Part I: Benchmarking sourcing contracts

Benchmarking is quite a hotly discussed topic in the sourcing industry, so perhaps it is timely to look at it firstly from a historical perspective, and later from a 'where-to-from-here' perspective.

Historically, benchmarking started in its early days in contracts as one means to realign contract pricing with significant market pricing shifts. Where such contracts were well designed, they already had numerous mechanisms for normal changes to contract prices including year-on-year productivity adjustments, inflation adjustments and defined pricing for changes in required service volumes. They also included a range of tools for maintaining price competitive, including reasonable termination for convenience fees insourcing and/or competitive re-sourcing rights.

As such, the intent to use benchmarking to address macro-level price adjustments was aligned with its structural place within the contract, and therefore benchmarking was used somewhat infrequently in such contracts.

As time passed,

• clients were sometimes less rigorous in establishing appropriate mechanisms for normal changes to contract prices, as well as the other well-established tools; and
• suppliers, because they had seldom seen benchmark clauses invoked, started to advise their customers that they've always got benchmarking to rely on if the suppliers' prices get out of sync with the marketplace, and put less energy into establishing the normal contract price change mechanisms and tools.

This interesting dynamic led to a significant shift in the positioning and, therefore, usage of benchmark clauses. As clients had fewer normal mechanisms to rely on for changes to contract prices, they were forced to try to use benchmark clauses to drive micro-level price adjustments. For example, this author has seen a number of contracts where the only contract price adjustment mechanism is the result of a benchmark.

As the reliance on benchmarking increased, many in the industry lost sight of its original purpose and positioning and other key issues because self-fulfilling was somewhat destructive, where:

• Increased reliance by clients on such clauses meant they worked harder on drafting them to guarantee price changes;
• Increased nervousness by suppliers meant they pushed harder back on prescriptive clauses resulting in extra tension even before an agreement was reached; and
• An entire industry developed, one that is constantly trying to figure out the best way to draft and then execute enforceable clauses that could drive normal changes to contract prices.

The result is that today we have a marketplace where both clients and suppliers are not fully satisfied with the effectiveness of benchmarking.

Next time, we'll look at where we should go from here.

Catch the second part of Michael Rehkopf's perspective on benchmarking here.