Watch Out For: The second year blues. "If the provider has a windfall one year, then the customer is likely to demand a stricter formula or a new basis for the payment the following year. Conversely, if the supplier lost out due to poor overall performance by the customer organization, they will want to change the measurements," says Tisnovsky. "This can lead to rebuilding the model every year."
Incentive-Based Pricing Model
What It Is: Bonus payments are made to the vendor for achieving specific performance levels above the contract's service level agreements. Often used in conjunction with a traditional pricing method, such as time-and-materials or fixed price, "the key is to ensure that the delivered outcome creates incremental business value for the customer," Pace Harmon's Martin says.
Best For: Customers who are able to identify specific investments the vendor could make in order to deliver a higher level of performance.
Pros: Incentives can compensate for drawbacks in the primary pricing method and better align provider motivation and customer goals, says Tisnovsky of Everest Group.
Cons: "This model often falls flat because companies end up rewarding their vendors for work they should arguably be doing anyway," says Martin. "The 'incentive' should be that they get to keep providing the service." Measuring bonus-worthy performance can be difficult and costly.
Watch Out For: Vendors who tell you that it's common practice to provide these bonuses if you require the provider to pay penalties for missed service levels. It's not.
Consumption-Based Pricing Model
What It Is: Costs are allocated based on actual usage (e.g., gigabytes of disk space used or help desk calls answered).
Best For: Buyers concerned about service provider productivity and those with variable demand. The utility model is particularly well-suited to situations in which the fixed costs of the services are shared across many customers, says Helms of K&L Gates, like cloud computing engagements.
Pros: Pay-per-use pricing can deliver productivity gains from day one and makes component cost-analysis and adjustments easy. Capital expenses become operating expenses.
Cons: Utility pricing requires a fairly accurate estimate of the demand volume and a commitment for certain minimum transaction volume, warns Everest Group's Tisnovsky. Annual costs are less predictable.