By Mark Burton, Co-Founder and VP of Consulting, Holden Advisors

The market for outsourced services - everything from short-term staffing to complete IT outsourcing programs - is in a state of upheaval. With strong, low-cost competitors and increasingly sophisticated customers who play off one vendor against another, there is enormous pressure on service providers to rethink every element of their cost positions and bid response processes. Knowing how best to respond starts with a clear understanding of what clients need in performance and relationships from their outsourcers.

What Clients Are Looking For

Research by MIT’s Center for Information Systems Research and CIO Magazine identified three different kinds of relationships clients choose when selecting an outsourcing partner:

1. In Transaction Relationships an outsourcer executes a well-defined, repeatable process
2. In Co-sourcing Alliances client and vendor share responsibility for managing projects
3. In Strategic Partnerships an outsourcer takes on responsibilities for a bundle of client operational services.

The problem is that many outsourcers are not prepared for any of these types of relationships.

Problems with Current Offering and Pricing Approaches

To address the needs for each client relationship, outsourcers should consider analyzing and correcting deficiencies in three key areas: offering definition, pricing, and sales approach.

In developing offerings many outsourcers still rely heavily on customizing most of their services. But this makes it difficult for customers to understand (and salespeople to explain) what they are getting. It also increases variation, and with it, the cost to deliver and the cost of quality. For transaction-based relationships, customization is neither cost- nor time-efficient and it often doesn’t match what the client wants. For both co-sourcing and strategic partnerships that are built on a high level of collaboration and trust, too much customization makes outcomes and costs unpredictable and damages trust.

On the pricing front, outsourcers have been slow to move away from traditional time and materials (T&M) pricing. T&M emphasizes cost to deliver (inputs) rather than the value of the results achieved (outputs). This invites constant client scrutiny on efficiency and work efforts - especially when low-cost competitors almost always look better on paper. It also puts the outsourcer and client at cross-purposes, undermining trust. We have met with many outsourcing clients who wonder out loud if their supplier is delaying improvements to avoid losing the revenue associated with constantly fixing problematic systems or processes.

As with any period of market turbulence there are significant opportunities for firms that are proactive about challenges they face. To begin this path outsourcers need to:

• Recognize that some clients want full-blown collaborative relationships, but some will buy on the basis of minimum specifications and lowest price while still others want to maximize their ROI.
• Develop very specific offerings for these different requirements.
• Deploy a range of pricing models, from traditional input-based approaches like T&M to sophisticated output-based approaches that can avoid price-based comparisons by connecting to very clear measures of client value.

It All Starts With Value to the Client

The starting point for defining the offering and pricing is to understand the business value your solutions create for your clients. The impact you can make on your client’s profit model is the key to developing relevant, highly-valued offerings, and will help you regain your pricing power.

Start simple. It is not necessary to understand everything about what clients value to make a credible start. Choose one area where you understand a need and how your solution will provide value or solve the problem - many firms simply start with their own internal assessment of highly-valued capabilities. Make some reasoned assumptions and test them in discussions with customers. Formal customer research and development of more sophisticated value models can follow later.

Next: Understanding Customer Buying Behaviors

In the sales process where the rubber meets the road, how should you adjust your offerings and pricing to the very different kinds of customers and their needs? We believe there are four different types of customer buying behaviors:

• Price Buyers drive aggressively to obtain services at the lowest possible prices for some acceptable level of quality. They often prefer transaction-based suppliers.
• Value Buyers are willing to switch among different vendors based on constant review of the vendors’ value and ROI. They will pay more for greater value, and use all three of the relationship strategies cited above – often simultaneously.
• Relationship Buyers rely on vendors to help them understand and apply solutions, and tend to prefer co-sourcing alliances or strategic partnerships.
• Poker Players are Value or Relationship customers who act like Price Buyers in order to get high levels of service at a better price. They often signal they want a transactional relationship – even when they really want a co-sourcing alliance or strategic partnership.

Each of these agendas requires a very different offering, pricing approach, and client relationship. Yet many outsourcers treat all clients as relationship buyers – so they over-invest in the sales and delivery processes for price buyers and poker players. This results in unnecessarily high costs-to-serve, and for many clients it provides a higher level of service than desired. It also drives customers to turn into poker players who pretend to be price buyers. The key to managing the poker players is to get them to show their hand – and the key to that is to develop a more effective offering framework.

Developing an Effective Offering Framework

By understanding different buying behaviors and providing different value to them, outsourcers can substantially improve offering definition. An effective offering framework produces a series of predefined offering “cores” or levels:

• Bare bones offering for Price Buyers with limited functionality and low delivery cost
• Enhanced or expected offering to meet the needs of most Value Buyers
• Fully-bundled complete solution for Relationship Buyers

Outsourcers can use this structure to standardize their offerings, and then adjust individual services, service levels, or delivery models for customers who want greater value and are willing to pay for it.

Choosing the Right Pricing Model

In a parallel effort, outsourcers should select the best pricing models by evaluating two variables. The most important variable is how clearly outsourcers’ offering impacts client value. If outsourcers cannot make this connection, they are forced to use price models that focus on cost recovery and margin targets – not on value. If they can make the connection, then a host of “value-based” pricing models such as output-, utility-based or gain share pricing are possible.

The second variable to consider is how much risk the outsourcer must assume to ensure successful, profitable service delivery. This weighs the impact that traditionally qualitative factors - such as firm and client capabilities, relationships, control systems, and complexity - will have on delivering the service on time, on budget, with a high degree of quality.

The graph below dimensions the trade-offs between these two variables. For example, output-based pricing would be a good option for the upper left quadrant - it requires that value be highly demonstrable, but it should not be attempted under risky project conditions that make those results uncertain. Likewise, a fixed price makes sense if for risky projects where the connection to value is not highly definable - but the outsourcer should charge a premium for the risk.

Final Thoughts

Making this new multi-level approach work requires involvement from all parts of the organization. First and foremost are sales people, since they will be presenting the new offering, pricing and value to clients. They need to be involved in every step of the process, from researching customer value, to defining the offering and pricing options, to helping develop supporting tools that demonstrate the delivered value to the customer.

We recommend you prepare to bootstrap your way through this process. A leader at one outsourcing firm told us that their first modeling to begin standardizing one of their offerings was only 10% effective in its first generation. Because of numerous iterations, it is now 80% effective. As this example suggests, the road to controlling service offering definitions, costs, and pricing requires courage, patience and intimate knowledge of your clients. The good news is that there are a number of relatively simple ways to get started. The bad news is reserved for those who fail to adapt to the new marketplace and the competitive realities of outsourced services.

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Jeanne W. Ross and Cynthia M. Beath. The MIT CISR Report – Sustainable Value From Outsourcing, CIO Magazine, October 1, 2005

Reed K. Holden. Critical Elements to Enable Value-Based Selling and Successful Pricing. Holden Advisors Whitepaper

About the Author:

Mark Burton, Co-Founder and Vice President of Consulting, Holden Advisors

Mburton@HoldenAdvisors.com

Mark Burton is an engagement executive for Holden Advisor clients and is responsible for client deliverables and for the firm’s consulting operation. He leads the development of the firm’s project methodologies and analytical processes.  Mark is the driving force in the firm’s efforts in developing offering and pricing strategies for services organizations.  In this capacity he has developed offering and pricing solutions for firms in industries such as IT outsourcing, transportation, financial and business services, and enterprise software maintenance.

Burton has 16 years of experience in sales and consulting in the areas of strategic marketing and pricing. He writes frequently on the challenges that companies face when implementing customer value-centered strategies including a white paper on the firm’s proprietary Case ROI™ methodology. Mark is currently at work with Dr. Reed Holden on a new book based on the Value Discipline SM.

Over the years, Mark has spoken at many Fortune 2000 company events and at several conferences on business-to-business marketing including: The Professional Pricing Society, The Institute for International Research, Capco Roundtable for Financial Executives, Association of Proposal Management Professionals.

Comments? Suggestions? We would like to hear from you. Please email the editor at sspanews@thesspa.com.

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