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Software Development

Pricing models in the spotlight

date: 5 April 2013
reading time: 3 min

At a recent IT industry event I went to, I was surprised at how many questions were about pricing models and the advantages of what was termed ‘input versus output based costing’. It seems that a lot of IT directors are now looking at pricing models as a way to cut their costs further.

At a recent IT industry event I went to, I was surprised at how many questions were about pricing models and the advantages of what was termed ‘input versus output based costing’. It seems that a lot of IT directors are now looking at pricing models as a way to cut their costs further.

In software development – and most other IT services contracts – there are two main types of pricing models: input- and output-based. With input-based pricing, prices are set in terms of the amount of resource used, for example, the number of days effort expended, the number of MIPS of processing power utilised, etc. Input-based pricing often takes the form of FTE (price per resource) or Time and Materials.  Input-based pricing makes the main price levers very transparent and also offers flexibility for scope changes which could otherwise lead to a return to the negotiating table. Output-based pricing defines a fixed rate for the final outputs or “deliverables” of the service. Output-based contracts tend to focus on defining the deliverables in detail, rather than on defining how the service is to be delivered, or which resources are to be used to deliver the service. As such it gives suppliers the freedom to drive maximum efficiency and is often simpler when more complex services are involved.

At Future Processing we offer both types of pricing models. While the vast majority of our customers choose the input-based method, I can honestly say that we don’t have a preference for one model over the other.

At the event I attended, several IT directors were asking whether output-based pricing incentivises suppliers to complete projects more quickly. My experience is that while it can be quicker to complete an output-based project, most of the time input- and output- based contracts take the same amount of time and cost the customer the same.  This is partly due to the attention to detail that is built into our approach.

On the other hand, if you are starting on your first project with a new supplier, I would strongly recommend that you stick to the input-based pricing model until you and your supplier know each other a little better and have some trust in place. Scoping a project accurately before you have ever worked with someone can be tricky.

If you are already working with a trusted supplier and are considering using an output-based pricing model, my advice would be to ensure you understand what is important to you – for example innovation or extremely good testing – and ensure that the pricing helps to deliver that. The other key success factor for output-based pricing is having clearly defined specifications and requirements agreed at the outset. Past experience or industry benchmarks for similar projects can be very helpful here.

If you are seriously thinking about changing your pricing model and would like further advice either from Future  Processing or from one of our customers, please do get in touch via the comments box.

What do you think?

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