What are the major differences between the variable-cost and user-based pricing models for outsourcing agreements?
The main difference is that one is fixed, and one is variable. They can be used apart or in conjunction with each other. They can be used in conjunction when you're committing to a fixed cost with a variable pricing option on top of that. For example: You might be in a hosting agreement. You're hosting for a certain number of hours. Users are a fixed cost –- a guaranteed minimum. On top of that, you may have a variable pricing structure. Variable pricing would theoretically affect your pricing by being a reduction for the additional hours. So, ultimately, it would cost you less than more to go over it [the number of hours]. Are there other pricing options available?
These two [variable-cost and user-based] cover most of what's out there. However, there are also models based on reduction in overall budget. These are often referred to as revenue-sharing models. The way it works is this: You have a situation where you have an existing IT group, with an existing cost structure –- this is often used as the benchmark. Then, if costs are reduced [below the benchmark], there is a sharing of that reduction that the provider participates in. It becomes the provider's profit margin. Which pricing models are most organizations using in outsourcing agreements, and why?
I think most are using some combination of the fixed and variable components. The reason for this is that both parties want some certainty on what the costs will be. The customer needs to know the costs for projected services and budget. And the provider needs guaranteed pay for services. The variable component is for the user or customer seeking cost reduction. The vendor or service provider is willing to provide it [the variable component] once the minimum is reached. Then they are assured profitability. Who in the IT organization should be involved in selecting the appropriate pricing plan?
The CFO and CIO should work together to come up with the appropriate pricing model. Don't rule out giving the vendor or service provider a chance to suggest their own pricing structure. Leave this area open-ended, specifically in the RFP. This will allow you to see what structures are being recommended for your situation by the vendor.
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This goes directly to how the contract is formulated. If it's done more on the partnering model, then it should be visited more frequently (every six months) with an eye toward a yearly renegotiation. In situations where there is a larger outsourcing commitment, I would consider revisiting the pricing plan more frequently. You don't want to create a situation where either party feels they're taken advantage of. This leads to just one thing: dispute and litigation. Is the revenue-sharing model used a lot?
It's not used as much as it should be, in my opinion. It promotes partnering, which promotes an understanding of what the actual costs are.