by Marcel Bryar

How NOT to use benchmark data in vendor negotiations

Sep 23, 2015
IT Strategy

Who wouldn't want benchmark data on their vendor's pricing and other contract terms? It provides insight into and leverage over the vendor. But, when negotiating, don't settle for the benchmark. More often than not, benchmark data is only a useful milestone on the path to even greater savings and vendor accountability.

Benchmarks drive our purchasing decisions, personal and business. 

We look at recent home sales when we’re trying to see if we’re paying too much for a house; we use pricing data to figure out if we’re getting a good deal on a used car; and, many companies leverage benchmark data in vendor negotiations, including data on software license fees, discounts on hardware and usage rates for telecommunication services.

The data is helpful in vendor negotiations.  It begins to level the information asymmetry between buyers and sellers.  Normally, vendors have perfect information regarding their own pricing and terms while customers, particularly new ones, have none.  The data gives customers a principled basis for challenging exorbitant vendor pricing and unreasonable terms.

But benchmarks should not be the yardstick by which we measure success in contracting with vendors.  It is tempting to put all of our faith in them.  They provide a sense of comforting certainty in otherwise dynamic and chaotic markets.  When we settle into that comfort zone, however, we leave tremendous value on the table.

Benchmarks do not represent markets

The price and terms of each deal are a function of what two people – the customer and the vendor – are willing to agree on.  A benchmark represents the prices and terms other customers – not the one using the data – have agreed on and it is always based on old deals.  If you settle on a benchmark as your goal, you are surrendering your ability to do better.

And you should be able to do better.  In 1936, an aeronautical engineer, Theodore “TP” Wright, published a paper in which he argued that the cost of building airplanes declined over time as the builder gained manufacturing experience. 

Needless to say, in a competitive market this dynamic – known as “Wright’s Law” – should allow customers to negotiate prices down over time.  If you base your negotiating position on other peoples’ old deals, however, you are missing the benefit of Wright’s Law.

Benchmarks are almost always better for vendors

Even if they don’t collude in developing their sales models – which would obviously violate the anti-trust laws – vendors operate in an echo system that tends to align their respective offerings.  They not only know their own pricing better than anyone else but they also pay very close attention to what their competitors are doing.  And they collect and read the same benchmark data their customers get. 

Vendors use this information advantage to put a floor on their negotiating position and, from there, to argue that your case is special and requires different – and more vendor favorable – terms.

Ever wonder why competing software vendors all insist on the reasonableness of their onerous, painful software audit rights that are universally hated by their customers?  Or why most hardware vendors tell you they won’t offer discounts from their list prices without minimum purchase commitments that lock you into buying their products no matter how poorly they perform?  Those positions come from the vendor’s echo chamber.

To benchmark or not to benchmark

I’m not arguing benchmarks are bad.  As noted above, they help anchor your position in a negotiation. 

But if customers don’t exercise their freedom to benefit from Wright’s Law and the dynamism of competitive markets, they risk repeating the mistakes of what was at one time the world’s biggest benchmark firm:  Gosplan.  Gosplan was the agency responsible for managing and planning the economy of the Soviet Union.  Gosplan collected pricing data from thousands of firms and experts to make allocation decisions.  I don’t need to tell you how that ended up.

To paraphrase DIRECTV’s adds with Rob Lowe, don’t be like Gosplan.  See what the benchmarks have to offer and then switch to negotiating for yourself.