New Trends in IT Outsourcing Service and Pricing Models

New trends in IT outsourcing service and pricing modelsNowadays IT outsourcing is not any more or not only about titanic cost savings. It’s a smart business move to cover the lack of specific expertise and an access to better capabilities to fulfill your IT needs. Moreover it’s freeing up your in-house resources to focus on strategic business issues.

This article compares the emerging and trusted business models that govern relationships between customers and IT outsourcing services providers; highlights problems of management of outsourced projects; tells about challenging though promising trend in IT outsourcing – the IT Service Integration.

Business model maturation is currently on notice

This year tendencies show that the evolution of the IT outsourcing market is perplexed with the deterioration/decline of the economic situation in both the U.S. and Europe. While building a long-term, healthy relationship with customers, IT leaders should not only be well-versed in the latest technologies and service provider offerings, but also parlay/stake on innovation and high performance.

Clients seek better incident, problem, and change management. They require outsourcing services suppliers to either integrate with or adopt cloud-based service management systems for service management activities and to determine the level of control, quality and communication. Pricing flexibility is not just a demand, it’s a must already, important to support improved process automation and healthy innovation pools. Choosing a right business model can reduce outsourcing risks dramatically.

Modern and Conservative Pricing/Business Models

Currently outsourcing companies invent and adopt new pricing models to lure the client with a more creative fee structure. At least four business models have emerged through the past year and even gained some popularity. Among them: gain-sharing agreements, incentive-based contracts, shared risk-reward arrangements and demand-based pricing. Each has its unquestionable pros and substantial cons. Anyhow they’re derivatives of the conservative or so to say “old” business models being adopted to specific client’s needs or project peculiarities.

The classic business models are considered to be a fixed-cost model, time and material and cost-plus model or its more popular modification – dedicated team model. Though it’s said and written a lot about them, we’d like to accentuate the main features of each.

Fixed-cost

It’s a truly ideal model for really small or pilot software outsourcing projects. Though it is falsely considered to be the cheapest one. Being the less flexible – the client pays not only for the time spent on the project but for all outsourcing risks put in it, namely the pricing mechanisms built into fixed-price deals are opaque. Why does it happen? There is a variety of causes: 1. The project is usually estimated by a team leader or senior technical specialist and can be executed by a middle or even junior staff. So the quantity of hours spent on this or that feature grows. 2. Your project can contain some unique features that the developers hadn’t faced yet. They put in the additional time for force majeure. Summing up, with the fixed-cost model the requirements need to be well-defined upfront to get the most reasonable price and, what is even more important, the quality of your software project.

Time & Material

Here you get an hourly rate and much more freedom to make changes or enhancements in your software development project. The model is great when you should start a project right away and the documentation isn’t ready yet. The developer’s rate encloses outsourcer’s revenue, programmer’s retention, vacation and sick leave, taxes, etc. The client can find several minuses in this model:

  • you rarely communicate or even know the real developer of your project. Communicating through the account manager or a tech lead just adds another chain in a line, which can lead to miscomprehension;
  • you have little possibilities to express negative feedback, reward for a good job or stimulate innovation;
  • you can’t set up and monitor the actual development process (Agile, SCRUM, etc);
  • you should be techie to understand how much time should be spent on this or that project iteration in order the timing be adequate.

Dedicated Team Model

This model is relatively new, but has already proved its effectiveness. The one objective minus/drawback of the model – it’s too bulky for little projects and is oriented on long-term partnership. You can take a look on a more elaborate article on this issue “Agile Dedicated Teams, or How to Make Outsourcing Software Development More Reliable” The main advantage is that staff is picked according to your project needs, works on your project exclusively and follows your development methodology of choice.

What does the client pay for? The pricing mechanism is the following:

Developer’s salary + Company’s management fee.

By the way, this agreement model answers another hot question in outsourcing software development: “How to get innovation from an outsourcer?” Indeed, no innovation is reasonable at a fixed cost agreement, since there is a risk to exceed the estimated development time. In the Time & Material model the customer risks to exceed his own budget immensely. And in both cases a collaborative innovation process is obstructed by the lack of personal communication between a customer and a development team. A client has no opportunity to initiate any reward or recognition programs tied to idea generation and corporate level goals incidental to innovation. The Dedicated Team model can solve the aforementioned problems.

But here we have a crucial problem of the team management: whether to outsource or keep in-house

Dedicated team management

Many outsourcers meet the idea of outsourced management of a dedicated team with warranted fox-guarding-the-henhouse concerns as it may add redundant/surplus complexity to the arrangement and additional investment. Opinions vary significantly. Though when inspecting the problem in detail from the point of the Integrated Outsourcing approach it becomes apparent that an internal management ensures the client receives a best-in-class approach and a more flexible and healthy service. Consequently the initial investment is usually offset by delivery cost reductions. The Service Integration adoption service increases the value growth by exposing development process flaws, revealing additional savings/cost reductions.

Service integration is a trend now

It means to get a plenty of high quality IT services like IT infrastructure, networking, application development, help desk from a single service provider or from several ones (in case of multi-sourcing). And if Service Integration is executed properly, then it can be an effective tool for driving down costs, improving customer satisfaction and reducing risks in the end-to-end service.

To provide an Integration Service a company requires high experience, scale and maturity. Hence this kind of service still is a great challenge for most IT outsourcing companies. The thing is the value gained from outsourcing is not tied explicitly to the lower salaries or an individual developer’s performance, but to a more effective organisation.

Conclusion

Market players now expect more value from their IT outsourcing service providers and they want potentially higher-margin work in a turn. Enterprises should constantly keep an eye on the emerging options to get the utmost from their outsourced deals. Right away the market offers a new level of service quality – IT Service Integration. Let’s follow up this evolution and reap the benefits.

February 22, 2013

About the Author

Dmitriy Kharchenko

is the CEO at Acceptic Ltd, a Ukrainian software development company. Acceptic provides custom Web application development, .NET programming, as well as dedicated development teams for companies from the USA, Europe, and Australia.

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