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What is outsourcing? Definitions, best practices, challenges and advice

Stephanie Overby | Nov. 8, 2017
Outsourcing can bring big benefits to your business, but there are significant risks and challenges when negotiating and managing outsourcing relationships. Here, we break down everything you need to know to ensure your IT outsourcing initiatives succeed.

In today’s cloud-enabled world, however, IT outsourcing can also include relationships with providers of software-, infrastructure-, and platforms-as-a-service. In fact, cloud services account for as much as one third of the outsourcing market, a share that is destined to grow. These services are increasingly offered not only by traditional outsourcing providers but by global and niche software vendors or even industrial companies offering technology-enabled services.

 

IT outsourcing models and pricing

The appropriate model for an IT service is typically determined by the type of service provided. Traditionally, most outsourcing contracts have been billed on a time and materials or fixed price basis. But as outsourcing services have matured from simply basic needs and services to more complex partnerships capable of producing transformation and innovation, contractual approaches have evolved to include managed services and more outcome-based arrangements.

The most common ways to structure an outsourcing engagement include:

Time and materials: As the name suggests, the clients pays the provider based on the time and material used to complete the work. Historically, this approach has been used in long-term application development and maintenance contracts. This model can be appropriate in situations where scope and specifications are difficult to estimate or needs evolve rapidly.

Unit/on-demand pricing: The vendor determines a set rate for a particular level of service, and the client pays based on its usage of that service. For instance, if you’re outsourcing desktop maintenance, the customer might pay a fixed amount per number of desktop users supported. Pay-per-use pricing can deliver productivity gains from day one and makes component cost analysis and adjustments easy. However, it requires an accurate estimate of the demand volume and a commitment for certain minimum transaction volume.

Fixed pricing: The deal price is determined at the start. This model can work well when there are stable and clear requirements, objectives, and scope. Paying a fixed priced for outsourced services can be appealing because it makes costs predictable. It can work out well, but when market pricing goes down over time (as it often does), a fixed price stays fixed. Fixed pricing is also hard on the vendor, which has to meet service levels at a certain price no matter how many resources those services end up requiring.

Variable pricing: The customer pays a fixed price at the low end of a supplier’s provided service, but this method allows for some variance in pricing based on providing higher levels of services.

Cost-plus: The contract is written so that the client pays the supplier for its actual costs, plus a predetermined percentage for profit. Such a pricing plan does not allow for flexibility as business objectives or technologies change, and it provides little incentive for a supplier to perform effectively.

 

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