Whenever a load of different activities increases in a company, they usually go for outsourcing their projects. The choice of an appropriate outsourcing partner is itself a difficult task. After the outsourcing partner is chosen, the next step is to decide on the best outsourcing pricing models. Determining the type of pricing models to use is possibly the most critical decision. It happens that if it is chosen mistakenly then you may end up with great quality and financial losses.
Nowadays outsourcing vendors present an extensive range of pricing models. Some pricing models are suitable for maintenance work or product support, some come with payment structures that are advantageous for long-term projects or for altering the business goals. At the first glance, it may seem that choosing the appropriate pricing model is confusing. This is because you need to balance the risk and reward for both parties. Also, it is important to make sure that your outsourcing partner offers solutions that guarantee the maximum value for the investment.
Let’s have a look at different outsourcing pricing models which lets you make an informed decision on which one to choose:
Fixed Price Models:
A fixed price model is known to be a conventional one but it is still found to be beneficial while your business is outsourcing. This outsourcing model comes with a clearly defined objective and a steady set of requirements. It is known that fixed-price contracts place all the risks linked with the project not being accomplished on the outsourcing firm by waiting to pay them till the assigned work gets completed. This would conveniently secure your budget.
This type of model is ideal for long-term projects along with great benefits to the outsourcing partner because it incentivizes them to accomplish the projects efficiently. Moreover, it also allows deriving more value from the agreed contract. In order to get success using this outsourcing pricing model, it is recommended to be prepared for your outsourcing partners to ask for flexibility in the matter of payment terms.
Incentive-based Pricing Models:
The incentive-based outsourcing pricing model offers bonus payments to the outsourced partner, in form of a reward for fulfilling the performance goals in addition to what is mentioned in the contract agreement. It is usually found that incentives can compensate for limitations in T&M models or fixed-price, making sure that your partner’s motivation aligns with your own. It is also true that when adding complexity to your engagement model, you would need to make sure that your outsourcing partner makes quantifiable benefits for your business.
Cost Plus Outsourcing Model:
The cost-plus outsourcing model is considered when you wish to get an idea of what you are paying for and to make sure that the particular outsourcing vendor does not employ the cheapest people for accomplishing your project. The model is alternatively referred to as the “open book” model. This is due to the fact that it offers excellent cost transparency, allowing you to decide how much each developer is remunerated. Above the salary of each member, you pay a fixed payout to your outsourcing provider which functions to encompass their services like hosting, hiring, retaining your remote team, etc.
The estimation of how much to spend on labor is now known, so after that, it becomes easy to examine overhead costs. If you do this, it would allow building a reliable partnership with the outsourcing vendor. This is because, in that, everyone has a similar goal and i.e., to recruit the finest people to allow the development of your business and the benefits of both the parties from the continued collaboration.
When you go for this outsourcing model, you are capable to take part in the process of interviewing and recruiting your remote team. The remote development team recruited with the help of this model allows you to get a good prospect of communicating with your prevailing personnel, in an effective manner. It will start showing the benefits of continuous and long-term projects. Irrespective of the kind of project you need to outsource, this outsourcing pricing model offers cost-effective benefits to you as well as transparency to each and every person involved in the process.
Performance-Based Pricing Model:
In this outsourcing pricing model, you will need to pay your outsourcing service provider based on their performance. Once you are satisfied with the results of the service provided, you need to reward your vendor, in form of incentives. But if in case you observe that the services offered are unsatisfactory, the vendor needs to pay a penalty. Whenever you go for this outsourcing pricing model, you are assured of the work quality, because your vendor will attempt their best to get incentives based on their performance level.
Shared Risk-Reward Pricing Model:
Similar to the Incentive-based model, this outsourcing pricing model comes with a flat rate and it holds bonus payments till the time your partner fulfills particular objectives. In this model, the service providers and clients typically share funding for the development of the products. This offers your partner a share in the rewards for a specified time period.
This model motivates your partners to come up with innovative ideas that enhance your business functioning by appropriately sharing the financial risk among-st both parties. When responsibilities are assigned to the partner, it helps to reduce the risks linked to new technology, processes, or models. It is possible that the result of the work of your partner is hard to measure. Therefore, you need to get ready to enjoy the upsides and endure the downsides.
Time and Materials (T&M) Pricing Model:
This is one of the conventional outsourcing pricing models and it is unique as compared to other models. It requires your outsourcing partner to place a bid for a particular project, depending on the project based on your requirements, its scope, and the quantity of work that needs to be completed. It is known that this pricing model functions seamlessly if your teams are proficient at outlining your business’ project needs. In this way, the particular outsourcing partner will devote less time to reworking problems, restricting your project completion time as well as it allows you to save money.
In order to reap maximum benefits out of this model, you need to get prepared to build valuable project management teams. This will let you make sure the whole project gets accomplished on time and on budget. Moreover, you need to strictly track project performance and stay away from expensive project delays.
Pay per Unit Pricing Model:
In this outsourcing pricing model, the outsourcing vendor will present you a unit–based set rate and after that, you need to remunerate for the service, based on the amount of use. To understand this, for instance, whenever you wish to outsource maintenance services, you only need to pay for the total number of units being utilized to use the maintenance service.
Mixed Mode Pricing Model:
You can reap the benefits of offshoring with the help of a mixed-mode pricing model. Whenever your project requirements are not precise but you wish that the job should be accomplished within the strict time frame, a blend of a fixed price with a time and material model could help you. This is the model that facilitates dual benefits i.e., fixed duration/cost invite and the dynamic requirements supplied by the Time & Material model.
If you choose this model you can save additional costs due to unintentional project schedules and you get enhanced control over timelines. Discussing in brief, you can go for a fixed cost model for areas where the project requirements are clearly defined and no expected to alter, whereas you would choose the T&M model for the remaining areas.
Staff Augmentation Pricing Model:
Considering this pricing model for outsourced projects enables the business to incorporate staff into their team depending on the extra skill sets needed to accomplish a project. The appealing aspect of this pricing model is that you obtain the required resources for your project for a stipulated duration and that too as per your administration. When you adopt this model you will perceive that there is a low overhead cost of recruiting a full-time employee and the control over staff is excellent. You get the freedom to select an employee based on the skills required. Even the aggressive deadlines are met efficiently.
Though this staff augmentation model comes with more benefits, it still poses a concern because of extreme dependence on internal processes which may decelerate the development cycle. In addition to that, augmented staff may need industry-compatible internal training which may raise the cost and time duration of the project. If in case you do not want to consume your management resources into augmenting staff then this model is not suitable for your business.
It is important to remember that outsourcing is a partnership, so the objectives should be clearly defined based on the requirements and budget. The choice of any of these outsourcing pricing models depends on the estimated budget and market trends as well.
Any queries about outsourcing development? feel free to contact us and get free quotations!
Also read: Staff Augmentation Vs. Project Outsourcing
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About The Author
My name is Stuti Dhruv & I am senior consultant at Aalpha, primarily working on pre sales, consulting with clients on latest technology trends.