The tech industry has witnessed a transformation across almost every modality, and that includes pricing. It is a crucial aspect, as a decision on pricing can have a long-term implication on the company’s business viability. A pragmatic pricing model should be a win-win for both the client and service provider to enable them to achieve their business objectives. However, service providers are struggling to meet the evolving expectations of clients. Clients expect their service providers to go beyond conventional engagement with cost saving as the primary goal towards a more skin-in-the-game approach. Understanding the various pricing models and figuring out the best fit will enable you to build a lasting and mutually beneficial partnership with your service provider.
Traditional Pricing Models: Linear
There are various types of pricing models that are practiced in the tech industry, and, they can be broadly classified into linear and non-linear. Traditionally, the simpler linear models have been extensively used for their simplicity – you can pay the service provider as and when the resource is provided for a given duration. Time and material (T&M), fixed price (FP), and dedicated team (DT) are some of the common types of linear pricing models used in the industry.
- T&M model: It is one of the earliest pricing models in practice. In this model, the service provider is paid for the number of person-hours spent performing the task defined by the client. The model is ideal for product development projects with frequent changes, where service provider is responsible for managing the scope, deliverables, management, and even quality. However, the margins as well as risks for service provider are low.
- FP model: The fixed price model can be the ideal choice when the requirement involves a small or medium sized project with a clearly defined scope. The service provider should be fully clear on the timelines and deliverables and must work on the specifications within a precise budget. Again, this is a low-risk low-margin option for service providers.
- DT model: In this model, a dedicated service provider offers a set of resources, acting as an inherent part of the client’s in-house team. The client gets the work done from the team and pays for the team. This option is best for clients who want tighter control on their projects.
Though straightforward, the linear models are rigid, with little scope for quick changes and modifications.
New-Age Pricing Models: Non-Linear
The shift towards on-demand service delivery, caused by the as-a-service economy, has created a need for more flexible pricing models. Such pricing models enable service providers to cater to client-specific engagement requirements delivering customized and dynamic solutions. These non-linear pricing models offer the much-needed versatility in pricing that match the flexibility of contemporary service delivery. Some of the popular innovative non-linear models in practice are hybrid, managed services, outcome-based and transaction-based pricing.
- Hybrid model: For a long ongoing project with no clear objectives to start with, using a hybrid of T&M and fixed price models can be effective. If you are confident that the service provider can perfect the deliverables over time, then you can pay on an hourly basis on top of a one-time payment. This would not only optimize your budget but also maintain your quality of service, leading to well-aligned processes and efficient workflows.
- Managed services model: You can opt for this model when you need the service provider to offer end-to-end service management at a fixed cost. The defined parameters or SLAs on quality and project performance help measure the value addition quantitatively. The model assures continuous fixed revenue to the service provider, in addition to the monetary rewards for exceeding the SLAs.
- Transaction-based pricing: This model considers the total volume of the transactions processed, which defines the scope of the project. It enables you to buy volumes whenever required. The service provider spreads the investment cost across multiple clients needing the same kind of service. As a result, the cost per transaction reduces drastically due to economies of scale, providing higher margins for both the stakeholders.
- Outcome-based pricing: Outcome-driven model is ideal for projects with clearly defined business outcomes. By delivering measurable results, the service provider can have a direct impact on your success. Through continuous optimization, the service provider can manage the risks and charge the appropriate risk premium, translating to higher incentives for better results. Similarly, when the fee is linked to a specific type of output, it turns into an output-based model.
When deciding on a service provider, you must look for a pricing model that matches your expectations on value proposition, quality, and timeliness. You must weigh in various factors such as the project scope, service provider’s proficiency, your business objectives, etc. A single rigid pricing model may not be suitable for every engagement. As such, a mutually beneficial pricing model that is flexible to the changing needs of each engagement could be the ideal option.
Pricing models have evolved to match the revolution in the tech services industry. The traditional linear models based on the relationship between resources and cost are simpler, but rigid. The issue of agility is addressed by innovative non-linear pricing models. As engagement models have transformed over time, the pricing models have become more flexible to cater to the specific needs of each engagement. To nail the right commercial model, work with your service provider to customize a model that drives value and competitive differentiation by focusing on the unique elements of your ecosystem. A tailored approach will help both you and your service provider to achieve critical business outcomes and foster a successful long-term partnership.