Paying for results: how to structure an outcome-based pricing model
Behavioural economics tells us that people will pay a premium for something once they are certain it will deliver what they want. It’s no wonder then that outcome based pricing components are popping up in contracts for services ranging from outsourcing and consulting through to technology and marketing. Let’s look at each of these service categories and how suppliers can assume or share risk with their clients for mutual reward.
Outsourcing: a mature market
Business process outsourcing is one of the most mature industries with a risk and reward regime. Nearly every BPO contract has a KPI schedule so that if services aren’t delivered in accordance with KPIs, penalties kick in. In a customer service contract, for example, the client may pay 90% of the outsourcer’s fees in the form of hourly rates or per call fees, no matter what. But the remaining 10% (effectively comprising the vendor’s profit margin) might only be payable subject to targets being met for critical indicators of service performance, such as customer satisfaction or Net Promoter Score. In some cases, the client’s executives might have a significant percentage of their own compensation based on achievement of these KPIs, so it’s not surprising they would want their chosen outsourcer aligned to the same goals. As you can see, there are several outsourcing pricing models and you can find outsourcers aligned to your business outcomes here.
When the function being outsourced has a sales component (for example, call centre or face-to-face sales), the percentage the outsourcer places “at risk” can skyrocket to 100%, ie. the client pays a cost per sale or cost per lead.
Back office outsourcing is less likely to be priced purely on an outcome basis, however suppliers are likely to be asked to reduce their price where there are unacceptable levels of backlog or inaccuracy.
Consulting services: where outcome pricing is trending
While fixed price is the most common way consulting services are charged, followed closely by day rates or hourly rates, there is a notable trend towards outcome-based pricing. One of the key reasons is that consultants no longer just help with strategy, they are often hired to deliver their recommendations as well. If a consultant is responsible for the “end-to-end”, then it’s fair to hold them accountable to some degree. One way of holding someone accountable is tying payment to delivery of agreed outcomes.
A classic case where the outcome-based model works well for both parties is when a consultant is hired to reduce cost in a very clear and narrow area, and then receives a percentage of the savings identified and implemented. This could be a consultant doing an audit of a client’s telecommunications expenditure, and restructuring fees and terms with the telco, or even running a fresh procurement process to identify cost savings.
Partial outcome-based pricing is more suitable when there are external factors, outside the consultant’s control, which influence the outcome. For example, a sales optimisation consultant might be so confident that their methodology will boost a client’s sales, they might be willing to put 20% of their fees at risk based on top line results improving within six months (they are still relying on the sales people to execute on their methodology, so a 100% risk model is unfair). Or a customer experience consultant might charge for time and materials at cost, and x dollars for every percentage point increase in customer satisfaction over a defined period.
Technology – outcomes can be mission-critical
Constant (99.999%) availability, or up-time, is an outcome that all users of technology desire. Outages can therefore cost a supplier dearly if the client has been wise enough to negotiate this upfront. Other outcome-based components include:
- If a client has a mission-critical deadline, the supplier may be paid a portion of its fees for on-time implementation.
- Time to respond to major incidents and fix issues – the best technology in the world fails without satisfactory customer support.
- Paying only when the technology is used – a good analogy is when government hires a private sector company to build a tunnel and the company receives toll revenues every time a vehicle passes through the tunnel. The same scenario can apply for a variety of bespoke software contracts.
Performance-based marketing is thriving
Thanks to data analytics, performance-based marketing is thriving, as the digital world enables us to measure every click, registration and sale. To the delight of clients, savvy digital agencies are now able to base part of their charges on realising pre-defined outcomes for marketing campaigns, such as a click rate or “share/like” rate on social media. A content marketing agency might put a percentage of its fees at risk based on statistics around unsubscribe rate and spam reports.
When should outcome-based pricing be considered?
While outcome based pricing is a trend in B2B service contracts, bear in mind it’s not a suitable structure for every contract. As a guideline, it’s more likely to work if your project or supplier relationship falls into at least one of these three buckets:
- Projects with black and white outcomes lend themselves to outcome-based pricing. Examples: you hire a bid management consultant to assist you with a tender, and you pay a bonus if you get shortlisted, or win; you hire a digital marketing agency to get you on page 1 of Google within 3 months with a certain budget – and the agency doesn’t charge you a cent until this happens; or you hire a customer experience consultant to recommend changes to lift your Net Promoter Score and you pay for every percentage point increase.
- Strong, existing relationship – if you have worked with a supplier for many years, and they know your business inside out, there is going to be more trust and less risk involved in pricing based on an outcome.
- The supplier has control over the end-to-end delivery of the project.
In Matchboard’s experience, it’s only a minority of service contracts that work well in a 100% risk environment. The majority of engagements are successful when risk is shared and both the client and supplier are invested in the same outcomes. As to what percentage is ideal to pass to the supplier, there is no golden formula, with factors such as historical data, industry experience and prior relationship coming into play.
Need help in structuring outsourcing pricing models with your supplier(s)? Contact us!
This post was authored by Sharon Melamed. With 25+ years’ experience in outsourcing, consulting and business development in Australia, the US and Japan, Sharon helps construct and promote innovative pricing frameworks which result in win-win partnerships. Sharon can be contacted at firstname.lastname@example.org or connect with Sharon on LinkedIn.