Pavel Kaplunou
, Labor arbitrage and information technology outsourcing have defined how businesses approach software development. No longer having to rely solely on in-house talent and skills, companies have tapped into a global pool of development resources. Yet, with outsourced software development providers comes the hardship of identifying the most efficient cost and collaboration model. For these intents and purposes Smart IT has put together a definite guide to IT services pricing and outsourcing engagement models.
What businesses can give up with inhouse talent, they can gain with software development outsourcing companies. Technology is eating the world and the number of software to be designed, developed and delivered is growing on a yearly basis. To add to the pressure, the talent and skill gap is already being felt by companies globally. Therefore, relaying software development offshore is a no-brainer, but the first thing that companies will need to do is select a pricing model, as well as an engagement model, that works for them.
IT Pricing Models
In most cases, the crux of most software development comes down to setting the budget. Coding costs tend to vary depending on the geography of the outsourcing provider, but most if not all will rely on several of the different pricing models:
Fixed cost
The most straightforward of all the software development pricing models is the fixed cost model. The model type is a transaction-based one. Besides an immutable development budget, the fixed price model clearly outlines the project deliverables, deadline and capacities.
With the fixed cost pricing model, the service provider takes on the most risk and is prompted to efficiently manage development without incurring losses. Therefore, service providers will often accept this model only if the client has a clearly defined scope of work and project requirements.
Some providers might demand a full down payment before beginning development or split the entire cost into instalments payable at regular intervals.
Time and Material
This consumption-based pricing model is an effective one for projects with a loosely defined scope. The material in its name refers to the resources involved, in this case the human talent per unit. The time component refers to the number of hours the resource unit spends on accomplishing given tasks. Therefore the final cost comes down to the number of human resources used, multiplied by the hours each puts in.
T&M is most suitable for work that might experience scope creep or does not have a defined spec sheet as it offers a lot of flexibility. The model is a great fit for new product development or legacy system modernization — projects that may extend way beyond their time or material projections. T&M ensures service provider productivity through constant and close cooperation with the client. At the same time, the client is prompted to devise and manage a project management plan of their own.
Performance-Based Pricing
An Incentive-based model can serve as an add-on to the previous two models. It stipulates the assignment of specific rewards for going beyond standard SLA requirements. Such bonuses are usually clearly outlined in the agreement itself and can manifest themselves in the form of delivering the project on time or before the deadline.
Performance milestones can boost the service providers motivation and ensure a higher degree of personal involvement. At the same time, the client is eligible for business advantages upon the team meeting incentivized provisions.
Value-Based Development Model
The value-based model is an outcome-based, profit-sharing model. It relies on both parties assigning a metric of success, normally in the form milestones. Upon completion of said milestones the service provider becomes eligible to a certain share of the profits directly gained by the client’s business as a result of his efforts.
Though not common as the standard modus operandi for software development projects, value-based pricing can be a strong driver of business growth. IT outsourcing providers will rely on agile development practices to realize and automate mechanisms that deliver the most value to the client’s business, while the client rapidly accrues a succession of milestones.
It is not to be confused with the value-based pricing strategy.
Cost and Equity
Cost and equity, or cost plus equity, is a shared risk-reward model. This approach sees the vendor directly take stock in the client’s business in the form of a partnership. This type of collaboration is still governed by a service level agreement, as the vendor still provides development services and expects to be reimbursed. However, they are also bound beyond costs to invest time and material into driving growth through equity in the client’s business.
This type of venture is directed at shared gains and shared risk. If the client experiences a loss as a result of the provider’s efforts, the provider cannot expect to profit. And vice versa, if the client succeeds in driving revenue as a result of the provider’s efforts, the provider can look forward to being compensated in the measure equal to their stake in the business.
The Cost and equity model requires active communication and participation from both sides at all times. It is a synergy that works when both sides are committed to producing results, and investing into the undertaking. While not all service providers will want to consider this model, some may be more entrepreneurial and seek to diversify.
What is an Outsourcing Engagement Model
In relation to IT outsourcing vendors and offshore development centers, an outsourcing engagement model relates to the principles of collaboration between the client and provider. These encompass everything such as, but not limited to, the project requirements, level of supervision, process workflow, timeline, and pricing. Picking an engagement model means selecting the approach that will be applied to software development and how it will be managed.
Each and every engagement model holds its own value proposition that can benefit the client profile and their unique circumstances. For example, a client operating on a limited budget might like to opt for an engagement model that caps expenses and safeguards them from risks in the form of excess expenses. In another scenario, a client without a complete understanding of the scope of work and resources required might like to choose a model that can be scaled.
Buyers eager to channel software development needs to a nearshore or offshore development center (ODC) should be aware of the available engagement options. Picking the right model means setting off on the right foot with your outsourcing vendor. It also establishes the appropriate framework for successful project completion or a lucrative long-term partnership.
The engagement models below are based on Staffing and Pricing. The guide also features background information on Tactical and Strategic approaches.
Staffing Approach
Staffing refers to the way the outsourced resource is managed. The two primary staffing approaches are Staff Augmentation and Dedicated Team.
Staff Augmentation
Sometimes also known as outstaffing, Staff Augmentation implies hiring remote developers to be an integral part of your in-house team. Outstaffed resources are integrated directly into the client team’s communications and processes. The supplementary team member answers to the project manager or team lead, and is based at the outsourcing provider’s premises.
Outstaffing significantly lowers the overheads and headaches of onboarding or letting go of a full-time employee. At the same time, the client can benefit from a highly specialized skill set that matches their business requirements. This way the client can maintain full control over his workforce and move in line with the set project deadlines.
Augmented staff are not normally bound to be a part of one single project at a time. Such software developers can split their time between several clients, dedicating an outlined number of hours daily to each.
Dedicated Team
A dedicated team of software engineers is exactly what it implies. It is usually a team of talent hand-picked on demand to service a particular project. Therefore, in contrast to augmented staff, a dedicated team concentrates its efforts entirely on one client.
To further distinguish itself from the staff augmentation model, a dedicated team is typically managed by the vendor’s team, rather than the client’s. The team exchanges information via a PM or team lead that guides the dedicated team through the development cycle.
In this option, the dedicated is not integrated into the client’s team as deeply. The client may not even have a team to begin with, and the dedicated team might make up his primary workforce. Yet, the client still maintains a high degree of control and is able to direct the team at a specific line of tasks or at completing a defined development goal.
Other engagement models
Project-based
The project-based approach is what is referred to as a time bound engagement model. It implies a stable and unchanging set of project requirements that, once completed, will see the vendor receive their fixed reward and the client a defined set of deliverables. After the project is delivered the provider will most likely have no further involvement in the project’s future.
Product Development Services 2.0
First defined by Forrester, the PDS 2.0 stipulates a synergy between client and offshore development company, where the latter has a bigger stake in not only the development and delivery of the product, but also its maintenance, support and further growth. The model sees client and vendor form a strategic value-driven partnership that extends beyond the scope of project-based work.
Strategic Consultancy
The strategic IT consultancy service encompasses people, processes and technology. This is a value-based engagement model that sees the outsourcing vendor help the client on their digital transformation journey by achieving value-based milestones. Here, the client can not only expect to contract business process outsourcing services, but also have a solid partner to watch their back and advise them on all things IT. It is not irregular for strategic consultants to provide fractional executive hire to set up internal processes and leverage outside technological and business expertise.
01 May 2020
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Pavel is Smart IT's Marketing Communication Manager. He oversees content creation and is in charge of the official Smart IT blog. Contact Pavel to learn about potential media and content collaborations. [email protected]
