October | 2020

In such a model, the volatility risk and management rests with the service provider and the buyer can focus on more strategic initiatives of his business, resulting in higher revenue productivity.

Pricing Model

Fixed cost

Time & Material (T & M)

Transaction based

Outcome based

Characteristics

Suitable when the scope is well defined and volumes are not fluctuating

Suitable when the scope is not well defined and requires a quick leverage of labor arbitrage

 

Suitable in case of well defined, stable requirements and service levels

 

Suitable in case of undefined scope/fluctuating volumes but there is alignment with a business outcome like usage, increased sales, reduced costs, inventory etc.

Costs

Broadly fixed costs irrespective of the quality of delivery

Costs based on time and material, but output may not be aligned to business outcome

Costs in units, but output may not be aligned to business outcome

Costs as per pre-agreed business benefit delivered

Risk

Service provider’s risk on estimation, buyer’s risk on delivery and quality

Little risk to service provider, buyer’s risk on delivery, quality and outcome

Service provider’s risk on volume estimation, buyer’s risk on delivery and outcome

Mutual risk, more for service provider but including rewards

Challenges (Buyer )

Volume fluctuations, scope creeps, perceived as paying too high for low usage/volume periods, aligning output to business goals

Management overhead

costs, return on investments

Scope/volume prediction, aligning output to business goals

 

Less risk for buyer, payouts linked to usage/business outcomes required

Challenges (Service Provider)

Risk on estimation

 

Negligible risk

Volume estimation,

ramp up - ramp downs,

seasonality

Estimation,

payout structure: Risk for potentially zero revenue, if business outcomes not met

Outcome-based Pricing Model - A win-win approach for the service provider and the buyer
Although the outcome-based model became increasingly popular to begin with, it has not been very successful as very few service providers have the operational depth, skill or experience to put their skin in the game.
These models are typically successful only where the service provider is willing to make the necessary investments and take the required risks as they may end up with potentially zero revenue, if business outcomes are not met. Investments may include people, process or technology intervention to design changes, implement them and then measure the results.
It is worth noting that a single model is not suitable for all commercial businesses. The business needs to consider different factors while evaluating the right model for them - need for control, risk appetite, staffing, investment requirement & plans, need to scale up, their current operational expertise, and core competence.

Cost Component

Year 1

Year 2

Year 3

……….

……….

……….

……….

……….

Year 10

Fixed fee charged (X)

16

16

16

16

16

16

16

16

16

Expenses borne by the service provider  (Y)

12

12

13

14

14

14

13

13

13

Margin (X-Y)

4

4

3

2

2

2

3

3

3

Total margin for service provider

26

Total cost for buyer

160

Cost Component

Year 1

Year 2

Year 3

……

……

……

….

….

Year 10

Fixed fee charged (X)

10

10

10

10

10

10

10

10

10

Utilization-based Fees (Z)

1

2

3

5

6

6

7

7

8

Gain share to service provider (% of benefits to buyer) (A)

0

0

1

1

2

2

3

4

3

Expenses borne by the service provider  (Y)

12

12

13

14

14

14

13

13

13

Service provider margin

(X + Z + A - Z)

-1

0

1

2

4

4

7

8

8

Total cost for buyer (X+Z+A)

11

12

14

16

18

18

20

21

21

Total margin for service provider

33

Total cost for buyer (X+Z+A)

151

Total benefit/revenue to the buyer

> 160 (assuming gain share of 10% passed to the service provider)

Based on the above comparison, it is evident that the outcome-oriented models have the potential to provide realized benefits to the buyer which in turn results in gains for the service provider. This is as a win-win approach for both parties in the long term.

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