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Negotiating Benchmarking Clauses – Ten Tips for Customers

Posted in Contracting/Outsourcing
David Crane

Having previously examined the rationale behind benchmarking, the factors that can undermine its utility and the circumstances in which benchmarking can be used effectively, here are my top ten tips to keep in mind when negotiating a benchmarking clause:

  1. Benchmarking rights are not a substitute for good due diligence on deal terms, especially pricing. Customers should do their homework to get a reasonable level of comfort that the terms and conditions of their deal will remain sufficiently market competitive over the term. It is important to remember the best way to make sure a deal stays up-to-date is to have a short contractual term and regularly re-procure the services competitively.
  2. While benchmarkings tend to be pricing-focused, consider whether other terms should be benchmarked, such as service levels.
  3. Ensure there will be sufficient market data available for the agreed upon comparable pool.
  4. Ensure the vendor grants the benchmarker sufficient information access rights to be able to properly conduct the benchmarking. Confidentiality issues with respect to the vendor’s pricing can be addressed with solutions such as confidentiality agreements and anonymized data.
  5. Benchmarking is more of an art, than a science. It is difficult to draft and negotiate a benchmarking mechanism that results in the identification of truly comparable deals and produces a meaningful and fair result. One potential solution is for both parties to trust the professional judgment of the benchmarker by giving the benchmarker the discretion to determine comparators and make any necessary normalization adjustments. If this solution is relied upon, then selection of an appropriately qualified benchmarker that is acceptable to both parties is essential. Customers should also keep in mind that spending a lot of time negotiating a detailed benchmarking process may not be worthwhile since benchmarking rights are not often invoked and simply having a benchmark right may be sufficient as a lever to re-negotiate terms.
  6. As a customer, try negotiating an “auto-adjust” clause that has the contract price reduce automatically if the benchmarking report concludes that the existing price of the vendor is above market.  Perhaps this is coupled with a dead band floor (of 4-5%) and perhaps a cap, but in between, there would be an automatic adjustment.
  7. If the vendor refuses to agree to an auto-adjust clause or allow a third party benchmarker to adjust the deal terms based on a benchmarking outcome that concludes that the deal terms are uncompetitive, then consider using a process whereby the vendor proposes the adjustment to the deal based on the benchmarking outcome. If the customer does not agree with the vendor’s proposal, then the benchmarker acts as an arbitrator by selecting either the vendor’s proposal or an adjustment proposal provided by the customer based on which proposal best brings the deal in line with the market in manner consistent with the benchmarking methodology.
  8. Exit (termination) rights are another potential remedy that can be substituted for a pricing adjustment if a benchmarking concludes that a deal has become uncompetitive.
  9. To avoid creating an incentive for the benchmarking process to be delayed, consider including a provision that provides that any changes to the contract resulting from the benchmarking (in particular, pricing changes) will be retroactive to a specific date (e.g., a fixed period of time after the benchmarking is initiated).
  10. Agreeing to reasonable limits on contractual changes that may result from a benchmarking (e.g. providing that a pricing adjustment will never result in the vendor having to provide services at a loss) may be a way to get a vendor to agree to an automatic adjustment mechanism as part of a benchmarking clause.

While benchmarking rights are never a perfect solution to pricing and other market-related deal term concerns, the inclusion of a benchmarking clause will typically have sufficient value for a customer to be worth the effort of negotiating as part of any long term contract. Further, if carefully structured in a manner that sufficiently addresses both parties concerns, a benchmarking clause can be a valuable contractual tool to improve the relationship between the parties and help drive the parties towards continuous improvement and innovation, which is usually a win-win for both parties.

I would be interested in hearing about other people’s experiences with negotiating and exercising benchmarking rights.  Do any readers have any tips to share?