Q&A: Ole Horsfeldt, ITechLaw Association
Ole Horsfeldt is a partner with Copenhagen-based law firm Gorrissen Federspiel, and a board-level director of the ITechLaw Association, a non-profit organisation “established to inform and educate lawyers about the unique legal issues arising from the evolution, production, marketing, acquisition and use of information and communications technology”. Ole recently authored a groundbreaking survey into benchmarking in IT outsourcing; we spoke with him about his findings and the ramifications for the IT sourcing space in Europe and the US…
Outsource: Ole, you’ve just published some research for ITechLaw on benchmarking terms in IT outsourcing agreements. Let’s take a look at this in some detail. Firstly, what was the intention of the study and how broad was its scope?
Ole Horsfeldt: The intention was to document global commercial and contractual practices with respect to benchmarking. Benchmarking is a key driver in major outsourcing agreements for securing long-term competitive pricing. However, in the past benchmarking has proven expensive and ineffective, and we wanted to identify current global best practices.
The study covered Europe and North America and dealt solely with large-scale complex IT infrastructure outsourcing.
O: One of your findings is that pretty much every outsourcing deal now contains benchmarking provisions. Can you comment on this – and give your thoughts on whether companies are making the most of these opportunities?
OH: This finding was no surprise. But the contents of benchmarking clauses vary significantly, and the effectiveness of a benchmarking option depends on a few key items, such as the right to require benchmarking of unit prices and automatic adjustment of unit prices (as opposed to benchmarking of total costs or service tower costs and having merely a renegotiation right rather than simply requiring automatic adjustment).
The reality is that few companies actually will do a benchmarking, but having a strong benchmarking clause is a key lever for renegotiation of prices and delivery methodology. If you ask me: do companies spend enough time and effort renegotiating, the answer is a clear “No”. Companies tend to see a contract term as a fixed term and any renegotiation will take place at the end of the term. Vendors see things quite differently – they would rather renegotiate every second year or so in order to offer better terms against additional years (and revenue).
Companies are simply not exploiting these opportunities to the extent possible. It requires that you be in constant “renegotiation mode” and most companies – even very large ones – do not have resources to optimise in this manner.
O: How does benchmarking vary from country to country? Does best practice differ significantly by geography?
OH: There are some differences but not big ones. Essentially, IT infrastructure outsourcing is a global business, and the commercial and contractual practices basically follow the same model in all but the most immature markets.
O: Your study found that benchmarking can cost up to €400,000 and take up to six months to complete. Is there any sign that this cost and effort is being – or even can be – reduced at a time when companies are extremely focused on the bottom line?
OH: Absolutely. The model for reducing costs to about a third is called “fast track benchmarking”. This methodology requires that a detailed profile of the services to be benchmarked is developed as part of the outsourcing contract and that all assumptions and normalisation factors are identified and resolved. This means that the benchmarker’s work associated with so-called “data-extraction” and “normalisation” is minimised. This in turn leads to a benchmarking process of approximately 100 days and significantly lower benchmarking costs.
O: What are the respective roles of the supplier and the provider when it comes to benchmarking and how tightly are these roles usually defined contractually?
OH: Their roles are not tightly defined and do not need to be. Vendors will basically want to be able to influence the result of a benchmarking as much as possible by having the benchmarking consult with the parties and by claiming the circumstances and assumptions particular to the contract at hand differ from general practices and make the contract much more expensive to perform.
Both parties have an interest in as much transparency in the benchmarking as possible, in particular in respect to normalisations, but the customer will want to make sure that no circumstances or assumptions not specifically identified in the benchmarking provisions can be introduced by the vendor.
O: How do companies actually use benchmarking results once the activity is completed – do outsourcing agreements tend to change dramatically as a result?
OH: As I said, the reality is that there are few benchmarkings conducted compared to the number of outsourcing contracts with benchmarking clauses. But renegotiations based on strong benchmarking levers do lead to dramatic savings in the range of 20-40% of yearly costs. Having said that, all renegotiations include a large number of commercial aspects, such as changes to delivery methodology, introduction of offshoring, prolongation of the term, which all contribute to achieving significant savings.