As the bursting of software outsourcing development trends, both IT service providers and IT service vendors have recognized the mutual values that outsourcing software development brings to them. Here are the four pricing models which are believed to optimize productivity so as to balance risks and rewards for both parties, and ensure the most value for outsourced projects.

Losing Potential Value with Cost-Based Pricing

With cost-based pricing, there's no incentive to maximize the value you create for the client since you cannot capture any of it with price. Sometimes, the client loses if the work done isn't bringing any value at all! 

IT Outsourcing Pricing Models Gain Popularity

Shared risk-reward pricing model

This model is considered to allow service providers and clients to jointly fund the development of new products, solutions, and services. Essentially, the two team up for a relatively equal distribution of work and benefits. This means your partner has responsibility for potential and existing risks during the project because of its mutual impact. However, they have the right to receive a sharing in rewards for a defined period of time.

Best For: Customers seeking dramatic business improvements who want to create a true alliance with IT suppliers. Cost-focused buyers need not apply.

Pros

• This business process outsourcing model motivates service providers to innovate and enhance the client’s business through a sense of shared risk. 
• Those risks can be reduced by getting more people involved in the decision-making process.

Cons

• It can be hard to measure just how much the service provider is contributing. This makes it even harder to implement rewards. 
• The client needs to hand over a lot of the management to the service provider. This creates more of a “Partner” relationship than a client/provider relationship. Therefore, they should have a strong management team
• The client's business goals and partner’s ones may be different and that can cause controversy during the collaboration process

Incentive-Based Pricing Model

Performance-Based Pricing Model

Similar to other incentive-based models, a Performance-Based Pricing Model rewards the service provider for producing satisfactory results, reaching milestones, or hitting certain metrics. It usually involves a lot of negotiation in order to set terms and benchmarks that both parties find suitable.

Best For: Larger or more established companies that don’t need to build partnerships with their service providers frequently employ this model.

Pros

• This is the most intense of all incentive models, as it provides a reward for superior performance and threatens punishment for underperformance. 
• You can almost always expect quality work from your vendor, as delivering good work is the only way they can assure payment.

Cons

• It requires a lot of oversight and interaction on the part of the client to make sure performance metrics are being hit. 
• “Docking” the pay of your IT team is not a great way to build trust. In fact, it often creates tension and even animosity between parties. 

The right Outsourcing Pricing Model

These models above have their own pros and cons. However, businesses can minimize the drawbacks by planning and preparing the solution for any potential issue before the contract agreement. Additionally, businesses need to understand your situation and depth of scope to decide which the most suitable models. In a nutshell, no matter which models your businesses choose, goals, objectives, timeframe, quality, and price should be smartly prioritized and balanced.