Benchmarking mechanisms in commercial agreements are intended to help customers to assess whether they are getting a good deal. But both suppliers and customers can sometimes end up feeling that the whole process is more trouble than it's worth. So how do you strike the right balance?
Benchmarking clauses typically allow a customer to instruct an independent third party to assess whether a supplier's prices and/or service levels are broadly consistent with those available from other suppliers in the market. This is every bit as difficult as it sounds.
For example, we toyed with calling this article "A better briefing on benchmarking than is customarily available from suppliers of equivalent services in the UK market". However, we concluded that, besides sounding a bit self-congratulatory, this would be pretty difficult to measure in any meaningful way. Finding other law firms to compare ourselves with would not be too hard, but we struggled to find many other briefings focussing purely on benchmarking – so what should the comparator be? Articles on contract drafting more generally? That seemed too wide. But how to narrow it down to an appropriate comparator?
This highlights one of the key objections to benchmarking, particularly from suppliers, who often complain that it's impossible to compare charges and service levels between different agreements entered into in different contexts. Meanwhile, customers often complain that, in part because of the need to involve an independent third party, benchmarking processes are too expensive and time-consuming to be of any practical value. That said, our experience is that if a benchmarking right is clearly expressed and carefully used, it can offer reassurance for both parties without doing lasting damage to their relationship.
In the remainder of this briefing, we look at why parties might choose benchmarking rather than alternative mechanisms for price review. We also discuss some of the key elements of an effective benchmarking process and negotiating priorities for the supplier and the customer.
In recent briefings, we have looked at other options for customers who want to ensure that they are getting a good deal on pricing, including:
Benchmarking can be used in addition to the above options, or on its own. Unlike a straightforward audit clause, a benchmarking process seeks to put prices and service levels in context. From a customer's perspective, it goes beyond the question of "is the supplier complying with the contract?" to address the question of "can I get a better deal elsewhere?". For a supplier who has given a general undertaking to minimise costs for the customer, benchmarking can give an independent, authoritative view on whether this is happening. This can be helpful in taking some of the heat out of pricing issues and maintaining a constructive long term relationship between the parties.
Benchmarking allows for slightly more refinement than a "most favoured nation" clause, recognising that pricing does not exist in isolation. In addition, as discussed in our earlier briefing, MFN clauses also come with their own challenges, in particular the practicality of enforcement and associated competition law risks. There is a temptation for customers to ensure suppliers' adherence with MFN clauses by talking to their competitors about what the same supplier is charging them. From a competition law perspective, this is extremely risky. By contrast, the appointment of an independent third party benchmarker should allow competitively sensitive information to be ringfenced, so the benchmarker can receive data from other market participants, then make a recommendation without passing that data on to either party. That said, it is important to ensure that your benchmarking process has been properly structured in line with relevant competition law guidance – see section 3 below.
Benchmarking is inherently more involved than either audit or MFN provisions, but that should also make it a more collaborative exercise. A well-drafted benchmarking clause will include opportunities for both parties to input on the identity of the benchmarker (or agreement of a pre-approved list), review the instructions to the benchmarker and comment on the benchmarker's findings. Of course, all these points need to be weighed against the downsides of benchmarking, particularly its cost and complexity compared with some of the alternatives. But, in our experience, there are situations in which it's worth giving it serious consideration, for example in the context of long-term, high value contracts where there is a recognition that prices and terms will need to change over time and a desire to minimise the risk of damage to the relationship from that process. From the customer's perspective, benchmarking may also be worth considering where:
Benchmarking rights are sometimes viewed by customers as a useful threat, rather than a right which they are realistically going to exercise – in which case, why get too bothered about the drafting? But a workable benchmarking process with some commercial teeth is more likely to get the supplier's attention. In addition, as explained above, it can support a more constructive discussion over changes to pricing which avoids doing lasting damage to the parties' relationship and helps to "keep the show on the road".
While customer and supplier may be aligned on aspects of the process, the key commercial points often prove more contentious. In particular, the following will be key considerations for both parties:
Benchmarking is only likely to be worth it in the context of a long-term, exclusive and high-value contract where a customer wants reassurance that it is still getting a good deal. Even so, neither party will want to go through benchmarking too often. The supplier might want to confine the right to certain "windows" so that it can plan for any disruption. A customer might resist this on the basis that a supplier can manipulate any benchmarked elements so they pass muster when the benchmarker comes calling, but could probably agree to (i) a maximum number of benchmarking exercises during the term and (ii) a minimum "bedding-in" period before the first benchmarking can happen.
In most cases, the initial focus is on pricing – the benchmarker will look around the market for contracts which they view as comparable and will consider how the charges compare. Service levels are then considered as a contextual factor, potentially justifying higher prices if the supplier can show that it is outperforming the market as a whole. Alternatively, a benchmarker may be asked to consider how the service levels which are being achieved stack up against those available from other suppliers. If this exercise shows that the supplier is under-performing against its comparators, it may trigger either an upward review of service levels or a downward review of price.
Benchmarking could cover the full range of prices and/or service levels under a contract; alternatively, it could focus just on those which a customer believes may be out of kilter with market practice. It makes sense for both parties to be able to restrict the scope (and therefore the cost) of the exercise, but the supplier will be particularly keen to ensure that the benchmarked elements are viewed in their proper context (see below).
For a benchmarking exercise to work, the parties need to agree what the benchmark looks like. The starting point is usually the median prices/service levels available in the market, but customers sometimes look for a higher standard – for example, reference to the top quartile for service levels if the supplier has promised (and/or is charging for) a premium product. A more challenging task can be to find other contracts, suppliers and customers which can provide a meaningful comparison. This will ultimately be for the benchmarker to decide, but allowances will inevitably have to be made for the bespoke nature of each contract. Which brings us to…
No two contracts are alike and any benchmarking exercise needs to recognise this. The benchmarker should be allowed to exercise their judgement when identifying contextual factors which might make the charges/service levels appear to be (or not to be) competitive, when in fact the opposite is true. We often also see tolerances built in to recognise the difficulty of making an exact comparison, perhaps allowing a margin of 5-10% before any consequences arise. High charges may reflect a genuinely market-leading service; conversely, low charges may drive below-average service levels. The overall scale and value of the contract and its legal terms – anything from liability caps to requirements for UK-based support – could also influence the view ultimately taken by the benchmarker.
The million-dollar question. Suppliers might get more comfortable about the scope and methodology of benchmarking if they have no contractual obligation to follow the benchmarker's recommendations. Customers will, understandably, push for automatic downward adjustments in pricing and/or better service levels to address any issues revealed by a benchmarking; they might be less receptive to an increase in fees (or dilution of service levels) if a supplier is found to be outperforming its comparators. An alternative approach would be for the parties to negotiate amendments to the contract, with termination rights if these cannot be agreed. At the very least, the results of a benchmarking exercise should be escalated for consideration by contract managers or senior executives, with any unresolved differences being subject to the agreed dispute resolution procedure.
In reality, even if the results are non-binding, it could be toxic for the commercial relationship if either party totally disregarded the benchmarker's findings. Renegotiation can work both ways, especially if the parties can agree on aspects of the original deal which can be streamlined to cut the supplier's costs or drive more efficient performance. Better for both parties to engage and find a way forward (or a way out) that works for everyone.
Finally, whilst benchmarking should pose fewer competition law risks than MFN clauses (and regulators recognise that it can lead to efficiency gains), it is important to ensure that the process is structured appropriately. For example, the data received from the independent third party benchmarker should be anonymised and it should not be possible for the parties to "reverse engineer" that data so as to identify individual competitors (which may be a risk in markets where there are relatively few players).
This is the eighth in a series of briefings about pricing and payment issues in commercial contracts. The previous seven briefings were:
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We have considerable experience of advising on pricing issues in commercial contracts across a wide range of sectors. We are also one of very few firms to be consistently ranked as one of the top tier advisers in the UK in this area.
