Once upon a time, application development and maintenance (ADM) outsourcing was done via the staff augmentation or time and materials model. It was the proverbial lose-lose. Customers could end up paying more than they should and providers could wind up with slim margins.
Over the years, the preferred model for ADM outsourcing matured became the fixed-fee contract, whereby clients pay a set amount of money for specific amount of work. Clients liked fixed-fee deals because they feel they were more likely to get what they paid for and suppliers appreciated them because they could appropriately staff their deals and increase their margins a bit.
However, in recent years attention has shifted to the managed service model. Managed service pricing is seen as the "holy grail" of ADM pricing models, says Steven Kirz, principal with outsourcing consultancy Pace Harmon.
"Managed service deals focus on meeting the client's exact requirements regardless of how a supplier chooses to staff and service it," Harmon says. The client establishes the outcomes and service levels and the supplier delivers based on their own methodologies, processes, tools and locations. In theory, it's a win-win arrangement. The client gets requirements met more economically than with the other previous models. (Kirz says he's seen clients cut their costs in half over the course of a five-year management service deal.) The supplier gets increased flexibility and margin opportunity in exchange for taking on more risk.
But if it were easy, everyone would already be doing it. CIO.com talked to Kirz about the challenges of the managed service approach to ADM outsourcing and how to overcome them, why an effective outcome-based relationship requires more than new pricing, and what a successful managed service deal looks like.
CIO.com: How difficult is it to apply outcome-based pricing to ADM deals?
Steven Kirz: It doesn't have to be difficult if the client fully understands their requirements and how to effectively measure outcomes for both application development and maintenance. Truth be told, however, the art of translating requirements into a plan that can be aligned with realistic pricing requires expertise and deep marketplace knowledge.
For outcome-based pricing in application development deals, you're paying to create an application that performs to particular specifications. Whether you're paying a fixed-fee or viewing it as outcome-based, the end result is the same. In good ADM deals, the client only pays if the application is delivered and works based on requirements.
We've seen outcome-based pricing work well for application development deals. Outcome-based pricing can work well for application maintenance deals as well. For example, if a company needs to maintain a suite of ten applications but two aren't profitable, then a supplier may be contracted to retire the two underperforming applications and then receive part of the savings generated by the company not having to maintain them anymore.
Sign up for CIO Asia eNewsletters.