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New Pricing Models for IT Outsourcing

by: Sarah Joson

Tuesday, April 24, 2012 | Outsourcing News |

IT outsourcing services used to be paid for like these were normal items in a shop. So if a company needed server management services, application development, or even network monitoring, they would look for a provider, get the job done, and pay for the materials used and services rendered at a definite price.

Customers in this day and age expect more value from their IT operations, which then pushes IT service providers to reformulate pricing models to tap the rapidly growing market for high end sales.

A partner at K&L Gates, Shawn Helms, said vendors now construct pricing models based on what the clients are typically looking for and are looking for ways that can maximize earnings. Furthermore, Steve Martin, partner at outsourcing consultancy firm Pace Harmon, said the new pricing models aim to cater to companies which have detailed/segmented IT processes or are having a hard time transitioning from traditional ones.

 

Advantages and drawbacks of various IT outsourcing pricing models

In an article written by Stephanie Overby and published at CIO.com, various IT outsourcing pricing models were discussed along with their advantages and drawbacks. These are the new pricing models for IT outsourcing:

Gain-Sharing Pricing Model
This pricing model focuses mainly on the volume or quality of output. This is typically used by vendors for clients who don’t mind paying more for maximum output or quality. This model works best for buyers who’d want immediate results and a strong partnership with vendors.

Ross Tisnovsky, Senior Vice-president at outsourcing consultancy firm Everest, believes aggressive collaborative effort from both parties is crucial since they both aim to maximize the expertise of the supplier to come up with the best and most number of outputs. Also, for this model, the budget for the suppliers is usually not restricted.

A huge drawback for this pricing model is initial cash out needed to start the operation. It would also mean that both parties should be transparent to create a relationship that can share risks and rewards. This is hard to do because according to Martin of Pace and Harmon, it is common that neither of the parties involved want to fund the initial budget, unless there is assurance that they will be able to see return on investments.
 
Incentive-based Pricing Model
This model allows vendors to receive incentives if they were able to over deliver. This is usually an add-on to basic pricing models. It is used by customers as motivation to push vendors to deliver more. If all goes well, both parties win. 

It is advised that this type of pricing model be used by buyers who have ample experience in dealing with IT vendors, so that it would be easier for them to quantify or measure the performance and output of the operation.
 
Consumption-based Pricing Model
In a nutshell, this pricing model means pay as you go through the process or pay-per-use. It works best for companies that have varying needs or those who only need service for a specific segment. The most popular platform that uses this pricing model is the cloud.

Transactions are also easier since instead of having one huge bill or an initial investment, it becomes an operating expense. Likewise, it would mean that determining the annual cost is harder since there will be months when you are not using the service and vice versa.

Shared Risk-Reward Pricing Model
This model requires the buyer and the team to synergize for a specific period of the contract. Go big as they say, which means buyers put everything at stake, like a captain aboard a ship portrayed by the vendor. If the ship sinks, the captain will be the last to jump. 

According to Gartner, the model somewhat alleviates risks since it is evenly distributed and both parties will be accountable for the outcome.  Since there will be a lot of sharing, results will be hard to measure and varying opinions will definitely take its toll on the entire operation.

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