In this article we will examine the different options to structure the payment for an outsourcing contract. Unit pricing, fixed/ variable pricing, cost plus profit, performance-based pay, profit/risk sharing and bundling are the most common approaches. The choice of the supplier as well as the pricing model depends on the business objectives of the buyer company.
Pay per Unit
In this method the vendor offers a unit-based set rate and the client company pays depending on the amount of usage. An example would be maintenance services, where the client pays for the number of units that avail the maintenance service.
As the name suggests, the client company pays a fixed rate under all circumstances. This looks like (and sometimes really works too) a viable option for many customers, as this way they can predict the costs. However this may not work well as the long term option, as you don’t get to avail lower costs when the market prices go down. Fixed rates again may not suit the vendor company very well, as they have to sometimes meet ever-increasing requirements for a fixed price.
Here the customer pays a fixed basic rate, but there is also the provision for extra payment for higher/ additional services.
Cost plus Profit
In this case the client company pays the service provider the actual costs and a fixed percentage enabling the service provider to make a profit. This scheme has little flexibility to accommodate changing technologies or business objectives. Moreover, the service provider/ supplier has little incentive to enhance their performance.
Performance based Pay
This is exactly the opposite of the previous option. The client gives incentives to the vendor for optimal performance. However the vendor often has to pay a penalty when the service levels are unsatisfactory to the client. A tricky proposition indeed, yet this is gaining popularity among outsourcing clients who have experienced poor levels of services previously.
The customer and vendor act like partners here. Both have their money at risk (though it may not be to equal extent). Each of them also have the opportunity to make profits if the vendor performs well and meets the objectives of the business.
This term is often applicable for IT services. The buyer pays a fixed price for two or more IT services or products bundled together. This is generally not a good option for the buyer. For instance, if you pay a fixed amount for a product bundled with certain services, you have to buy those services every time you buy the product, regardless of your need for it. Also it is difficult to distinguish how much you are paying for what or compare it with market rates.
Ideally, you should be getting an itemized bill- the vendor is more accountable this way. Further, it is easy for the buyer to direct the usage fee to the different user departments.
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