Companies in the service-driven industries like software development, IT services, engineering design and services (ER&D), new product development, construction and other professional services, have a unique business model. These companies typically send bids or proposals with a quotation in response to the RFP (request for proposal) and many time the lowest bidder with a reasonable quality wins the project contract. So the project pricing strategy becomes important for these projectized companies.
The project pricing or billing is driven by two components
- Estimation of the total time required to deliver the project, which is based on the project scope
- Project delivery deadlines might stipulate the time to deliver irrespective of the project scope
- Depending on the project scope and delivery deadline, the service vendor estimates the resources required to do the project
- These are engineers and other experts and their costs are dependent on their skill levels
There are many variants of the project pricing or billing contracts, let’s understand the most prevalent types of project billing contracts
Types of Project Pricing/ Billing Models
Time and Material Contract
In this model, the service provider offers their resources (skilled labor) to dedicatedly work for the user company. In turn, the product company pays a service fee for buying their time and getting the service. The per unit rates for various categories of resources (for example senior engineers) are predefined in the contract.
In this model, it is often the responsibility of the user company to assign work/task to the resource. Periodically, the product company pays a service fee to the service provider for the work executed by the resource.
This model is more suited for software development projects that do not have a pre-decided end goal or a vision where flexibility is required from both the parties.
If the project scope and development requirements are not precise and have a constant scattered flow of tasks, this billing model can benefit your business in several ways-
- Facilitates Agile Development – development is incremental
- More client control over the project
- Task Prioritization
Fixed Cost Contract
This is a common billing method also known as a transaction-based billing model, which means it includes an agreement to get paid a fixed price for pre-decided services, to be delivered within a fixed time.
In this model the customer company pays a fixed fee to the service provider. It is the responsibility of the service provider to deliver the agreed service deliverable to the company
This model is challenging for the service provider. If the service provider does not have the capability to create and deliver the service, then the service provider is likely to incur a loss by executing such projects.
Benefits of this model are
- Low risk due to high predictability
- Predictable project planning and scheduling
- Clear requirements
- Less client supervision
- Assured defined deliverables
- Known costs before project commencement
Offshore Development Center (ODC) Model
As per Deloitte’s 2016 Global Outsourcing Survey, 59% of the respondents believe that outsourcing provides an opportunity to businesses to reduce costs while 35% of respondents are already focused on measuring the value of innovation in their outsourcing relationships.
In this model, the service provider acts as an extension to the user company. The service provider offers engineering, maintenance and support facilities to the buyer company. The service provider often creates a dedicated team on behalf of the user company.
This model is ideal for companies which do not want to spend huge money on the software engineering, maintenance and support facilities in their country. To save money, these companies approach software service vendors to develop a dedicated development center in low-cost countries.
The billing formula agreed upon can be based on a cost-plus model where the service provider makes a certain margin on the costs incurred.
This refers to a pricing model where the service provider is paid based on the business result achieved by the customer through the service provider’s contribution such as a percentage of increased profits or reduced operating expenses.
The mechanisms for paying the service provider vary, but generally, the payment is made in one lump sum when the result is achieved or over a short period of time, so that the provider can recover the investment in a reasonable, stipulated time.
Dedicated Team Model
In the Dedicated team model outsourcing company provides competent IT experts, equipment, and other resources based on project requirements. In return client pays a single sum of money that basically includes each team member’s monthly salary and provider’s fee. This team acts as the virtual extension of the client’s in-house development team.
The customer takes the onus of getting work done effectively by the team.
It is suited for long-term projects where project requirements are not clear and there is a frequent change in requirements.
Some software outsourcing companies combine the positive elements of various traditional models and use innovative models like
- Cost plus model/ open book model – The outsourcer adds a mark up to the actual costs incurred so as to ensure a profit.
- Incentive-based model – An incentive is paid to the service vendor over and above the fixed costs or T&M contract costs, which is linked to the vendor completing the milestone
- Shared risk, shared reward model – A new model where the software service vendor and the buyer jointly invest in the project initiative and share the risks and rewards. According to Gartner, this model encourages the provider to come up with innovative ideas and solutions to improve business and also mitigates the risk associated with new technologies by spreading it over both parties
- Pay per use model – The user pays the service provider based on a unit rate and services utilized. This is ideal when the work requirements fluctuate a lot.
- Gainsharing model – In this model, the user rewards the solution provider if the services are delivered over and above the contractual requirements in terms of the time to deliver or the quality or costs savings, etc.
Traditional models in a nutshell
|Features||Fixed Price||Time and Material||Dedicated Team|
|Size of the Project||Small to medium||Medium to large||Large|
|Project Scope||Clear and Defined||Evolving||Evolving|
|Pro’s||A low-risk model for customers||A low-risk model for service provider and moderate risk model for client||Flexibility to utilize the team for different requirements as needed|
|Con’s||A high-risk model for a service provider||Not closely related to customer’s business need or outcome||No Time/ effort commitment from the customer in the utilization of resources from a service provider|