Output-based pricing has become the norm in information services deals as buyers seek to align IT infrastructure consumption with business needs in a dynamic way
The customer care industry is going through myriad changes, but none as far-reaching and impactful as the rise in the adoption of non-voice channels. Recognizing this shift in customer behavior, enterprises are working to ensure their customers have a seamless experience across the channels of their choice, in order to increase customer acquisition, retention, and loyalty. This change in buyer expectations is having its effect on the global Contact Center Outsourcing (CCO) market as well.
One of the key findings in Everest Group’s Contact Center Outsourcing Annual Report 2015 is an almost 10 percent erosion between 2011 and 2014 in the voice channel’s revenue share, even though it remained the dominant channel of customer interaction. While voice has grown at a sluggish pace (3 percent CAGR between 2011 and 2014), non-voice channels have witnessed robust growth, led by email, which experienced a handsome 22 percent CAGR revenue share growth between 2011 and 2014. Chat and social media account for smaller proportions of non-voice channel revenue, but grew at 43 percent and 53 percent, respectively, in the same period.
Increasing adoption of non-voice channels has also given rise to solutions specifically targeting multi-channel requirements. Everest Group research shows inclusion of channel management as a value-added service had almost tripled from 7 percent of the contracts signed in 2008-2010 to 19 percent in 2013-2014. In fact, multi-channel solutions have become so pervasive that growth opportunities for players supporting the voice channel predominantly are diminishing rapidly. Barring contracts focused on outbound sales services, 60 percent of new contracts focused on operational or value-added services have a non-voice component. As discussed in our recently published viewpoint, it is becoming increasingly imperative for service providers to design solutions with a portfolio that combines value-added services and non-voice channels.
As service providers make investments to augment their capabilities and build expertise in managing non-voice channels, below are some implications they should keep in mind:
- Outlining the right shoring strategy. Our research shows a clear move towards onshore delivery as CCO clients increasingly prefer agents closer to home, especially for the voice channel. The changing channel mix will dictate the direction in which the shoring strategies evolve in the future
- Defining the right skill-sets. Non-voice channels provide productivity gains by allowing agents the opportunity to juggle multiple channels without impacting quality. Service providers must ensure agents are upskilled through the right set of training programs and hiring requirements, which are different from those for voice
- Leveraging analytics. Non-voice channels are more digital-friendly by definition, and are suited for use of advanced analytics tools. Close alignment of analytics solutions to derive incremental insight and information from the data generated from non-voice channels will be critical
- Using sophisticated pricing models. Non-voice channels align well with output- and outcome-based pricing models, and have witnessed higher adoption of these pricing models than the voice channel. As they build capabilities on the non-voice front, CCO service providers must also look at how to best align their processes and metrics around non-voice channels to support clients’ desired business and customer experience outcomes. This essentially involves redefining CCO’s value proposition beyond cost savings to include business performance
- Supporting clients through the journey. CCO clients require guidance and clarity on where to begin the non-voice channel journey, and how to move forward with it. We have already seen consulting practices within BPO firms helping clients confidently undertake this transformative journey, and could be a very critical component in the successful adoption of non-voice channels.
In a heavily commoditized market, non-voice channels give service providers an opportunity to differentiate themselves and stand out from the crowd. While some providers have taken the lead and become front-runners in the multi-channel solutions race, others have more recently started augmenting their capabilities in this space through acquisitions and partnerships. Building capabilities is a key success factor, but as highlighted earlier there are other factors for service providers to consider to ensure they make the best use of these capabilities.
As we work with service providers across the industry, a theme we hear increasingly is the buyers’ unrelenting pressure on providers to reduce price. The pressure is exacerbated by the growth slowdown in the industry. I believe this pricing pressure will soon show up in providers’ financial performance with decreased earnings per share.
The unrelenting pressure — which also seems to be growing — is linked to the power of purchasing departments and their inability and unwillingness to consider factors outside of price per unit in decisions.
The pressure frustrates service providers across two dimensions. First of all, it’s always unpleasant to have a services client ask a provider to reduce its price when its costs are rising. I think this is one of the reasons why we see a rise in anti-incumbency that I’ve blogged about before. If not the number-one reason, it’s at least a significant concern of service providers. Customers increasingly ask their providers to make investments in the customer’s business, but their pricing pressure deprives the providers of the margins with which to do that.
The second frustrating aspect is that the pricing pressure creates a set of unintended consequences. Most notably, there is less and less time for clients to take into consideration quality, total cost or total efficiencies the providers deliver. Instead they place more focus on reducing the cost per FTE or cost per unit.
It was easier for providers to resist, or at least manage, pricing pressures when the industry enjoyed a fast-growing marketplace thus affording providers the benefit of scale. In addition, most service providers also have been fortunate over the last few years to have forex tailwinds with the dollar to rupee or the pound or Euro to rupee. But the rupee depreciation can’t go on forever and may well be reversed as India puts its house in order.
Certainly there are growth areas in the market today: automation, cloud and as a service. And providers have the possibility of changing pricing algorithms from FTE-based deals to transactional outcome-based deals. However, those techniques are uncertain, difficult and, taken collectively, may not be sufficient to offset the downward pricing pressure on a provider’s core business.
The slowly fading recession has left a profound impact on pricing in sourcing contracts. That impact is seen in a trilogy of forces with long-term ramifications that will keep pricing at recession-era levels for the foreseeable future, even as contract volume rebounds with pent-up demand. This “new normal” imparts lasting implications on future sourcing agreements.
Price benchmarking is a constructive tool to understand and align commercial offerings to market norms; however, if not carried out in a structured and thoughtful way, it can cause unnecessary frustration for both buyers and service providers, and can lead to significant value erosion
There has been a lot of talk in the services industry around new pricing vehicles: non-linear pricing, outcome-based pricing, pricing for results and gainsharing, for example. All these new pricing models whipped up by providers have something in common: they’re complex. I’ve been in this industry since 1983. Here’s one of the important things I’ve learned over the years: complicated pricing breaks down.
I’ve looked at function-point pricing and all kinds of algorithms. The complexities don’t stand up well.
That’s why cloud pricing is so compelling— it deals with pricing complexities by bundling components and customers pay for the service based on consumption and a few key metrics. It’s simple. It’s this simplicity that gives the cloud model so much power.
Simplicity is also what made labor arbitrage pricing so powerful. It’s based on a body and an increment of time in India versus the United States. You can have an FTE on an hourly or daily basis. It eliminates a lot of moving parts. The service pricing is easy to understand.
The acid test for pricing models
Here is my acid test for whether a pricing model is simple enough: You must be able to tell it to your mother, and your mother has to be able to tell it to her friends, and when you hear it from her friends, you must recognize what you’re hearing.
This acid test for simplicity is important. In a customer organization people have to explain the pricing model to other people, and it has to survive multiple layers of people telling and retelling it clear down to the users. Nothing complicated will survive that. The pricing must make sense to the people who use the service based on that pricing model. Otherwise, there will be misunderstandings and misalignment and eventually the structure will break down.
Bottom line: New pricing models are often too complex, very painful to break down. My advice is to remember the well-known KISS Principle — Keep it simple, Stupid.
A colleague of mine recently had an interesting discussion with a senior stakeholder from a large buyer organization. The buyer had engaged multiple partners to benchmark the company’s contracted ADM prices every year since 2009 and had difficulty understanding why the actual pricing trend was opposite what the benchmarks suggested each year. After some probing, it emerged that the buyer was using the benchmarks to interpret likely future pricing, rather than assess current pricing.
Let’s look at the difference between the two via a weather example.
The average temperatures in Delhi in Q1 and Q2 2012 are summarized below.
Clearly, temperatures increased consistently during Q1 and Q2. Based on that information, a tourist planning an August 2012 trip to the region could have concluded that it would be even warmer during that month and added more sunscreen to his or her list of pre-travel purchases.
In reality, as shown below, Delhi was cooler in Q3 (and it was rainy). If the tourist incorrectly surmised that past weather trends meant that August temperatures would be higher, he or she would have packed an extra pair of sunglasses, rather than an umbrella…and gotten wet.
Note: for those who use the Fahrenheit scale and are itching to know what Delhi’s temperatures were last Q1-Q3, an easy – but not quite precise – conversion is to multiply the Celsius number by two, and then add 30. (The actual formula is to multiply by 1.8, and then add 32.)
Similarly, although price benchmarks represent current market pricing, they may, or may not, indicate the future trend. Thus, they are not particularly useful for buyers trying to negotiate future prices with their service providers. Rather, proper pricing negotiations require having a pulse on multiple drivers broadly classified as demand-side, supply-side and macro-economic. Equally important is understanding the relevance of these drivers in the deal-specific context of a particular buyer. For example, in Everest Group’s PricePoint: Q4 2012 analysis of ADM services, we noted that prices were at the same level as 12 months prior. Looking ahead, supply-side cues indicated stability in operating costs, potentially indicating status-quo on pricing. However the recovery in demand for transformation projects is expected to materialize in more ERP deals. Thus, buyers with significant ERP initiatives could witness higher prices in 2013.
So how can benchmarking exercises work to a buyer’s benefit?
Here is Everest Group’s take:
- Price benchmarks typically represent current market (or sometimes past) pricing. They can help identify whether a service provider has been, or is, over-charging. In many situations, buyers can realize more than 5-7 percent savings simply by calibrating their contracted prices per the benchmarks
- Where pricing is currently in line with the benchmarks but is due for revision, understanding the pricing outlook is most beneficial. However, this involves accurate assessment of multiple pricing drivers without which any forward-looking pricing discussion will be incomplete (and could leave the buyer out in the rain, sans umbrella.)
Input-based pricing has traditionally been the preferred engagement model for buyers of application outsourcing (AO) services. Their penchant for input-based pricing is indicative of their ability to own more risk. However, when lightning struck in the form of the economic downturn, buyers began revisiting their engagement models to derive the best value from their IT contracts, and in 2009, we saw a surge in output-based pricing contracts for AO services. But the choppy shift was short-lived, and by 2011, buyers opted to play it safe and stick with tested input-based pricing contracts:
AO deal share by pricing model
Although their motivation for moving to output-based pricing was driven by cost and quality aspirations, buyers quickly found the shift was far from easy, and fraught with challenges.
The difficulties with output-based pricing – then and now – include:
Complexity: The setup involved with an output-based pricing model is considerably more complex, as these contracts require transactions to be defined unambiguously and measured over multiple time periods.
Volume uncertainty: Buyers need to be able to predict future volumes to a reasonable level of accuracy, and overall transaction volumes must be sufficiently high for service providers to derive equitable scale benefits.
Process scope: Service providers must have a good understanding of the process in order to price transactions effectively. Additionally, output-based pricing is not suited for processes that are heavily reliant on people skills, e.g., development of cutting-edge technology apps.
Organizational change: The concept of internal charging in a buyer organization may require expectation settings and change management. Further, as benchmarking data may not always be readily available, a significant data collection effort is required during the contract negotiation phase.
Before transitioning to an output-based pricing model, buyers must ask themselves the following questions:
- What is really important to me?
What is driving my aspiration to shift to output-based pricing? Is it innovation, or leverage, or cost savings? IT contracts should always be drafted in-line with a buyer’s primary motivation.
- How do I define consumption units?
What resource unit should I use for billing? The choice of resource unit reflects organizational context and trade-offs. For example, when pricing a helpdesk offering, a US$/ticket and US$/user supported have distinct and varying impacts on productivity improvements.
- How do I manage demand variation?
How can I help control over-staffing or under utilization of resources? Baseline pricing and banded pricing are often used mechanisms for services that are subject to demand variation. For a successful transition, buyers must – as cited above – be able to forecast future volumes with a sound degree of accuracy.
Buyers must also carefully consider when to transition to output-based pricing for AO services. In an application maintenance outsourcing contract, output-based pricing is viable if the environment is mature and stable, and good baseline data is available on staffing, costs, and service metrics such as notice tickets, bug fixes, enhancements, etc. In an application development outsourcing contract, output-based pricing is suitable when the requirements and specifications are clearly defined and agreed.
If your organization has made the pricing model jump, what experiences – good, bad, or ugly – with the transition to output-based pricing can you share with your peers?