Open Book Accounting

Some of our most difficult negotiations are dealing with open book accounting. The concept is now widely known, but ensuring that suppliers will be receptive to making open book accounting a contractual reality is quite another matter. The supplier’s pricing decisions have, historically, been steeped in mystery and there remains a culture whereby the detail of a price is confidential. The logic for a buyer to probe the cost drivers, including labour, materials, overheads, profit and contingency provision is impeccable. Our approach in negotiation is to persuade the supplier that we want them to make a profit. The profit must give due consideration to risks inherent in the procurement and the nature of any capital investment. The level of profit is a negotiable facet of pricing. Our business reasoning is that we want a supplier to remain in business in the long-term. We accept that there is, on occasions, sound reasoning for a supplier to provide for contingency. Fine! Not, however for it to be a hidden inclusion in the price. Contingency sums should be isolated from the price and a contractual agreement reached about how the contingency can be accessed by the supplier, with the buyer’s knowledge and approval. There is a linkage between contingency management and the risk modelling on a specific procurement.

Overhead recovery is a very problematic area. A well constructed cost model should expose overheads of a fixed and variable nature. It is not surprising to find accountants playing their cards in a negotiation. We have heard responses such as “We recover overheads at 183% of direct labour.” What exactly does this mean? In one service contract negotiation we found the hourly rate for maintenance engineers to include mobile ‘phone charges, mortgages, health insurance, average travel and hotel costs and training. If these are also included in the overhead recovery, double charging is taking place.

The logic for exposing labour and material costs in very important. The supplier must recover genuine costs. Let us use this to probe what happens in the real world. We constantly find contracts that provide for open book accounting but the buying organisation has never applied it. Our research has recently directed us to a City of Austin (USA) Audit Report AU11107 “Aramark Contract Audit.” An extract from the report (dated 2011) states: “The City cannot reasonably assure the validity of the revenues received from Aramark. Despite contract requirements, annual financial audits of Aramark’s operations have not been provided to the City since 2003. Additionally, ACCD performs limited review of financial information received from Aramark.”

When we negotiate open book accounting we typically engage with the supplier’s commercial, legal, finance and operational people. An often encountered aggressive question is “To what purpose will you put open book accounting?” Be ready to respond with a structured response, based upon excellent business logic. What will you say? One final point. Be sure that if the supplier agrees to open book accounting, who in your organisation has the time and ability to conduct the review/audit?