The Great Inflatable Service Bill

In December, PricewaterhouseCoopers LLP settled charges that it had overbilled clients by hundreds of millions of dollars by not passing on rebates received from travel agencies (class-action suits against KPMG and Ernst & Young are still pending). The new year brought the indictment of executives at ad agency Ogilvy & Mather, which is charged with instructing employees to falsify time sheets for work done on a U.S. government account. And then there are the charges swirling around Halliburton, including the allegation that one of the firm's food-service subcontractors vastly overcharged for meals provided to U.S. soldiers in Iraq.

One thing is certain—companies spend a great deal on services. According to CAPS Research, an organization that tracks corporate purchasing, the average company devotes 33 percent of its total spending to services, a broad category that ranges from legal and consulting advice to process outsourcing. The number can vary widely—for financial-services firms, such spending can exceed 80 percent of the total. And although companies cut many forms of spending during the downturn, services spending has continued to rise an average of 3.5 percent annually.

Fraud or Foolishness?
Although it grabs headlines, outright fraud appears to be relatively rare. More common, say experts, are simple carelessness and poor recordkeeping on the part of many service providers. "Overcharges happen all the time, but it's rarely intentional," says Stephen Broderick, chief operating officer at FirmDecisions, a London-based company that conducts audits of ad-agency compliance with client contracts. "It's because [the agency] doesn't have the systems to track [costs], doesn't understand the agreement with the client, or is so busy looking ahead to the next year that the housekeeping is not really taken care of." The recession has made matters worse as firms reduce back-office staff, including the finance professionals who handle billing.

To be sure, the errors—intentional or not—can be costly. Broderick cites a recent audit that revealed that an ad agency mistakenly billed a client $84,000 for 12 hours of secretarial work. In another example, a law firm's partners were found to be charging all of their meals and transportation costs to a client, regardless of the time actually spent on the client's work, according to Judie Bronsther, president of New York-based Accountability Services Inc., a company that provides advice on legal bills.

Companies can also fall victim to the pressure some professionals feel to extract additional business from clients. According to Tom Rodenhauser, president of Consulting Information Services LLC, in Keene, New Hampshire, one common tactic of management consultants is to come in for one project and use the opportunity to identify additional, expensive problems. "The challenge is for the client to keep the contract tight enough that the provider can't navigate its way around the contract to get more business," says Rodenhauser.

The Problem with Services
Overbilling can often be caught through an audit or prevented in the first place by developing a detailed billing policy (see "Grilling Your Lawyer," at the end of this article). But what about the self-perpetuating consulting engagement (which most consultants would argue is a legitimate way of sustaining their business)? Or services for which a company is unknowingly paying above-market rates? Or services that may be unnecessary in the first place?

The answer, according to procurement professionals, is to apply the same rigor to buying services that many companies do to purchasing physical goods. Today, most big companies have centralized the procurement of supplies and use the company's aggregate buying power to obtain lower prices from suppliers.

Spending on services isn't controlled nearly as well. One reason is that it's hard to put a value on advice. Unlike when buying paper clips or personal computers, it's inadvisable to merely specify a quantity for a service and shop around for the best price. And because quality can vary dramatically from provider to provider, unit cost­such as an hourly rate­is relatively unimportant. Second, service contracts are usually complex. A project may have many components and intricate pricing—for example, payments linked to milestones and various contingencies (such as on-time performance). According to Pierre Mitchell of Boston-based AMR Research, all of this can be hard to capture cleanly in an E-procurement system, meaning that such spending is often left out entirely. This in turn ensures that supplier contract management remains fragmented at many companies.

There is also the way companies account for these costs. Money spent on materials used in manufacturing affects a business's cost of sales directly. Saving 10 percent on these purchases yields an immediate improvement in the bottom line. By contrast, services are budgetary. If there is $5,000 in the budget for advertising, a manager will probably spend the full amount­if not out of need, then out of fear that not spending it will mean losing it in next year's budget. For the same reason, securing a better rate for advertising may just encourage the manager to use more.

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