Types of Outsourcing Pricing Models for Your Business

Last updated on 

January 19, 2022

by

The VA Reviewer
Types of Outsourcing Pricing Models for Your Business

Business process outsourcing enables companies to reduce costs, scale operations, and expand flexibly. Ever since the rise in the popularity of call centers, they have assisted businesses in generating savings and providing better service to their customers. Outsourcing also fosters a relationship between the clients and their service providers.

Outsourcing is now applicable not only to large corporations but also to small businesses. Some startups are now using this to build a distributed workforce. Though companies use outsourcing services to increase their business value, the cost savings that come with this service are undeniably appealing. It could even be concluded that the cost-benefit ratio provided by outsourcing is the most important motivator for businesses to choose it.

IT outsourcing services aim to get the best output possible, which can only be accomplished by selecting the suitable pricing model that provides the most benefits. The pricing structure of outsourced services changes and adapts over time. 

The most common outsourcing pricing models are listed below.

Which type of outsourcing pricing model is best for your business?

A pricing model is a concept that has been proposed as means of an agreement between service providers and businesses. The cost of the software development service is agreed upon by both parties based on this agreement contract. Pricing models should be chosen based on the needs of the business; there is no right or wrong pricing model in the market.

Fixed Price (FP) model

In this transaction-based model, both parties agree on a fixed price before the work begins, and the job must be completed within the specified time frame. Depending on the client’s preference, this can be charged monthly or annually and includes charges for tools and workspace. The FP model can also be modified based on various factors such as salaries, incentives, and success goals.

If you already have a set of criteria in mind and are confident that they will not change during software development, this model may be the best option. The complex set criteria are auctioned hourly, and both parties agree to complete the project within a specified time frame. 

This pricing model is appropriate for projects with a minor or medium-scale when a budget has been established and there are no prospects of incurring variable costs. Implementing such a pricing model is simple, beginning with an inquiry, followed by negotiation, a proposal, and lastly, an agreement.

Fixed Price (FP) Adjustments

Fixed price with economic price adjustment (FP EPA)

Adjustments to the costs of labor, materials, workspaces, and other resources included in a service provider’s rate may impact their pricing. Salary differences between junior and senior levels, material upgrades, and changes in the number of employees, for example, may all have an impact.

Fixed price with incentive (FPI)

Fixed pricing can also be used in conjunction with an incentive-based model. However, changes in this model are unavoidable based on the client’s metrics.

FPI successive target (FPI ST)

This model functions in the same way as FPI. FPI ST, on the other hand, allows clients to adjust their target costs and profit values for the entire project. They usually have an initial pricing structure when they begin a project. Then, as they see progress in their operation, they can gradually adjust their incentives, and the period they are given.

Benefits of Fixed Pricing Model:

  • Specified requirements
  • Less supervision is required.
  • Predictable project planning and scheduling
  • Deliverables have been defined.
  • Low risks are a result of high predictability.
  • Costs are determined before the start of the project.

As previously stated, this may be a suitable option for you if you know the requirements ahead of time and have a fixed cost to pay for it. However, the price plan may change depending on the changing market scenario. Again, if the demand for your project fluctuates within your company, you can expect surprises at the end.

Cost Reimbursable Adjustment

Cost Plus Fixed Fee (CPFF)

The client only pays a flat fee at the end of the project. Meanwhile, the consumable prices for the entire project may vary. Because service providers profit from the fixed fee, they may not require incentive charging under this model.

Cost Plus Incentive (CPI)

Unlike CPFF, CPI only adds incentives when the provider outperforms its peers for a set period. This model is measured using the metrics provided by the client.

Cost Plus Award (CPA)

Unlike CPI, CPA only charges clients based on the work performance of the service provider. The client’s metrics may also determine this model, such as whether the provider meets a specific timeline, deliverable, and expectation.

Time and materials (T&M) Model

The time and materials (T&M) model, also known as the cost and materials (C&M) model, is standard in long-term IT projects. This model necessitates service providers bidding on a specific task and submitting a proposal based on the client’s specifications.

This model can also be found on a build-operate-transfer (BOT) process, wherein the provider initially builds and manages a project’s development. The T&M model also requires the provider to operate in-house or under the supervision of the client.

Benefits of Time and materials Model:

  • Prioritization of tasks
  • Flexible
  • Aids in agile development
  • The client has suggestions for the project.

This pricing model necessitates regular client involvement and strict control over the final costs.

T&M variation

T&M with cap

The client establishes a cap or upper limit for a specific project to keep costs under control. This allows them to keep track of their proposal’s budget and avoid overcharging for the project.

Consumption-based Pricing Model

On the other hand, Cloud service providers primarily use consumption-based pricing for their services. Here, clients are charged based on their actual usage over a month or a year. Meanwhile, the clients benefit from the costing’s flexibility because they only pay for what they use.

Profit-sharing Pricing Model

Meanwhile, the profit-sharing model may be contingent on an agreement between the client and the service provider. As opposed to the incentive-based model, profit-sharing allows the client to allocate a percentage of their profit to the service provider. This model is typically used as a reward for excellent work performance that results in a positive outcome for the client.

Profit-sharing elevates the client and service provider’s partnership to a new level. This model enables them to collaborate more and solve problems within the company and their team’s operation for a more efficient workflow.

Incentive-based Pricing Model

Clients may agree to send a bonus or commission to their service provider in addition to their regular pricing to improve their performance.

The incentive-based pricing model is typically used for seasonal accounts and extra services such as 24/7 service and after-hours.

Shared Risk-Reward Pricing Model

Like the incentive-based model, a shared risk-reward model is added on top of the standard flat rate. The client and service provider, on the other hand, share the risks and developments of their operation.

This model can be used with the T&M, FP, or profit-sharing models. According to Gartner, delegating responsibilities to a partner reduces the risks associated with new technologies, processes, or models. This model has benefited both the provider and their clients.

Takeaway

Selecting the best pricing model for your software development project is indeed a difficult task. If you are unsure about your project’s requirements, you may end up selecting the incorrect model. They may cause project delays as well as unplanned and unexplained expenses.

It would be best if you made well-thought-out and strategically considered decisions for your company’s success. So, when selecting the best pricing model for your business, take your time to weigh different options or consult with a business solution consultant.

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