Traditional Outsourcing Pricing Models: Pros and Cons

On April 17, 2012, in Outsourcing, by Business Development Group
The basic pricing options for an outsourcing contract, long used in the outsourcing industry, include: Fixed-Price, Time-and-Material, and Cost-Plus Pricing. However, it is more common today to use pricing model combinations or hybrids than any of the pure forms of these basic pricing models.

The basic pricing options for an outsourcing contract, long used in the outsourcing industry, include: Fixed-Price, Time-and-Material, and Cost-Plus Pricing. However, it is more common today to use pricing model combinations or hybrids than any of the pure forms of these basic pricing models.

The outsourcing industry, over the years, has grown to become a complex environment where the pricing model is just one of the aspects that organizations need to get right. A price model that worked for a certain organization with a particular supplier may not work for another set of client and vendor. Setting up a pricing framework may not just mean simply selecting a particular pricing model; it may include the combination of or creating hybrids of traditional ones.

The basic pricing options for an outsourcing contract, long used in the outsourcing industry, include: Fixed-Price, Time-and-Material, and Cost-Plus Pricing. However, it is more common today to use pricing model combinations or hybrids than any of the pure forms of these basic pricing models.

      Read related article:Knowledge Process Outsourcing

Fixed-Price Pricing

Choosing a Fixed-Price model will enable the lock-in of prices for outsourcing services and consequentially obtain predictable and controllable costs. However, this pricing model can only be effective when demand and cost of outsourcing services are both highly predictable.

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Time-and-Material Pricing

The Time-and-Material Pricing model is an arrangement wherein services are charged on a usage basis, addressing issues on fluctuating demand while also obtaining volume discounts. However, clients bear a high risk of exceeding budget in this pricing model especially in cases where demand forecasts for the vendor’s services fail.

Read related article: How to Successfully Transition to Outsourcing

Cost-Plus Pricing

This approach offers the benefit of having a full understanding of the service provider’s operations and service cost. The outsourcing provider, however, won’t have any motivation to reduce costs since this model allows it to pass on operational costs and make provisions for profit. This model has high management overhead due to the need to verify that the “best cost” was achieved and the appropriate mitigating controls were implemented.

These models, although already long in use in the outsourcing industry, are not without their own risks and management issues. Thus, in order to cope with the pitfalls associated with these pricing models, more experienced organizations have turned to creating combinations/hybrids of these traditional models that are able to address demand and cost predictability concerns of both parties.

Related Article: Pricing Outsourcing

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2 Responses to “Traditional Outsourcing Pricing Models: Pros and Cons”

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