Analytics Insight | December 28, 2022 | Key to Successful Evaluation
To businesses following a Fixed-Price Pricing or even Time & Material model in 2022 — hate to break it, but linear pricing is struggling.
In a recently conducted Enterprise Customer Success Study and Outlook survey, Deloitte researchers found that 76% of enterprise customers were keen to discuss outcomes with their IT providers. The evolution of customer preferences has begun. Surviving in today’s volatile market scenario without a progressive monetization strategy is as difficult as it gets. This is where outcome-based pricing comes in.
Customers seek high values first; industry giants have cracked this code and are charging based on the outcomes they deliver or pay-as-you-go, not fixed rates. But should hypergrowth or mid-size enterprises care? I think so. Outcome-based pricing could give such businesses a much-needed boost with a lower initial capital requirement despite the high uncertainty factor.
The emergence of outcome-based pricing
Pricing is an exchange rate for the value an enterprise offers to the market. But here’s the problem: the market is always out of control. Effort-driven services leveraged traditional pricing strategies, including cost/value-based or market/competitor-based in the yesteryears. Then the pandemic happened, and the market has been volatile like never before.
Simultaneously, we saw the advent of an all-digital world in which the traditional models were incompatible with technology-led disruption and increased clients’ demands of higher value and reduced costs over bone-stock product features.
Outcome-based pricing rose as the well-deserved shift from traditional pricing. The “why” is simple. In 2023, customers will have loads to choose from. It’s all about linking the cost of service to the value derived from them. These models are flexible enough to take various shapes and forms depending on the client’s unique situation and the nature of the business. IT companies that commit to certain outcomes and promise an attractive ROI will have the upper hand.
Outcome-based pricing models have multiple variations, including:
- Progressive value-sharing model: When providers deliver incremental value over time, they are incrementally paid more. Quite fair, honestly.
- Utilization-based model: Here, the service provider charges their clients only for the services they utilize, or simply put, based on consumption, in other words, pay-as-you-go.
- Expense-sharing model: The parties split some of the costs in this model. In a different variation, the provider is responsible for covering any deviations from the agreed-upon result greater than a certain amount.
- Mixed-hybrid model: Tailored to specific enterprise requirements, here, a fraction of the incentive is fixed, and the remaining part is contingent on performance.
One-size-fits-all approach or not?
Not as far as we can see. While outcome-based pricing can reap rich rewards, it requires thorough consideration. Although many of Movate’s clients have 10x-ed their business with these models, we have advised quite a few to choose alternatives.
Clients and providers engaging in an outcome-based model must thoroughly study every underlying parameter in detail — the client’s need for control, investment requirement, plans, and scaling vision, and the provider’s current operational expertise, risk appetite, and core competence. Blanket adoption without due diligence only leads to failure. However, overcoming the temporary roadblocks with strategic planning leads to incredible paybacks.
Outcome-based pricing for the win
More customers, more revenue
Outcome-based pricing makes increasing revenue and customer retention easier for IT companies. First, customers today only continue using and referring service providers to others if they consistently exceed expectations. Post the initial contract, repeat service agreements, project-based service agreements, etc., are governed by the provider’s performance. This strategy creates a win-win situation for both clients and providers.
Flexibility in pricing
Enterprises want to avoid paying for lofty promises and ill-fated efforts; outcome-based pricing solves this challenge by charging for practical solutions and results while eliminating unanticipated costs and haphazard budget provisioning.
Risk-sharing
Outcome models transfer the risk to the provider significantly from the client. Service provider revenues are a direct reflection of customers’ business outcomes. Being bound by a risk-sharing engagement in hand cuts out any room for slack and motivates the provider to perform better.
Addressing the key challenges
Despite numerous benefits, even outcome-based pricing has its fair share of roadblocks. Forecasting the efforts or resources, factoring the risk-to-reward margin, and integrating both into a mutually agreed pricing strategy is complex.
Getting the metrics right
Establishing an array of outcome metrics on which all stakeholders of the corporate hierarchy can mutually concur is the most difficult struggle. In most cases, the metrics that the customers prioritize vary from those that the provider finds important. The outcomes must be carefully drafted by having both parties on the same page.
Utilization of resources
When a provider willingly pivots toward outcome-based pricing, instances, where the capacity fluctuates from predicted results, are common. Thus, the provider must revise its resource allocation capabilities for optimal utilization and better output.
Managing expectations
Macroeconomic factors, like declining revenue within or across industries due to external influencing factors or changing priorities with internal challenges, can impact the results and should be factored in.
The right tool in your enterprise arsenal
Customers today are highly value-driven and cost-conscious. The key to customer acquisition and retention in today’s market is constantly reinventing ideas and revamping operations.
Outcome-based pricing is definitely an answer. But right now, pure outcome-based pricing excels in a limited number of environments. It is only for some, but if chosen with the right awareness, shared enthusiasm, and proper approach, it could significantly boost your business growth with predictability, transparency, and flexibility in budgeting and pricing.