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Offshoring: Introducing a new, hybrid pricing model

Stephanie Overby | Sept. 16, 2009
As IT leaders focus on cutting costs, they continue to put pricing pressure on offshore outsourcers

FRAMINGHAM, 15 SEPTEMBER 2009 - As IT leaders focus on cutting costs, they continue to put pricing pressure on offshore outsourcers. Since suppliers who respond with repeated price cuts could be slitting their own throats, some are offering up new pricing models to soothe the savage customer.

Bangalore-based IT service provider MindTree is talking up its new "hybrid" pricing for offshore IT services.

There are two well-established methods for pricing an outsourcing deal: time-and-materials (where the client pays for work on a cost-plus-margin basis) and fixed price, though variations on the two themes continue to emerge. An outsourcing customer will opt for a time-and-materials deal when overall requirements aren't clear or they want the transparency of the cost-plus model. The drawback of such deals is that they require more hands-on management by the provider and costs can spiral out of control.

Other customers like fixed-price deals because the cost of the deal is, theoretically, capped, and deliverables can be directly linked to service level agreements and associated penalties. The downside is that requirements need to be well-defined upfront, and there is limited visibility into underlying costs.

The new MindTree model incorporates both time-and-materials and fixed-price methods in one contract. According to Dattaguru Hegde, general manager with the mid-tier offshore player, it combines the best of both worlds.

Say a customer wants to set up an offshore development center to create an e-commerce solution. The client is clear about the twenty features to be included in the first release, but beyond that, can only say that it wants multiple iterations to incorporate enhancements and fixes to the software throughout the year.

MindTree would draw up a deal with a fixed price for the first release and time-and-materials pricing for the remaining work. "Typically, when a fixed-price quote is given for a defined piece of work, the service provider plans the full-time employees for the project lifecycle, ramping up and down according to need," says Hegde. "In a hybrid model, the service provider plans fractional full-time employees for the fixed-price engagement to meet service level agreements, then the remaining [man-hours] for each role are made available to the client on a time-and-materials basis."

The model works best for customers who have some requirements in place for an offshore vendor, says Hegde. He adds that the hybrid model can save 15 to 25 percent more than pure time-and-materials or fixed-price contracts for similar work.

Hybrid Pricing: Fad or Future?

Hybrid pricing is not yet prevalent in the outsourcing industry, says Adam Strichman, a Mechanicsville, Va.-based independent outsourcing consultant who has studied IT service prices for more than a decade. "What is common, however, is that clients in this economy are pushing for price reductions and other mechanisms to ensure they are getting value."

 

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