Pricing is more than a mechanism to compensate service providers for their efforts
Today pricing is often still seen as the mechanism to pay a service provider for their efforts as long as service level agreements with several KPIs are reached. However, pricing can be a much more powerful tool to ensure compliance, drive efficiency and deliver desired business outcomes.
Pricing as tool to ensure compliance and drive efficiencies
In my experience, applying differentiated pricing for transactions can enforce the right behaviours. Let’s take purchasing as an example: imagine if purchases made without a purchase order were priced considerably higher than those with a purchase order. I think we can all agree that P&L managers would show more interest and enforce stricter compliance in their area of responsibility and there would be a sharp rise in the Purchase Order coverage percentage. By the way, this approach does not require any outsourcing as the very same logic can be applied to internal pricing mechanisms replacing traditional cost allocation approaches which often do not set any incentives to improve.
Pricing as tool to increase flexibility and protect the P&L
From my own experience as a CFO in the chemical industry, I remember well that a major worry of any P&L manager, particularly for manufacturing companies, is the high proportion of fixed costs of seasonal businesses or during an economic decline. By moving to an arrangement of “transactional pricing” you can considerably reduce the negative P&L impact as you effectively “pay as you go”. This will reduce profit and margin fluctuations, particularly in the event of changes which were not foreseen in the forecast. As a consequence you will have higher stability which results in higher shareholder confidence and thus, better share performance. This can be especially beneficial for those manufacturing companies who struggle to pass on raw material price increases to their customers when their top-line is under pressure – and the outlook of a more volatile oil price will certainly lead to increased volatility in quite a few industries
Pricing as tool to ensure desired business outcomes
The most advanced pricing mechanism is outcome based where a supplier is paid for achieving desired business outcomes such reducing DSI & DSO, decreasing purchases or minimizing the financial closing timeline. This shifts considerably more responsibility to a supplier and reduces costs if business outcomes are not achieved.
Pricing mechanisms should be an evolution rather than a revolution
While transactional pricing can be established quite early in the relationship between a customer and a supplier (particularly for mature services such as accounting where sufficient benchmarks are available), outcome based pricing is more complex to implement and there are many factors to be considered. As we know, not everything can be measured with 100% accuracy and there are always unforeseen circumstances which could not be predicted when the business outcomes where defined. As a consequence, moving to a business outcome based pricing model requires a good degree of experience and trust between the customers and their suppliers – and when you have the right trust and partnerships you can move earlier. Having said this, it does not require an outcome based pricing mechanism for customers and suppliers to work jointly towards their desired business outcomes. This is increasingly the way innovative and transformational outsourcing providers such Capgemini work with their customers independently from formal contractual pricing agreements.