Many service providers are promoting the concept of outcome-based pricing for Application Outsourcing. While the model holds promise, challenges abound and success remains elusive.
Consider these points:
Establishing attribution: Defining a direct causal link between a service provider’s efforts and the outcome presents a challenge. At a minimum, the outcome-based model requires a high degree of trust between the client and the service provider.
What is referred to as outcome-based is actually often output-based: Output-based pricing involves pricing per transaction, such as test scripts executed or tickets resolved. Although such an ‘output’ is usually a ‘successful output,’ calling that true outcome-based pricing would be a stretch.
Rarely found in Development environments: Application development is often too far removed from business outcomes for the outcome-based model to work. Indeed, true outcome-based pricing accounts for less than 10 percent of deals involving ADM, even among top-tier service providers who manage large end-to-end projects. We’ve not seen much evidence of emerging pricing models in ADM, as the age-old fixed fees and time and material models still account for the vast majority of application development contracts.
End-to-end control: True outcome-based pricing also requires end-to-end control, and frequently involves both ADM and BPO. While business processes generally lend themselves better to business outcomes than does ADM, service providers typically manage a multitude of both business processes as well as the underlying transactional systems. Establishing attribution under these circumstances requires control of significant swathes of the processes and systems that influence the outcome. In many cases, an engagement will cover business consulting as well, which further complicates the tracking of outcomes.
Contractual complexity: The complexity of drafting an outcome-based contract and the level of trust required partly explains the difficulty of implementing the model. Establishing who is responsible for what and ensuring that the vendor’s influence on the outcome is not impeded by a client’s acts of omission and commission is not straightforward. Also, clients are not always ready to cede control, and budget holders like to maintain cost predictability. The service provider’s motivation is often suspect – the client may believe margins earned will be higher than industry average. Multi-decade relationships are often managed on the time-and-materials model, with the client managing the service provider resource pool closely.
Many ideas in the sourcing industry make for great talking points, but the amount of ink and air time devoted to these ideas is not always in proportion with the actual volume of business transacted. At present, outcome-based pricing is one such idea. This is not to say that outcome-based pricing is not relevant. However, the model is currently limited to very specific areas of applicability. While adoption may grow in the long term, change is likely to be evolutionary.