Optimal Valuation and Timing of Price Benchmarks for IT Services Contracts

Information technology (IT) services contracts often contain provisions for benchmarking fixed prices to current market prices. Prices of IT services tend to be opaque, but can be revealed through third-party benchmarks. Little research has been conducted on the value and timing of such benchmarks. We draw upon the theory of mortgage refinance and value-at-risk analysis from financial economics, and the IT investment under uncertainty literature to create a model of the benchmarking decision for IT services contracts. Our model permits the determination of the value and optimal timing of the benchmark. We provide conditions under which a client firm should consider one or multiple benchmark provisions. Our solution is robust to uncertainty surrounding benchmark forecasts. Firms can leverage market price uncertainties and exercise benchmarks even when the potential rate of declining IT prices does not reach a minimum threshold to benchmark.