How ITO pricing models will change through 2016

Posted: 01/25/2016 - 21:35

It wasn’t all too long ago that pricing models offered by information technology outsourcing (ITO) services and firms fell strictly into the “static” category. In fact, thinking of these agreements as anything but fixed or rigid in nature simply didn’t make much sense based on the layout of the outsourcing landscape. Customers requested a certain type of IT or software development and service providers fit this requisition into an inelastic pricing structure that had little room for change or adaptability.

However, with the new year now well under way, the various trends and developments within this industry point to the growth of considerably more flexible – and effective – alternatives to these static selections. With this in mind, let’s spend a few minutes taking an inside look at the major shifts currently taking place within IT pricing models, as well as what these changes could mean for the future of outsourcing firms and services.

Firms are moving toward scalable pricing models that match the needs of the project at hand

The first big shift within pricing models for 2016 comes in the form of scalable models that focus on the specific requirements of each individual IT project. At its core, this change boils down to the realisation that outsourced IT contracts have become far more specialised in recent years, thus creating an industry in which the “one size fits all” pricing model simply isn’t applicable to client needs anymore.

So what does a scalable model look like in action? It honestly depends on the desired app or web service development of the client. Instead of purchasing a set or “packaged” development solution, consumers now expect to pick and choose from numerous services as they need, thereby creating a scalable solution. Some of the most commonly requested unique services that come together and build into this scaled response include:

  • Web development (Java, PHP, etc.)
  • Software-as-a-Service (SaaS)
  • Mobile app creation (iOS, Android, etc.)
  • eCommerce development (Magento, custom platforms, etc.)

As EM Rawes of The Houston Chronicle points out, this type of pricing model helps keep costs competitive for enterprise consumers, all while ensuring that the IT firm on the other side of the equation retains sustainable profit margins. Going a step farther, the meteoric rise of cloud computing connections and web-based IT services stands as the much needed foundation upon which effective and scalable solutions can grow and prosper as we head through the 2016 calendar year.

Hybrid pricing models that rethink the client/vendor relationship are gaining serious ground among IT vendors and firms

Hybrid pricing models often combine traditional cost and allocation structures with innovative contract agreements and performance metrics. In doing so, outsourcing firms are able to offer a specialised approach to the development process, all while embracing the varied nature of most IT contracts and the increasingly interconnected relationship between service provider and client.

“The better contracts aspire to satisfy the customer across prioritized business objectives that were either unable to be converted to traditional service level agreements or reduced to a performance specification.” – Steve Martin, via Stephanie Overby of CIO magazine.

This viewpoint, as explained by Stephanie Overby, showcases the appeal found within the hybrid pricing model approach. Having flexibility helps handle the demands of a project, all while retaining an equitable exchange of resources and incentives between client and outsourced IT professionals.

In terms of actual models that are picking up steam in the modern IT landscape, the following examples lead the pack:

  • Gain-Sharing. Within this model, the outsourced firm helps cut the costs of the client in exchange for a portion of the revenue generated on the consumer-side of this process. More specifically, the IT vendor can improve operational network efficiency, reduce power consumption, or even lower bandwidth utilisation as part of this “shared gains” agreement.
  • Incentive-Based Pricing. By subscribing to an incentive-based model, the firm in question receives additional compensation as they meet or exceed key performance indicators (KPIs) or other metrics and benchmarks set forth during the contract negotiation process.
  • Risk-Reward Model. The service provider enters a joint investment agreement with the client as a way to take part in the rewards – and mitigate any potential risk – that come with the successful completion of the project.

It doesn’t take much to see that each of these models approach the client-vendor bond from a variety of different angles. As this relationship continues to evolve, there’s plenty of reason to believe that these hybrid pricing models will also adapt at a similar rate that keeps pace with this growth.

Raw profit-driven models have lost ground to structures that promote market share

Much like the recent spread of pricing models that provide compensation from non-conventional sources, Varun Sood of Livemint reports that models that focus on increasing total client numbers and market share are on the rise as well. The big key here is that letting go of raw profit-driven approaches and taking a hit to short-term profitability promotes brand longevity, all while developing a scenario in which sustained growth can take place.

Not surprisingly, those firms that have embraced this approach are the ones that have a propensity to run “lean” within their services offered. More specifically, these IT firms keep operating costs low, all while providing competitive services and support; both key functions of the market share model.

As far as actual tactics that fit into this model go, offering up pricing discounts for enterprise and small-scale clients alike serves as a key contributor to the process. Additionally, Sood also notes that being flexible during the bidding phase of the relationship and thinking long term with organisational decisions help round out this lean approach.

Licensing fees are taking a back seat to maintenance costs and renewable revenue 

Another major shift taking the industry by storm during the transition to 2016 revolves around the diminishing influence of licensing fees within the IT development process. Instead of hammering out the details surrounding upfront investments that gate access to perpetual software rights, customers of all shapes and sizes prefer agreements that focus on smaller, recurring maintenance fees.

Yes, this “renewable” revenue doesn’t provide the same immediate impact as the big upfront licensing fees that once dominated the IT outsourcing marketplace. However, as the team of industry experts at PricewaterhouseCoopers point out in their review of current industry trends, IT service providers don’t really have much of a say in the matter when it comes to the adoption of this process.

“Vendors have seen license revenues decline and as a result are more dependent on maintenance revenues.” – ‘Software Pricing Trends’, PricewaterhouseCoopers

Consumers within this portion of the digital ecosystem simply don’t want to deal with the hassle of large upfront expenditure. This means that vendors must either acquiesce to this rising demand for provisioned infrastructure and make due with a pricing model that hones in on maintenance and upkeep fees or run the risk of being driven out of the market by competitors who are willing to play by this new set of rules.

Fortunately, the aforementioned ability of outsourcing IT services to run on lean pricing models helps accommodate this renewable revenue approach. Margins are often lower via this approach, but the sustained influx of profits driven by smaller, recurring payments promotes sustainability over a much longer timeframe.

Pricing models must shift to accommodate customer expectations and behaviour

The team from PricewaterhouseCoopers also explains that pricing models in 2016 must shift to accommodate changing customer expectations and behaviours. Without this new mindset leading the way, it’s only a matter of time before a significant portion of clients become disgruntled or disillusioned with the IT development experience.

“Software prices are under pressure from constrained IT budgets and customer perceptions that software is overpriced.” – ‘Software Pricing Trends’, PricewaterhouseCoopers

Whether or not this viewpoint is correct is irrelevant to the situation. Prospective clients will continue to behave in a manner that promotes this mentality, so adjusting pricing models to accommodate the pressure set forth by these expectations is the only viable option in 2016 and beyond.

Thankfully, some tweaks and adjustments to the presentation of software pricing and contract agreements can help assuage the concerns of vendors who struggle with this developing trend. The following tactics currently lead the charge on this front, promoting a better connection between the services offered by an outsourced firm and the expectations of consumers within this sector:

  • Access to alternative pricing or contractual structures.
  • Delivery models that partition the fiscal burden and limit upfront expenditure.
  • A willingness to work through the resistance shown toward renewals and upgrades via appealing and informative marketing practices.

For the IT vendors that truly understand the mindset of the consumer, these suggestions are just the tip of the iceberg in terms of tactics that resonate with the modern outsourcing client. Learning more about the needs and motivations of this audience can ensure that a wider variety of applicable responses enter the lexicon of IT firms and professionals.

Vendors are adopting multiple pricing models to ensure coverage for all types of clients

Finally, and perhaps most importantly, is the growing number of IT vendors who are willing to adopt multiple pricing models as a way to handle the needs of a wider cross-section of clients. While some small portion of the outsourcing industry still vehemently clings to a singular pricing model, the experts from PricewaterhouseCoopers go on to explain that these vendors represent only a small minority of the players in the modern marketplace.

The truth of the matter is that with each passing day, the needs and desires of the target audience of IT vendors grow more complex and varied, so adaptability is vital if a firm plans on operating in this sector of the digital world. It might not seem like a major issue now, but the threat of lost business opportunities and potential revenue looms ever closer for brands that aren’t capable of offering up multiple pricing models to their prospective clients.

From scalable solutions and hybrid models, to the shift from licensing fees to maintenance costs, any and all of the previously reviewed models can end up being utilised by a vendor as it handles the needs of multiple clients. The big key here is that flexibility and working around the unique requirements of the client – and not latching on to one particular pricing model – is crucial to the success of IT outsourcing firms in 2016.

Looking to the future

By now, the message should be crystal clear regarding the state of pricing models for IT outsourcing services and firms in 2016 and beyond. A vast set of changes and shifts are currently underway, which in turn has led to the constantly fluctuating and evolving marketplace landscape now experienced by the industry.

In total, the following six movements should define the 2016 experience for IT vendors as these firms continue to optimise their ability to accommodate the needs of enterprise and small-scale clients:

  • Firms are moving toward scalable pricing models that match the needs of the project at hand.
  • Hybrid pricing models that come in a variety of forms are gaining serious ground among it vendors and firms.
  • Raw profit-driven models have lost ground to structures that promote market share.
  • Licensing fees are taking a back seat to maintenance costs and renewable revenue.
  • Pricing models must shift to accommodate customer expectations and behaviour.
  • Vendors are adopting multiple pricing models to ensure coverage for all types of clients.

Considering the expansive nature of these shifts, it’s hardly unrealistic to assume that the 2016 pricing model outlook will look nothing like what IT firms and vendors are familiar with from the previous calendar year. However, by taking the time to become familiar with these changes in the present, organisations that fall into this portion of the digital marketplace can gain a leg up on the competition and prepare for the lasting ramifications that come with these developments in how IT outsourcing firms handle contracts and pricing with future customers and clients.


About The Author

Sameer Jain is the CEO of Net Solutions, a digital solutions provider serving businesses across six continents including customers like Microsoft, Xerox, Mothercare and IMG. He is an entrepreneur with over 20 years of professional experience in the digital technology sector, with a focus on consumer internet and mobility. Sameer is the Co-Chairperson for NASSCOM as well as a member of CII’s National Committee on IT & ITeS. He has also been featured in global publications of repute such as The Wall Street Journal, Entrepreneur and Inc magazines.