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4 new IT outsourcing pricing models gain popularity

Stephanie Overby | April 16, 2012
Enterprises that have gone the outsourcing route now expect more value from their IT service providers and IT service vendors want potentially higher-margin work. The combination has resulted in several new pricing models. CIO.com looks at four emerging options.

Incentive-Based Pricing Model

What It Is: Bonus payments are made to the vendor for achieving specific performance levels above the contract's service level agreements. Often used in conjunction with a traditional pricing method, such as time-and-materials or fixed price, "the key is to ensure that the delivered outcome creates incremental business value for the customer," Pace Harmon's Martin says.

Best For: Customers who are able to identify specific investments the vendor could make in order to deliver a higher level of performance.

Pros: Incentives can compensate for drawbacks in the primary pricing method and better align provider motivation and customer goals, says Tisnovsky of Everest Group.

Cons: "This model often falls flat because companies end up rewarding their vendors for work they should arguably be doing anyway," says Martin. "The 'incentive' should be that they get to keep providing the service." Measuring bonus-worthy performance can be difficult and costly.

Watch Out For: Vendors who tell you that it's common practice to provide these bonuses if you require the provider to pay penalties for missed service levels. It's not.

Consumption-Based Pricing Model

What It Is: Costs are allocated based on actual usage (e.g., gigabytes of disk space used or help desk calls answered).

Best For: Buyers concerned about service provider productivity and those with variable demand. The utility model is particularly well-suited to situations in which the fixed costs of the services are shared across many customers, says Helms of K&L Gates, like cloud computing engagements.

Pros: Pay-per-use pricing can deliver productivity gains from day one and makes component cost-analysis and adjustments easy. Capital expenses become operating expenses.

Cons: Utility pricing requires a fairly accurate estimate of the demand volume and a commitment for certain minimum transaction volume, warns Everest Group's Tisnovsky. Annual costs are less predictable.

Watch Out For: Internal reluctance to add needed services in order to keep monthly bills low. In addition, "this model only works from the service provider's perspective if the services provided are directly related to the cost incurred as reflected in the price of the resource units," says Helms. "The service provider bears the risk that an insufficient number of resource units will be used and the provider will not recover its fixed costs, but the customer bears the risk that it continues to pay an inflated price after the service provider has recovered all of its fixed costs."

Shared Risk-Reward Pricing Model

What It Is: Provider and customer jointly fund the development of new products, solutions, and services with the provider sharing in rewards for a defined period of time.

Best For: Customers with the level of governance necessary to partner with the provider on these projects. Most importantly, according to analysis by Gartner, the client must be willing to share in either the upside or downside potential.

 

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