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Benchmarking clauses in IT outsourcing contracts important

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IT outsourcing has become common practice in organisations looking to reduce costs, increase capacity and gain access to skills that they may not have in-house.

However, the reality is that a large proportion of IT outsourcing contracts fail to deliver the expected benefits, and organisations end up terminating contracts early, renegotiating during the contract term or repatriating services to bring them back within the company. This is according to Allan Dickson, consultant at Compass Management Consultants.
Outsourcing does not necessarily reduce costs or deliver on the expected benefits, and the outsourcing contract is of the utmost importance in ensuring a greater likelihood that this will happen. And the complexity of the outsourcing contract requires certain clauses to be put into place at the outset, to protect organisations and ensure they receive the desired value from the outsourced service.
One of the clauses organisations can imbed into an outsourcing contract is a benchmarking clause, which measures the levels of services and their associated costs at agreed-upon intervals throughout the contract term.
The benchmarking clause is a useful contracting tool when used in the right context, as a mechanism to fairly address major shifts in market pricing over long-term agreements and as a check against price "drift" over time.
Price drift refers to the tendency for technology prices to become increasingly lower over time, and often what happens in outsourcing contracts is that there is no mechanism in place to account for this, so
what may have been a good price at the beginning of the contract might end up being fairly expensive a few years down the line.
A benchmarking clause measures the differences between contract pricing and prevailing market pricing to ensure that the customer's pricing remains competitive throughout, and is essential in longer term contracts – those of five years or more in duration.
The benchmarking clause itself has several elements that should be covered in the outsourcing agreement. Firstly, the benchmarking frequency should be considered; the freedom to benchmark too freely, widely or frequently should be weighed against the actual value this will bring to the business.
Next, the benchmark qualifications should be considered; in other words, the criteria that benchmarkers need to meet before they can perform a formal benchmark, such as independence, proven methodology and proven access to relevant data.
The benchmarking process also needs to be defined at the outset, taking into account what the benchmarker is actually able to perform.
Finally, the results of the benchmark should also be considered, and key areas to cover include setting a reasonable threshold supported by the limits of data; when determining that a discrepancy between benchmarking and contract pricing should trigger a change, basing the decision on what the data can realistically support; and setting a reasonable maximum limit on how much a service provider's price should change in the event of a discrepancy.
When it comes to the actual benchmarking process, there are often several models available for both cost and price benchmarking, including IT service models with a customer interface for capturing and aligning service and quality data and an IT functional model which focuses on cost oriented and functional processes for cost data and evaluation of differences.
The data gained from a benchmark can provide valuable guidance in the development and implementation of the IT strategy, and there are a wide range of benchmark initiatives available to meet client objectives, such as an initial baseline of the IT organisation, quantitative support of an IT cost reduction programme, building the business case for sourcing decisions, in depth performance analysis of an IT function or service, validation of IT charges to the business stakeholders, and evaluation of a consolidation or transformation programme.
The benchmark itself, while an important part of any IT outsourcing contract, is only the tip of the iceberg so to speak, as the benefits of conducting such an exercise extend well outside the contract space.
Benchmarking can be used to justify the time and money spent on IT to the board and business stakeholders using an independent, impartial outside view and factual data that demonstrates the value of the IT contribution to the business. This is also important for compliance and regulatory guidelines such as King III, which require a business to be able to demonstrate the value of IT spend and sustainability.
Benchmarking data can also be used to measure performance against KPIs and can be a tool for sustainable performance improvement.
While many organisations see benchmarking as an unnecessary expense, in today's world where the performance of an IT organisation is directly linked to the performance and profitability of the business as a whole, the long-term cost of not conducting such an exercise can in fact outweigh the initial expense required.