The technique described can, in principle, be applied to other outsourced services, although, here, its use is described with outsourced telecoms services.
What is benchmarking? Benchmarking in the context of outsourced services is the independent establishment of a fair market price for the provision of a prescribed set of outsourced services in accordance with the associated contract conditions. These can then be compared with the charges and services that are actually being supplied.
The benchmarking exercise will consider the customer's stated technical telecoms and other bespoke requirements, and establish whether the outsourced telecoms services, as provided by the supplier, correspond with what is being contracted for, and whether the charges for those telecoms services are in line with prevailing market conditions.
It is for this reason – maintenance of the supply's parity with prevailing conditions – that benchmarking is done periodically during the life-time of the contract, not just when it is due to be renegotiated.
To ensure impartiality, the benchmarking exercise should, ideally, be performed by a trusted third party, nominated by both parties to the outsource contract. These parties should also share the costs of the benchmarking exercise, which includes, but is not limited to, the charges of the third party.
The third party should be given access to the outsourced service requirements and to the outsource contract itself, although to avoid any possible bias, the contract charges should not be disclosed to the third party. The third party should bring to the table up-to-date telecoms knowledge concerning service offerings, technologies and tariffs, as well as experience in performing the benchmarking itself.
In principle, a benchmark review can be performed by parties who are either about to enter into a new outsource contract, or who are already well into the term of their existing contracts:
- Benchmarking of new contracts will provide guidelines regarding the contract terms regulating the freshly outsourced services
- Benchmarking of existing contracts will establish whether or not a customer is about to receive or is receiving value for money on its existing outsourced services.
To ensure that a fair market value is being paid for services received throughout the term of the contract, it is desirable that benchmarking is performed regularly. It is therefore becoming increasingly the norm for periodic benchmarking to be a condition of contract.
To derive a credible and reliable benchmark, it is necessary to know all of the salient features of the telecoms service being benchmarked. For example, it is vital to have knowledge of the specification of the telecoms service to be benchmarked, the performance levels required and the degree of contract management involved. On the other hand, little will be contributed to the benchmarking exercise if the terms of payment for the service (unless these are unusually generous or the charges are capitalised) or the method of contract dispute resolution are not known.
For the avoidance of doubt, the benchmarking discussed here is not just the simple comparison of tariffs or the like; rather, it concerns the derivation of a price for a complex set of services to be provided over a considerable period of time. Before proceeding with a benchmarking exercise, it is useful to ask whether all the material features of the service to be provided are sufficiently well known so that the service can be fully described. If this is not the case, then the results of the benchmarking will be open to question.
Benchmarking is not just the comparison of tariffs... it concerns the derivation of a price for a complex set of services to be provided over a considerable period of time
In fact, it will be prudent for the recipients of the results to verify that the party performing the benchmarking has fully understood and can actually write down the principles of the specification of the telecoms service being benchmarked, and the delineation between supplier and customer responsibility. Otherwise, the party performing the benchmark will have to rely on certain assumptions that may place the veracity of the benchmark process itself into question.
Since benchmarking can be a painstaking exercise lasting about 10-12 weeks, assuming no disputes arise, care must be taken to strike a balance between using too little and too much information. Using too little information will render the benchmark results unreliable, while using too much information will cause the cost of benchmarking to rise as more and more information – some potentially of doubtful contribution to the benchmarking exercise – is introduced.
In the case of benchmarking telecoms services, the following is normally the minimum information required:
- Service specification
- Levels of performance
- Charging method (but not the actual charges)
- Special treatment of charges, if any
- How technology refresh is handled
- Changes and how change is handled
- Term of the contract
- Contract and service management
- Any special or unusual requirements.
The detailed approach to benchmarking
To date we have used two approaches to benchmarking telecoms services.The first approach involves consideration of all the material and relevant contractual details of the telecoms outsource contract, with the view to modelling them and deriving the likely cost of all the components. The details are taken from the contract itself. Elements considered and priced are those falling into the categories listed above, except that the practice has been to include other items which are of secondary importance, such as:
- Design
- Risk of early contract termination
- Other risks such as off-net/on-net traffic patterns
- Credits and financial penalties
- Unusual support requirements.
While the inclusion of the above secondary items might be said to be fairer, as it does simulate the contract more closely, it may be unnecessarily cumbersome. It may also be considered unnecessary because most of the additional items listed above represent financial risks to the supplier which, if the service were to be properly managed, should be managed out of the contract.
A third objection to this approach is the possible artificiality of this benchmarking approach. While it provides a valuable service/price ratio guide, it may not reflect the supplier's pricing 'eagerness' in a real competitive tendering situation. Most probably the price would have been lower under competitive negotiations, and it is left to the benchmarker to estimate by how much the benchmarked price would have dropped.
A fourth objection to this approach is the benchmarker's lack of knowledge concerning volume discounts that are available to the service supplier and which would, under competitive situations, be passed on to the customer, in part at least. Information on these is unlikely to be shared. Thus, the resulting price/service ratio may be higher than it should be. A way out of this has been for the benchmarker to isolate elements that would attract hefty discounts and leave it either to the parties or to the benchmarker to assign/agree what proportion of the discount should be passed on.
The global approach to benchmarking
This dispenses with the use of most details of the contract and starts from the premise that any telecoms service comprises a 'materials' and a 'labour' component to which the supplier applies margins to cover risk, overhead and profit.
The assumption is that any supplier preparing to submit a tender for the provision of the service will first examine the service's specifications and, accordingly, determine what telecoms equipment (material) and staff are required to deliver that service. Having ascertained the basic costs required to deliver the service, the supplier will then increase those base costs by a given margin to ensure all overheads, risks and profits are covered. The benchmarking exercise, therefore, becomes one of determining the marginal increases on raw or base costs.
A distinct feature of this approach to benchmarking is that it relies on 'open book' costs to start off with. However, not all suppliers are prepared to reveal these. It has yet to be tested in the market place over a longer period, since it relies on the benchmarker knowing the range of margins which suppliers would normally apply to their base material and labour costs. These, in deference to tariffs and other telecoms charges, are not normally published.
One of the ways to ensure that proper price reviews take place at required milestones is to introduce a benchmarking clause into the outsource contract
Benchmarking exercises performed along these lines reveal that suppliers do not normally apply a margin to cover risk. The view is held that a properly controlled provision
of the service should eliminate the need for this margin and therefore reduce costs. The only pertinent margins were those covering overhead and profit, and these were normally combined into a single margin, which was then applied
in different magnitudes to materials and/or labour. This method of benchmarking overcomes some of the objections raised in connection with the first benchmarking method discussed above. It is not cumbersome and does not rely on the subjective selection of contract elements. It simply takes the supplier's base costs associated with the service delivery, and examines the values of the two or three uplift parameters. In the limit, benchmarking here could comprise the determination of the margins most appropriate for the service.
The problem of artificiality, the third objection raised with respect to the first benchmarking method, applies here too. The fourth objection, however, seems to have been overcome here, since any discounts will be visible, arguably only to an extent, when examining base costs and corresponding uplift parameters.
Making benchmarking happen
The prudent customer will insist on some form of regular price reviews during the tenure of the outsourced service. Furthermore, it is advisable to insist that a price review occurs at the end of the contract, if only to establish whether or not to continue with the current supplier. However, unless the method whereby this review will take place is properly legislated in the contract, it is unlikely to occur in any meaningful way.
One of the ways to ensure that proper price reviews take place at required milestones is to introduce a benchmarking clause into the telecoms outsource contract. Under such a clause, regular benchmarking by a third party is to be commissioned by the parties to the contract. The clause need not specify what benchmarking approach is to be used, since the art of benchmarking will evolve with time anyway.
However, it is important that the parties to the contract specify which components of the service are to be benchmarked, how the results of such benchmarking are to be used and what is to happen in the event that one of the parties fails to abide by its results. The contract should also specify which of the parties to the contract is responsible for obtaining the benchmark evaluation and paying for it.
It would be unfair for the customer to insist on benchmarking the cost of an early capital investment made by the supplier at the outset of the contract, even though the charge for this up-front investment by the supplier is being amortised in the charges levied over the lifetime of the contract. However, the running costs of a particular service, leased line charges and call charges are examples of what can and should be benchmarked in any event.
Care must also be taken when new services are added, to ensure that the parameters to be benchmarked with respect to those new services are added to the benchmark clause in the contract.
Source
The Facilities Business
