When it comes to facility services outsourcing contracts, there's another area where the benefits of cost-plus deals may be at risk: rebates/volume allowances. All of the costs of the supplier (e.g., labor, third party costs, cost of goods and materials, etc.) are supposed to be passed through to the customer at cost, and as such, all rebates or volume discounts associated with the costs should also belong to the customer.
Increasingly, suppliers are arguing that the volume discount arrangements that they have in their underlying contracts with their own providers (often their key national agreements) are too complex and that the rebates/volume discounts cannot be passed on to their facility services outsourcing customers. The suppliers often want the rebates and volume discounts carved out from the “pass-through” requirement that is inherent in cost-plus and GMP deals, permitting the suppliers to keep any rebates or volume discounts provided under contracts with their own providers.
For example, imagine that Supplier A has a GMP facility services outsourcing agreement with Customer X in which Supplier A operates and manages Customer X’s cafeterias at its multiple office buildings. In Supplier A’s and Facility Manager X’s GMP agreement, Supplier A is permitted to keep all of the rebates/volume discounts that Supplier A receives from its providers. Supplier A has a food and beverage contract with one of its wholesale providers in which Supplier A receives a 10 percent rebate/volume discount from the wholesale provider at the end of each year based on the overall spend by Supplier A. Supplier A earns a 5 percent management fee from Facility Manager X based on the managed volume spend. Facility manager X is invoiced by Supplier A for $1 million for food and beverages for the year and $50,000 in corresponding management fees.
In such a scenario, the invoice price that Facility Manager X pays to Supplier A for food and beverages is $100,000 higher than what it actually costs Supplier A, since Supplier A would receive a check for 10 percent of the food and beverage spend at the end of the year. Without the application of Supplier A’s rebates/volume discounts to Facility Manager X, Facility Manager X will not know Supplier A’s true costs from its wholesale provider for the food and beverages. The $100,000 that Supplier A gets to keep from its provider is pure profit to Supplier A, outside of the management fee. In addition, Supplier A’s management fee is inflated by $5,000 (i.e., $100,000 x 5 percent), because the 5 percent management fee is being applied to the full $1 million in food and beverage, but the actual costs after rebate to Supplier A is more accurately $900,000.
The creative arrangement of rebates/volume discounts allows facility services outsourcing providers to pass on to their customers a higher invoice price that does not reflect true market cost because of the rebate/volume discount that suppliers receive on the back end. For these reasons, we resist attempts by suppliers to create carve outs from at cost models and require suppliers to pass-through to the customer any rebates/volume discounts that they receive. If a supplier claims that it is too difficult to calculate the rebates/volume discounts under its contracts, we point out that there are simple ways to manage such calculations. In some instances we have seen customers agree to set the rebates/volume discounts that get passed on to the customer as a flat fee (e.g., 12 percent), with the right to have a third party auditor validate annually that the percentage approximates the rebates that the supplier is actually receiving. Without the right to such checks and balances, suppliers can erode the intended transparency that facility managers look to cost-plus facility services outsourcing deals to provide.
Kevin Rang is a partner in the Chicago technology transactions practice of Mayer Brown, where he focuses on global facilities management outsourcing matters, complex IT matters, and other sophisticated commercial transactions. He can be reached at krang@mayerbrown.com.
Donald Moon is a Chicago-based associate in Mayer Brown’s technology transactions practice. He concentrates on global facilities management outsourcing and other sophisticated commercial transactions, including those involving technology and business process outsourcing. He can be reached at dmoon@mayerbrown.com
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