Three Threats to Cost Transparency in Cost-Plus Facility Services Outsourcing
There are times when a pass-through deal is not really pass-through
Facility managers often take comfort in the cost transparency that cost-plus and guaranteed maximum price (GMP) pricing models traditionally provide in facility management outsourcing deals, but there are increasing methods that suppliers are using to chip away at that protection. There are three threats to the cost transparency that a facility manager may be expecting in a facility services outsourcing deal: limited and restrictive audit rights; purchases of supplies/food from related parties; and rebates/volume allowances.
A traditional cost-plus contract in a facility management outsourcing deal is a cost-type contract where the supplier is compensated for its actual costs (e.g., labor, third party costs, cost of goods and materials, etc.) incurred in delivering the facility services, plus a management fee. A GMP (a.k.a glide-path) contract builds on a cost-plus model, but adds the element that the overall price be subject to a maximum ceiling amount (e.g., a budget).
These types of contracts are commonly "open book" contracts, meaning the customer has every right to inspect the books at any time and conduct an audit of the fees and invoices. Customers often implement these models in their facility management outsourcing arrangements, as opposed to a fixed price model, in order to better track the true costs and fees associated with the outsourced services.
Limited and Restrictive Audit Rights
Suppliers will push back on open-ended audit rights by trying to limit audits to formal occurrences once per year or some other limited period. Further, suppliers may try to carve back customers’ rights to detailed invoices and line-item accounting, especially when related to charges from subcontractors or third party vendors that the supplier is passing along. Some suppliers have argued that they cannot provide wage information on their personnel who are delivering the services, because of HR and other confidentiality reasons.
While suppliers may attempt to bring novel arguments about why they cannot provide underlying cost details, in order for a customer to benefit from the cost transparency of a cost-plus deal, they must be able to verify the actual costs that are being charged, whether as a direct charge by a supplier or a pass-through cost from a third party vendor. If a supplier has agreed to a cost-plus model, then the supplier needs to abide by its commitments and cooperate with a reasonable level of transparency so that the facility manager can verify the actual costs. If a supplier is reluctant to share such information, then the facility manager should ask why or whether the supplier is truly offering a cost-plus deal.
That said, “the devil is in the details,” and, in order to hold suppliers accountable, facility managers not only need the ability to access the relevant details, but also must remember to actually exercise their rights and actively review and verify the charges on a periodic basis. Doing so will help keep both parties aligned with their understandings and their expectations.
Purchases of Supplies or Food from Related Parties
In a cost-plus deal, suppliers are supposed to be compensated for the actual costs, plus an agreed upon markup/management fee. The understanding of customers is that there is transparency in the deal and that the supplier should only benefit based upon the agreed markup.
However, some larger supplier organizations with affiliates who are part of the “supply chain” may be able to double benefit from their positions and influence. If a supplier purchases certain goods or supplies that it uses to deliver the services from one of its affiliates, then the supplier organization may be able to benefit from the application of a markup by the affiliate entity as well as the markup applied by the supplier. Even if the supplier organization and the affiliate in question may be able to provide the goods to the supplier at a cheaper price than one of its competitors, the incentives and disguising of profits leaves facility managers without the transparency and openness that they are expecting from a cost-plus deal.
For these reasons, it is often advisable to include language stating that, if a facility services provider purchases goods from a related party, then the charges for such goods shall be the invoice price paid by such related party to an unrelated third party to avoid a double markup scenario.