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ABC: An Introduction to Outsourcing

Everything you need to know to avoid the pitfalls of outsourcing.

By Stephanie Overby

PAGE 3

• What is outsourcing?
• Why outsource?
• ITO, BPO, KPO—what’s the difference?
• Why is outsourcing so hard?
• What about bundling?
• What is an SLA?
• What is the best length for an outsourcing contract?
• Should I outsource everything to one vendor? Or should I use a best-of-breed approach?
• How do I decide what vendor or vendors to work with?
• Can I get outside help with this decision?
• Do you have any tips for negotiations?
• What are the "hidden costs" of outsourcing?
• What do I need to know about the transition period?
• How important is ongoing relationship management to outsourcing success?
• Where’s the best place in the world to outsource IT?
• What if outsourcing doesn’t work out? Can I just bring the work back in?

How is outsourcing priced?

There are various ways to structure pricing within an outsourcing contract, including:

Unit pricing: The vendor determines a set rate for a particular level of service, and the client pays based on its usage of that service. For instance, if you’re outsourcing desktop maintenance, the customer might pay a fixed amount per number of desktop users supported.

Fixed pricing: The customer pays a flat rate for services no matter what. Paying a fixed priced for outsourced services always looks good to customers at first because costs are predictable. And sometimes it works out well. But when market pricing goes down over time (as it often does), a fixed price stays fixed. And suddenly it doesn’t look so good. Fixed pricing is also hard on the vendor, who has to meet service levels at a certain price no matter how many resources those services end up requiring.

Variable pricing: This means that the customer pays a fixed price at the low end of a supplier’s provided service, but allows for some variance in pricing based on providing higher levels of services.

Cost-plus: The contract is written so that the client pays the supplier for its actual costs, plus a predetermined percentage for profit. Such a pricing plan does not allow for flexibility as business objectives or technologies change, and it provides little incentive for a supplier to perform effectively.

Performance-based pricing: At the opposite end of the spectrum from cost-plus pricing, a buyer provides financial incentives that encourage the supplier to perform optimally. Conversely, this type of pricing plan requires suppliers to pay a penalty for unsatisfactory service levels. This can be tricky to pull off successfully, but is becoming more popular among outsourcing customers, dissatisfied with performance in their previous forays into outsourcing.

Risk/reward sharing: With this kind of arrangement, the customer and vendor each have some skin in the game. Here, buyer and supplier each have an amount of money at risk, and each stands to gain a percentage of the profits if the supplier's performance is optimum and meets the buyer's objectives. The buyer will select a supplier using a pricing model that best fits the business objectives the buyer is trying to accomplish by outsourcing.

What about bundling?

Bundling services means paying an IT services provider one price that has more than one IT service or product lumped together. It’s usually not a good idea (see Bundle With Care). If you agree to the bundling of certain service levels into the price of a product, for example, you must buy that service every time you buy the product—whether you need it or not. Bundling also makes it difficult to understand what you’re paying for individual products or services and to benchmark that against market pricing. Itemizing products and services keeps the vendor more accountable and enables the buyer to be able to charge back the usage fees to its various user departments.

 

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