The Bottom Line

How to Make Benchmarks Less Tricky in Vendor Contract Negotiations

Posted by Patrick Goodwin, President on Oct 17, 2018 10:00:00 AM

iStock-921345556

Every institution wants its various processes and practices to be best of breed. Most, at minimum, want to know how they stack up against the best in their business. Typically, peer groups are established for this purpose, usually based on a bank or credit union’s asset base.

However, there are countless reasons why the performance of two financial institutions of identical size may not warrant side-by-side comparison. For example, one institution using a service bureau for core processing will have a lower efficiency ratio than one of its peers that does not use one. The retail/corporate mix within loan portfolios will also give rise to operational differences.

One of the most challenging areas in which to conduct peer group comparisons on best practices is around the core system vendor relationship. The permutations for engagement with these backbone providers are almost limitless, involving variables around the modules contracted, the extent of services outsourced versus handled in-house, etc. Research groups assembling peer group data do not have access to this level of detail, and this can lead to significant differences in specific expense classes and financial ratios. 

High-level comparative metrics are readily available from sources like The Nilson Report (for debit/credit card operations) or paid analytics services such as SNL for overall financial services info. Unfortunately, the available measures provided by these organizations, e.g., an efficiency ratio, tend to be broad-based by necessity, enabling banks and credit unions to assess their relative standing, but offering little if any insight to the more granular information needed to understand where any necessary improvements should be made.

Sometimes cross-referencing this macro data with available peer data can help. However, sharing information relative to the terms, pricing and incentives of a vendor contract at the level of detail required to draw actionable conclusions risks placing a financial institution in violation of its vendor contract confidentiality terms. Anonymized benchmarks are an alternative that allows banks and credit unions to maintain a layer of removal from the protected details in their supplier contracts while still reaping benefit from the data. Typically, this anonymized data will provide “market rate” benchmarking. While this type of view has value, it is important to note that the definition of “market rate” for banking services evolves continually.

Consider the contract terms of professional athletes by comparison. The benchmark salary for a top football defender has been reset twice in the past three months alone. A lucrative contract for an ace baseball pitcher signed a season or two ago looks like a bargain today.

Fortunately for banks and credit unions, prices for many of the critical services institutions rely on are trending downward rather than upward. Nonetheless, a procurement manager tasked with negotiating such deals every four to five years cannot be expected to possess full knowledge of the market’s latest nuances. Institutions understand that having current information of this type levels the playing field with vendors. That is why many turn to outside third parties to negotiate their vendor agreements.

The opportunity to leverage such data to help optimize the value of contracts in areas such as core systems, card services and digital product suites certainly warrants exploration. Data alone, however, will not be enough. Deep subject matter expertise from industry veterans is required to provide a context for that data. Proven negotiating skills are necessary if that data is to be converted into actionable information that delivers value to the institution. 

Finding that configuration of skills is worth the search. Anyone who needs convincing of that should do a quick review of the card networks’ public reporting. The net margins in those reports are the envy of virtually any other industry. Banking service providers are faring nearly as well. There is little debate from most objective observers that additional latitude for financial institution negotiations certainly remains.

Topics: Vendors & Contracts