By Bob Mathers

Executives charged with managing sourcing relationships face the challenge of ensuring cost efficiency and at the same time addressing business requirements.  Key questions include: How do we know existing pricing is competitive? Should we outsource, repatriate, or keep services in-house? What are the long-term implications of our current sourcing strategy?

Increasingly, businesses are turning to “proxy bid” initiatives to address these questions. A proxy bid is an analysis – conducted by an independent third party – that compares the actual price an organization pays for particular set of services against the prevailing market price of a comparable set of services. In addition to providing a market-based context for sourcing decisions, the proxy bid can define alternative scenarios by modelling the financial implications of various sourcing options.  Moreover, proxy bids are significantly faster and less expensive than alternative methods of pricing analysis.

Proxy Bid Scenarios

In a sense, a proxy bid represents what the independent third party or benchmarker would “bid” to provide the services – if the benchmarker were in the outsourcing business. While independent benchmarking firms are not in the outsourcing business, they do have access to extensive data on service costs and pricing, and in many cases have extensive insight into client operations and processes.  As a result, they can provide an objective and realistic analysis that can facilitate effective decision-making in a variety of sourcing scenarios.   

At a basic level, proxy bids can provide a stake in the ground for client organizations that simply “don’t know what they don’t know” about their services, and assess whether prices are in synch with the market.  Based on the findings of a proxy analysis, they can decide whether or not to proceed with outsourcing, repatriation, or a formal benchmark of the incumbent service provider.

More specifically, a company receiving RFP responses from multiple service providers can use a proxy bid to assess the competitiveness and market viability of vendor proposals. This can be a critical benefit, allowing client organizations to identify vendors seeking to win business simply through deliberate underbidding (ultimately a losing strategy for all parties), as well as those whose bids reflect lack of preparation or inadequate understanding of the client’s requirements.

Service providers, meanwhile, can use proxy bids to determine whether an RFP response is competitive and in line with established market rates, and to test the viability and potential profitability of a new or existing customer.

State of the Clause

Proxy bids are perhaps most often applied as an alternative to formal benchmark reviews of outsourcing contracts.  Outsourcing agreements typically contain clauses mandating periodic benchmark rate reviews.  These initiatives are designed to gauge existing prices and service levels against market standards, as well as to provide a broader context for the client and service provider to assess business objectives and improve the sourcing relationship.

While often effective, exercising a formal benchmark clause isn’t always feasible or applicable, and in certain situations, even represents an obstacle to communication between stakeholders. In these instances, a proxy bid can be a viable alternative. The primary difference between a proxy bid and a contractually mandated benchmark review is that the service provider is not involved in the proxy analysis. (That said, the lack of vendor involvement in the analysis does compromise the accuracy of the proxy analysis to some extent.) 

The specific role and utility of a proxy bid in a benchmarking scenario varies according to the terms of the contract’s benchmarking clause.  Some clauses mandate price adjustments based on the benchmark results, placing the customer in a strong position when the formal benchmark is complete.  A proxy bid can still be effective in these cases, by giving the client leverage to implement improvements in exchange for not triggering the formal benchmark. If, however, a client organization is confident that significant price gaps exist, and if the existing contract is clear in requiring changes based on benchmark results, then the formal benchmark proceedings should be initiated; in this instance, the proxy bid would be superfluous.

Other benchmark clauses state that the analysis will simply guide further discussion and negotiation.  For the most part, these types of clauses are most effective if a positive client/vendor relationship exists, or if the customer seeks assurance that pricing is at least marginally in line with market standards.  Here, a proxy bid can establish some pricing targets to use in negotiation, thereby bypassing the formal benchmark while still providing a stake in the ground for discussions. In other words, the end result is similar to that of the formal benchmark.

State of the Relationship

The service provider’s attitude to benchmarking also affects how proxy bids are employed, as does the state of the client/vendor relationship. Due to the basic fact that benchmark analyses can potentially threaten a service provider’s revenue stream, some vendors engage in various tactics to challenge, delay, or derail the benchmarking process. 

Considered in this context, proxy bids can be a viable alternative to the adversarial confrontations and intransigence that can characterize formal benchmarks. Proxies can be especially appealing if the client/vendor relationship is already tense, or if past experiences with formal benchmarks have been unsatisfactory.  Conversely, in a positive relationship, a proxy can allow a business to gauge performance without potentially disrupting the existing harmony through a formal benchmark.

Faster, Cheaper

A proxy bid takes less time and costs less to perform than a formal benchmark. A key factor is the absence of a need for arbitration to ensure agreement on measures and standards of comparison.  Rather, the process focuses on analyzing available data and information and delivering the results. Formal benchmarks also require the vendor to utilize operational staff to provide data and participate in interviews, which may be a burden to already-busy personnel.

As a result, a proxy bid can be conducted in 50 percent to 80 percent of the time required for a formal benchmark, with a corresponding reduction in cost, e.g., 20 percent to 50 percent less expensive.

Summary

A proxy bid can be an effective way to cost-effectively analyze the pricing of a discrete set of processes or services. 

Versatility is a key benefit – a proxy bid can be applied to a wide range of scenarios, either as a pre-sourcing tool to define options and evaluate proposals, or as part of an end-of-contract initiative to gauge existing services and consider next steps.

Increasingly, top-performing organizations are incorporating proxy bids into their toolkit of sourcing management capabilities.

Bob Mathers is a Principal Consultant with Compass Management Consulting (www.compassmc.com), a global firm specializing in business and IT operational improvement.  Contact facts@compassmc.com for more information.