How is an Outsourcing Deal Priced?

Pricing models are important not just because they determine the cost. They have a significant effect on the outsourcing engagement.

How is an outsourcing deal priced?

There are multiple pricing models for outsourcing. It all depends on what the outsourcing client and service provider want to achieve.

Outsourcing pricing models can be broadly classified into two groups.

Input-based
Pricing is based on the service provider's input such as labour, time, and materials. For example, 200 agents for customer service at $5 per hour (average hourly wage of a customer service/call centre agent in the Philippines). Input-based schemes are cost-efficient. They are ideal for rules-driven services in a fixed environment. 

Output-based
Pricing is based on the outcome of the work delivered. For example, the client pays for the number of products that were successfully sold through leads that the service provider generated. Output-based schemes encourage collaboration. These are ideal for services that are likely to change because of business and technology.

Common Outsourcing Pricing Models

FTE
Pricing is based on the full-time equivalent (FTE). The FTE is the total number of billable hours by the employee. The fee varies based on the skills required and complexity of the process. Naturally, high level skills and specialised jobs will command a higher fee. This type of pricing model is common in BPO companies that provide offshore staff leasing services.

Unit
Pricing is based on a unit price for a particular level of service. The client pays based on the usage of that service. For example, in outsourcing IT support, you may pay a fixed amount per number of users or systems supported.

Fixed
Pricing is based on a flat rate no matter what the actual cost is. This provides predictable costs for businesses. The problem arises when the market pricing drops. The service provider has to meet service levels at a fixed price no matter how much resources they end up using for the outsourced services.

Cost-plus
Pricing is based on the actual costs and an agreed percentage of the profit. The percentage is used to cover the overhead costs of the service provider.

Performance-based
Pricing is based on the performance of the service provider. The service provider gets financial incentives for performing well, but they are also required to pay penalties for unsatisfactory service levels.

Risk-reward
Both the client and service provider risk a certain amount of money in the deal. They both stand to earn a percentage of the profits if the service provider meets the client's objectives.

Outcome-based Pricing
Pricing is based on the results of the service provider's effort. They get paid if they meet specific business outcomes. This is a popular alternative to input-based schemes because they focus on the results rather than the volume of work.

Gain-sharing
Pricing is based on the value derived from the service provider's expertise and contribution. This allows the service provider to determine the best way they can achieve results.

Incentive-based
The service provider gets bonus payments for achieving service levels that are beyond their contractual obligations. This is often used with input-based schemes such as the FTE or fixed pricing model.

Consumption-based
Pricing is based on actual usage of the service, such as the pay-per-use subscription. This is used in Cloud-based solutions.

How does the pricing model affect the outsourcing engagement?

Input-based schemes focus on technical service level agreements such as tasks. On the other hand, output-based schemes focus on business-oriented service level agreements such as outcomes.

If your business requires a specific volume of work, input-based schemes are suitable. If you are focused on desired results outcome-based schemes are better.

Outsourcing clients can also modify pricing models to suit their sourcing strategy.