- Post 07 March 2013
Consumption-based pricing model
This is a highly dynamic model in which the costs are allocated based on actual resource usage. This model is highly suited for outsourcing organizations that have to contend with issues, such as service provider productivity and variable demand. This model is well suited in situations where the fixed costs could be shared across many customers. Consumption based pricing delivers substantial productivity gains and makes cost structure analysis and adjustments relatively an easy task. Furthermore, this model converts capital expenses into operating expenses.
Despite these merits, this model requires a fairly accurate prediction of demand so that service providers could adequately provision their resources. Furthermore, for low transaction volumes, the unit price of an individual transaction may be prohibitive. Besides, due to the changing demand pattern, it is a challenge to predict annual growth rates. From the service provider's perspective, the service provision costs could be directly attributed to the services delivered as measured in terms of resource units. The service provider also bears the risk that the resource units consumed are less than that required to break even and will not thus be able to cover fixed costs. These costs are then passed on to the client, who bears the now pays inflated prices so that the service provider could cover its fixed costs and make a tidy profit on top.
Profit sharing pricing model
The profit sharing pricing model is an outcome-based pricing model. This framework is based on incentivizing and rewarding the service provider for increasing the overall value delivered to the outsourcing organization beyond what is contractually expected from the service providers. Much of the value is deriving from the service provider's expertise and contribution. Such overall economic value addition is typical of strategic partnerships and alliances outsourcing models. This model is highly unsuited in condition where cost savings are the main fulcrum of an outsourcing engagement. Typically, customers seeking this contractual model do so because they rely on specific expertise from their service providers. These customers, hence, expect dramatic business improvements, which are typical outcomes of the transformational outsourcing model.
This model encourages and empowers service providers to engage in collaborative and creative problem solving as they work with the client organization towards achieving mutually beneficial business goals. This model, therefore, instills the service provider with a greater degree of freedom to best to achieve tactical and strategic business results. For a successful outcome, this model requires a high level of trust to exist between the participating organizations, equal distribution of risk and reward, and significant upfront investment. In general, the profit participation is closely linked to the risk sharing.
Typically the service provider, to the extent of its ability to influence the results, will adjust risk-taking.
An interesting feature of the profit sharing pricing model is that it is not the input that is rewarded, but rather the bottom line the client organization expects. Hence, this model differs substantially from other incentive based models.
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