the pricing model should be based on the appropriate type of contract and the incentives used to reward
the outsource provider. Other important considerations are the length of the contract and the prospects
for stable demand and funding. The outsource
provider will use all four of these factors to calculate
the price for its services.
Selecting the right type of contract
Most companies rely on one of two contract types
when building a pricing model for their outsourced
business arrangements: cost-reimbursement or
fixed-price. In both cases, a company is expected to
pay the outsource provider for its costs and a profit
for performing its services.
Cost-reimbursement contracts
Under a cost-reimbursement contract, a company
pays its outsource provider the actual costs of performing a service. By definition, a cost-reimbursement contract is a variable-price contract, with fees
dependent on the amount of service provided over
a specified time period.
In addition to paying for actual costs incurred by
the outsource provider, the company pays the
provider a profit through a fixed fee; a variable profit such
as a fixed percentage markup linked to costs; or a variable
profit tied to prearranged targets.
One of the primary disadvantages of a cost-reimbursement contract is that the outsource provider has no real
incentive to control its costs. If the fee is calculated as a percentage of the provider’s costs, then as costs increase, the fee
increases, too. If the provider manages to reduce costs, it is
effectively penalized by reduced revenue and profits.
To address this issue, some companies are incorporating
cost-based incentives into their pricing models. In these
cases, outsource providers are rewarded with a gainshare in
return for reducing costs. The company that is outsourcing
and the outsource provider share those savings.
Fixed-price contracts
In a fixed-price contract, the outsource provider’s price is
agreed upon in advance and is not subject to any adjustments. As such, the price the customer pays is fixed and
includes the provider’s costs and profit. A fixed-price contract therefore eliminates budgeting variation for the company that is outsourcing. Fixed-price contracts also are the
easiest type of contracts to administer because there is no
need for the company to keep track of actual costs to determine payment.
This type of contract places full responsibility for costs on
the outsource provider. Its ability to manage costs directly
impacts its ability to make a profit. The better the outsource
EXCERPTED AND ADAPTED FROM VESTED OUTSOURCING: FIVE RULES THAT WILL TRANSFORM OUTSOURCING, BY KATE VITASEK WITH MIKE LEDYARD AND KARL
MANRODT. PUBLISHED BY PALGRAVE MACMILLAN, 2010. REPRINTED BY PERMISSION OF THE PUBLISHER.
