In outsourcing agreements, customers usually request the so-called most favoured customer (MFC) clause from their service providers. The MFC clause is a promise from the service provider to treat the customer not less favourably than its customers. The clause can take various forms but invariably it requires the service provider who offers lower charges to any other customers for the same or substantially similar services to reduce the charge of the customers. Some customers like the clause because it provides them with comfort that the charges under its outsourcing agreement will be competitive during the term of the contract. This is important for customers in a long-term outsourcing arrangement relationship, because customers do not need to wait to the end of the term or pay early termination fees if the charges are no longer competitive. Should the service provider fail to deliver on this promise, it may be subject to a claim for damages.
We need to pause and reflect on the usefulness of this clause. While MFC clause may be useful in certain cases (for example, where customer becomes the first client of the Supplier in a new geographic market), the value this clause will need to be assessed on a case-by-case basis. The MFC clause is problematic for both service provider and customer. From the service provider’s perspective, the clause poses an administrative problem. It is very difficult for service provider to police its compliance with this provision, not only because of the number of clients and contracts involved, but also because of the unique nature of outsourcing services. Many of the outsourcing solutions are customized and therefore, no two deals are alike. The like-for-like comparison is very difficult to implement. In addition, some of the MFC clauses include retroactive price adjustment to the date the lower charges were first offered to other customers. This raises a revenue recognition concern for service providers, in that the MFC clause violates the price fixed or determinable revenue recognition criteria. This means the revenue (not the cost) from the arrangement will need to be deferred. Moreover, the MFN clause will also pose difficulty to the service provider in offering a “better” deal to other customers for strategic reason.
From the customer’s perspective, the clause is also problematic. All of the outsourcing agreements are covered by confidentiality provisions. This means that the terms of the agreement cannot be shared with any third parties. Customers realize this restriction and sometimes we see wordings in the MFC provisions which provide the right to a customer’s auditor to verify supplier’s agreements with its third party customers. This audit wording fails to recognize the fact that the customer’s auditor will also be subject to the same confidentiality restrictions as the customer itself. Very often, customers will need to just rely on the statements from the service provider’s officer. Customers cannot have an independent verification of service provider’s compliance with the MFC clause. The other big issue lies in the difficulties in its measurement. It is very difficult to normalize different sets of services and different customers. The MFC clause often includes language to take into account deals of similar nature, size, scope, term, locations, delivery model, service levels, technical complexity, pricing components, etc. The more qualifiers included in the normalization process, the less likely that there will be another deal that is alike and the less meaningful the clause becomes. The MFC clause does not provide protection to customers that the pricing offered by a service provider is competitive to the competitors’ pricing. The MFC clause does not take into account the price in the marketplace.
In addition to the measurement, enforcement, and revenue recognition issues we mentioned above, the MFC clause does not serve an incentive for service providers to renegotiate pricing with individual customers because the MFC clause could increase the cost of such negotiation by requiring service providers to pay the renegotiated pricing to all customers who have such MFC clause in the contracts. One could also potentially raise an argument under the anti-competition legislation.
Benchmarking can offer a more objective assessment of the competitiveness of the charges. Benchmarking provides a better assurance to customers that the price is fair and reasonable in the marketplace. Very often, the mere threat by the customer of invoking the benchmarking clause can result in pricing concession or discount from the service provider in return for customers waiving the right to perform benchmarking for a certain period of time. Although there will also be issues in finding like-for-like comparators, at least there is a prescribed process and conditions.