Which pricing mechanism should your company choose when buying third-party services? What is the optimal contract length? And what is the best way to manage switching costs? These questions are even more important today than in the past because the services industry is switching to new pricing mechanisms for digital services. Understandably, these changes create consternation and confusion for buyers of services. What comprises service prices? In this post, I’ll explain how pricing works and, hopefully, clear up confusion and help your company make optimal decision.
I’ve blogged several times in the past three years about the benefits of switching to a consumption-based pricing model for services, especially the benefit it delivers in shaving off operational costs. In this model, companies pay only for what they use instead of paying for over-capacity. We see customers’ desire for consumption-based pricing coming across all service lines. But, as one of the world’s largest electronics companies found in switching to consumption-based services, it creates some new challenges.
The situation that motivated the electronics company to consider switching to consumption-based services is that the company was splitting into two different operating units to strengthen its market in both areas. So agility was the main driver. The leaders knew they needed a lot more flexibility in adding or subtracting apps and services and quickly scaling the volume of work up or down. They wanted to make it easier to adopt providers’ services, and they wanted to ensure the company would not overpay for services.
But as I mentioned earlier, the company encountered some challenges. Challenges tend to increase costs. Here are three aspects to keep in mind when you work with your service provider in a consumption-based model.
- Pay attention to the architecture mindset. Service providers that were “born in the cloud” have a cloud mentality and expertise when it comes to architecture. But it can be challenging to work with established providers having to change their mindset around solution design and traditional architectures. The electronics company found some providers wanting to wrap cloud capabilities in traditional delivery models. A characteristic of this type of provider is the demand to establish change control procedures. The electronics company found that changing mindsets works both ways. A big lesson learned was that the company couldn’t manage IT as it did before in that it couldn’t treat infrastructure as if the company owned it. Working from an ownership mentality will drive up costs. Another lesson learned was to turn off services and components the company no longer needed.
- Accurately define compliance requirements up front. As the electronics company found, it’s crucial to map out all the different regulatory compliance and legal requirements and what each means for IT as well as business continuity. They encountered service providers that lacked understanding of patterns among multiple compliance and legal requirements. For example, some providers didn’t know whether a requirement also applied to other regulations, or providers didn’t know how compliance with Russian regulations for storing personal data differed from European compliance.
- Operational changes will be required. In a consumption-based services model, your organization will need fewer people to monitor the services. Monitoring the infrastructure will no longer be necessary, but you will need to make sure the service provider monitors it. The electronics company used multiple providers for different cloud components and found it necessary to aggregate their performance, coordinate among them if something was not working and, in such case, escalate upwards to decide what to do. Aggregating, coordinating and escalating require different skills and capabilities than performance monitoring.
When the operating model changes to a consumption basis, you may also need to configure your database differently. And you may need to retrain employees or augment current staff with new skills. The electronics company, for instance, found it lacked IT people with the skills necessary to lead a solution design discussion with the business.
The outcome for the electronics company was worth the challenges. The company achieved significant cost benefits from the consumption-based strategy, including:
- Fees elimination. The company implemented a cloud model for IT infrastructure, which ensured it would pay only for what it used, plus it eliminated start-up and termination fees to service providers.
- Cost reduction—in fact, 70 percent unit-cost reduction in most of the Infrastructure-as-a-Service components. First came a 40 percent reduction by recompeting legacy outsourcing agreements. The next tactic was moving core cloud infrastructure services and workloads (including storage, compute, security, analytics, devices and network) to the company’s infrastructure and operating platform based on a consumption model. This resulted in an additional 30 percent cost reduction.
- Portability. Using SaaS apps made it easier to switch applications such as email and analytics.
- Standardization. Market standards in areas as analytics, storage and the Internet of Things are still evolving. To avoid additional costs while market standards evolve, the company standardized on the service provider’s architecture instead of on a market standard.
Most of all, switching to a consumption-based model eliminated the friction that exists in many services relationships. It eliminated the problem of misaligned provider/customer interests that occurs in traditional take-or-pay situations that often result in customers deciding to switch to a different service provider.