Outsourcing Pricing Models - Pros and Cons

Outsourcing Pricing Models

• Fixed – Pricing model in which a project is undertaken by the service provider for a pre-agreed-upon price
  • Predictability
    • Pros:
      • Known price, easily bid and compared
      • Easily budgeted and predicted
      • No variances over contract period
    • Cons:
      • Fixed bill may conflict with internal cost reduction pressures
      • Price based on known data prior to contract signing, which can change
  • Adjustments
    • Pros:
      • Predictable, stable cost structure
    • Cons:
      • Triggered through significant events like volume
      • Require renegotiation in the absence of contracted adjustment clauses
  • Productivity
    • Pros:
      • Generally guaranteed year over year with certain client participation caveats
    • Cons:
      • Discourages provider from introducing efficiencies that would reduce headcount
      • Out years harder to predict by service provider, can result in over paying or losses by provider
• Fixed with ARCs/RRCs – Pricing model that combines an annual fixed price as a “baseline” with a variable pricing component called ARCs/RRCs to increase and decrease headcount based on volume predictions, and is intended to account for adjustments to an established “Baseline Rate” caused by fluctuations in work arrivals both up and down.
  • Predictability
    • Pros:
      • Links payment to consumption
      • Allows for defined volume adjustments up and down
      • Stable pricing when there are normally only minor volume changes
    • Cons:
      • Fixed bill may conflict with internal cost reduction pressures
      • Price based on known data prior to contract signing, which can change.
      • Harder  to budget due to volume changes
  • Adjustments
    • Pros:
      • Monthly bill tied to actual output
      • Changes in contract terms pre-defined and therefore quicker
    • Cons:
      • Requires reliable measurement and mechanisms
      • Triggered through significant events like major volume fluctuations
      • May be slow to react to sudden spikes
  • Productivity:
    • Pros:
      • Volume based consumption
    • Cons:
      • Discourages provider from introducing efficiencies that would reduce headcount
• Unit – pricing model intended to provide a price per transaction enabling more efficient management of costs within a outsourced environment.  
  • Predictability
    • Pros:
      • Provider bill tied to exact effort of specified, repeatable processes
      • Little error for misinterpretation
      • Productivity can be easily measured
    • Cons:
      • Volumes can lead to peaks and valleys which cause forecast and budgeting challenges
      • Small overestimate on unit prices can result in large overpayment
  • Adjustments
    • Pros:
      • Built into unit price model
    • Cons:
      • May be harder to manage- requires many tiers of pricing, and accurate metrics
  • Productivity
    • Pros:
      • Providers incented to create the highest efficiencies and throughput
    • Cons:
      • Most applicable to simple and routine transactions showing little productivity gain potential
• Tiered - This pricing methodology is intended to provide a price per transaction with discounts provided as volume ranges increase.  
  • Predictability
    • Pros:
      • Discounts for bulk volumes
      • Forecasting and budgeting is simplified
    • Cons:
      • Volumes can lead to peaks and valley’s which cause budgeting errors and inconsistency in forecasting.
      • Overestimate on unit prices can cause unfair price
      • Forecasting can be difficult depending on volume fluctuations
  • Adjustments
    • Pros:
      • Accommodates sustained fluctuation patterns
    • Cons:
      • Often more difficult to manage – revenues and expenses tied
  • Productivity
    • Pros:
      • Providers incented to create highest efficiencies and throughput
    • Cons:
      • Most applicable to routine processes showing small efficiency gain potentials
      • Harder to build into multi-tiered pricing
• Layered - A pricing methodology with three components. A base minimum fee, a transaction rate for a certain amount of the first transactions, and then a separate transaction rate for all remaining transactions. It is intended for growth models with smaller volumes.
  • Predictability
    • Pros:
      • Very easy for companies to create business case to add additional organizations or business units.
      • Once original transactions are achieved all remaining transactions are at discounted price
      • Very simple to budget
    • Cons:
      • Overestimate on unit prices can cause unfair price
      • If volumes do not grow pricing can feel like a fixed fee deal.
      • More difficult to budget than fixed models
  • Adjustments
    • Pros:
      • Easier to budget because there are only 2 price points
      • Volume protection built into model
    • Cons:
      • Relies on measurement mutually trusted and which might not exist
  • Productivity
    • Pros:
      • Easily measured given good mechanisms are in place
    • Cons:
      • Measurement mechanisms often lacking
• Cost Plus - This pricing methodology is intended to provide clear visibility into the cost of operational resources with a reasonable mark up for profit.  Also known as “Open Book” pricing
  • Predictability
    • Pros:
      • Clients have significant visibility into supplier cost structure and margin
      • Vendor is protected from loss due to unpredictable volumes
      • Service Providers are guaranteed  a profit and put in place procedures to keep that cost under control
    • Cons:
      • Disagreements on what constitutes a cost can strain partnership
      • No incentive for process reengineering or optimization.
  • Adjustments
    • Pros:
      • Flexibility in multi-vendor scenarios to throttle and direct work to most economical channel by volume
    • Cons:
      • Requires detailed and trusted cost accounting mechanisms
      • Disagreements on cost structure can strain a governance relationship
  • Productivity
    • Pros:
      • Efficiency gains would directly affect bottom line
    • Cons:
      • No incentive for vendor to reduce cost or increase productivity
• FTE based - This pricing methodology is intended to provide mutual agreed terms of the number of FTEs it costs to perform a particular process with defined parameters on fluctuations and adjustments.
  • Predictability
    • Pros:
      • Can follow a development life cycle
      • Individual service components can be delivered
      • Dedicated team
      • Client involvement is high
    • Cons:
      • Significant change in a process can cause major disruption in staffing.
  • Adjustments
    • Pros:
      • FTE’s can be consistently measured through governance
    • Cons:
      • Low bids sometimes result in unprofitable relationships requiring renegotiation of contract in absence of other adjustment mechanisms
  • Productivity
    • Pros:
      • Efficiency gains can reduce headcount over time with
    • Cons:
      • Productivity not innately part of the pricing formula
      • Gauging productivity is difficult because price is loaded with more cost levers than other pricing models
• Gain Share - a model typically requiring little-to-no up-front investment by the client whereby measurable capital gains in either increased income or reduced cost are shared by both provider and client – often on a sliding scale weighted toward the provider in the beginning in order to recoup expenditures in optimization technologies and process reengineering.
  • Predictability
    • Pros:
      • Low risk to client
      • Payment is only against measurable gains and presumably paid by same
      • Income is usually “found money”
    • Cons:
      • Non-standard model requires rethinking standard charge-for-services models
      • Full burden of risk usually falls on the provider
      • Few workflow types and environments are appropriate for mutual benefit
  • Adjustments
    • Pros:
      • Gains for cost savings typically decrease as capital investments are recouped
    • Cons:
      • Requires trusted measurement mechanisms that often don’t exist and cannot be introduced
      • Lack of billing clarity can engender disputes and ill will
  • Productivity
    • Pros:
      • Both parties incented to drive highest efficiencies
    • Cons:
      • Trusted and accurate measurement mechanisms often lacking
      • Gains can be disputed easily
      • Client doesn’t realize  cost savings