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Outsourcing Journal, May 2006

IT Outsourcing and Pricing: How Much, How Long, and What to Price?

By Frank Usher, Everest Group

Pricing is always primo for buyers of outsourced services. Asking the right questions helps buyers achieve the appropriate price. Learning how suppliers price IT deals will help you prepare the proper questions.

IT pricing has three main attributes: how much, how long and what elements you need to price.

The "how much" is a subjective number, which is totally dependent on the current position of the buyer and what it hopes to accomplish. The most straight-forward pricing is "the same scope for less." That is everyone's underlying desire. The key in this approach is deciding what "the same scope" is, and is that what the buyer really needs.

A more realistic approach is to identify all goals in the purchase. They could be such things as improved processes, investment avoidance, or access to additional skill sets. As a result of broadening pricing goals, the best answer may be not a price decrease, but rather improvement in performance or quality areas or avoidance of future costs. Irrespective of the outcome, one should be sure that the base financial business case takes all the variables into consideration when comparing with supplier pricing.

The next determination is "how long?" The length of the contract should be the minimum length that does not create an economic disadvantage for either party. The contract has to be long enough for a supplier to recover investments, either one-time costs such as transition or implementation of a new ERP, and still provide the desired annual cost for the buyer.

In addition, the length of the contract needs to reflect the ability to forecast changes in the buyer's business or paradigm changes in how the services are delivered. For those reasons, it is not uncommon to have different contract lengths for components in an outsourcing arrangement. A classic case is a shorter term for desktop services than data center services which involve consolidation and relocation.

Determining What to Price

The final area is deciding what elements to price. As a core principle, pricing needs to be at the highest level possible, such that it doesn't shift risk between the buyer and supplier. By that I mean that pricing every single variable is of marginal value and creates an administrative nightmare. On the other hand, too much consolidation of the pricing obscures some of the major elements that drive cost and preclude the buyer from participating in savings that should be made available to the buyer.

The principles apply to all outsourcing, but for illustrative purposes, let's consider desktop pricing. A buyer could pay a supplier a per-seat price for each user that would include desk-side support and help desk. The agreement could also include some amount of installation/move/add/change activity and refresh of the PC asset. Before agreeing to this consolidated view, one must ask what changes could take place that would significantly alter the supplier's cost of providing services and result in savings for the buyer.

First, let's look at help desk. Two elements could be affected: the cost of labor and the frequency of the calls. Where the supplier answers the calls determines the labor cost. Using an offshore supplier provides a significant cost advantage to on-shore support. If the supplier priced the contract using on-shore labor and then moves offshore, it's difficult for the buyer to receive the full cost benefit.

The stability of the applications and the amount of user self-help is the second parameter of volume that could be significantly affected. Both would drive down the number of calls to the help desk. If an underlying assumption in the consolidated pricing was a call volume that did not reflect the impact of improvements driving down the call volume, the buyer would be hard pressed to recover the full value of the savings.

Installation/Moves/Adds/Changes (IMACs) are another area to consider. Suppliers can accomplish more and more installs and changes remotely without the need to dispatch a technician. If the contract pricing is based on technician dispatch, then the buyer loses some potential for savings in the bundled approach.

Finally there is the cost of the PC. The inclusion or exclusion of the asset refresh price is largely a matter of the purchase leverage that a supplier can bring. In most cases where there is a large installed base, the supplier has little purchase leverage. In addition, the actual cost of the PC has pretty much leveled off, with the difference being a more powerful PC for the same dollars. The key is that the buyer must keep the assets current to ensure efficient supportability by the supplier.

To sum it up, pay attention to the details when setting pricing strategy. Make sure that it is structured to get the buyer needed visibility into areas that have some significant potential for change while not making the pricing needlessly complex.

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