained in terms of soft savings,findings. An independent benchmarking consultant process improvement and supplier management remainmaintains objectivity and integrity of the results, assures significant.the use of proven techniques and tools, and providesaccess to industry data for comparable companies.Transparency is paramount. While benchmarks maycommonly be performed without involvement of theservice provider, the process of collecting, validating, andnormalizing data should involve all parties. Thistransparency facilitates a sense of fairness andobjectivity, and helps assure that accurate data was usedfor the analysis and that all parties will agree with theresults (even if they do not like them).Benchmarking is mostly a science, but partially an art,particularly when normalizations or adjustments areappropriate. A benchmark team must engender trust.The right personnel will have knowledge, skills,experience, and a proven ability to achieve actionableresults for organizations that are comparable to theBENCHMARKS STILL COUNT ■ LAWRENCE KANE 4
  6. 6. LOOKING FOR A STRATEGIC PARTNER?Lawrence Kane is Sr. Leader, IT Infrastructure Strategy, Sourcing, and Asset Management Execution at Boeing. Lawrencehelped develop and execute the IT infrastructure competitiveness strategy in 1999, of which benchmarking was a keycomponent. Having completed more than sixty studies using a variety of benchmarkers since the program’s inception, hehas acquired vital data that helped shape the company’s sourcing strategy, save hundreds of millions of dollars, andimprove quality and service delivery. He is currently responsible for IT infrastructure strategy, sourcing, and assetmanagement execution at Boeing.John Lytle, a Director with ISG, contributed to this report.For further information, please contact Alex Kozlov, Director of Marketing, Americas, at alex.kozlov@isg-one.comor +1 617 558 3377Information Services Group (ISG) (NASDAQ: III) is a leading technology insights, market intelligence and advisory servicescompany, serving more than 500 clients around the world to help them achieve operational excellence. ISG supports private andpublic sector organizations to transform and optimize their operational environments through research, benchmarking, consultingand managed services, with a focus on information technology, business process transformation, program management servicesand enterprise resource planning. Clients look to ISG for unique insights and innovative solutions for leveraging technology, thedeepest data source in the industry, and more than five decades of experience of global leadership in information and advisoryservices. Based in Stamford, Conn., the company has more than 800 employees and operates in 21 countries. For additionalinformation, visit 011113 © Copyright 2013 Information Services Group – All Rights Reserved