With the current pressure on companies to cut costs, though, "benchmarking agreements have evolved to be more useful," says Jenny McClennan, counsel for Shaw Pittman. Many specify the comparison pool up front, she says, and also spell out the process for renegotiations should the benchmarking turn up a material discrepancy in prices. In many cases, contracts say a customer must be given "most-favored customer" status, receiving the best prices that the outsourcer gives to any client. Adds Hall, "We've seen a number of cases where just the fact the client has indicated it's thinking of benchmarking will start the process of renegotiations." In one instance, he says, a large outsourcer even promised a major client rock-bottom rates if it would forgo its right to benchmark for the duration of the contract.
Companies, though, say getting a read on how their terms compare with the market is useful for a variety of reasons beyond pricing. Wilmington, Delaware-based DuPont, which is in its sixth year of a $4 billion joint outsourcing agreement with Computer Sciences Corp. and Accenture, says it plans to incorporate benchmarking data into all its renegotiations, given the success it recently had in using such data to tweak a networking-services contract with CSC.
After working with internal staff and external consultants to define the services it was getting and "minimize any uniqueness we might have," says director of technology integration Diane Strickler, DuPont told CSC that it would compare its bid to the market prices for the services.
The company generally benchmarks at least one segment of its outsourced functions per year, says Strickler, "but what was different this time was that we brought [the data] in up front rather than after the fact, which shortened the price negotiations by weeks, a considerable amount." The comparison data has been valuable for internal use as well. "You can assure the user community that you're getting a competitive price," she says. "And if there's noise of 'we could do it cheaper,' you can quiet it before it becomes an uproar."
Double-Edged Sword?
Benchmarking leads to renegotiated rates in about half the cases, say experts. One of the biggest limitations of the process is the difficulty of finding other companies with a similar package of services, and finding out their prices. That's just one of the reasons an outsourcer might use to argue for staying with the original terms. "It's very common for the Tier 1 and even some Tier 2 providers to have teams dedicated to responding to benchmarking," coming up with reasons why the price differentials don't merit a change, says Hall. "That puts the customer at somewhat of a disadvantage."
In some newer contracts, outsourcers actually have the option to raise prices if it turns out they're in the low end of the market. "It could be a double-edged sword — there's nothing that guarantees negotiations will always be in favor of the user," says Strickler. While that's not often done in practice, according to consultants, it could become a likelier prospect if vendors begin to suffer.
As companies press their advantages with vendors desperate for volume, some say the worries about the long-term health of the industry are not unfounded. Moody's has kept EDS on its credit-watch list, in part because it anticipates "there will be a tension to renegotiate, which could have adverse implications for forecasted financial results." Seen in that light, outsourcers may have to make tough business decisions — like walking away — to remain viable.
"Their challenge is to make sure they enter into good contracts and don't make dumb concessions," says CGE&Y's Pryor. "Certainly, it takes a lot of emotional fortitude to walk. But if you don't, it really calls into question your risk as a service provider."
Alix Nyberg is a staff writer at CFO.
Failure Is Not an Option
While the prospect of an outsourcing firm going into financial ruin is not a pleasant one, customers of WorldCom and others in Chapter 11 have found that it's not as bad as they might have thought. "Practically speaking, vendors are going to service customers until they no longer can," says David Hudanish, a partner at San Francisco-based Brobeck Phleger & Harrison LLP who specializes in outsourcing contracts. "They absolutely don't want to lose their customer base, or [failure] will become a self-fulfilling prophecy." Financially troubled outsourcers "definitely make [customers] uneasy," adds Dana Stiffler, an analyst with AMR Research, "but whether [customers] actually suffer a decline in the business's ability to operate is questionable."
That's a lesson that Farmington, Connecticut-based air-conditioner giant Carrier Corp., a United Technologies company, learned as Genuity floundered into bankruptcy. When Carrier engaged the hosting company in 1997 to run its business-to-business Web sites, which now process more than $10 million worth of transactions, it looked like a solid bet. Genuity was an offshoot of the more-established GTE Corp. and financially backed by GTE's acquirer, telecommunications giant Verizon. But after Verizon yanked some of its equity and Genuity's $1.15 billion borrowing privileges last July, things quickly went south for Genuity — sending its business into Chapter 11 and leaving its customers more than a little concerned.
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