Nov 26, 2019 | 5 min read

Why Outsourcing Hates the Cost Plus Equity Model

Pavel Kaplunou, Marketing Communications

There are more than a handful of reasons why firms choose to outsource custom software development to offshore development companies. Skilled talent, higher flexibility and considerably lower rates are among those reasons. However, traditional pricing models offered by remote development firms have not always fit the bill when it comes to mitigating business risks. Neither have they sufficiently distributed responsibility between client and vendor. Despite a seeming abundance of cost models, decision makers are still left pondering which option is best, all the while overlooking a simple model that could just work.

Naturally, no such thing as a silver bullet exists when it comes to risk management in outsourced software development. Each price model is fraught with its own perils if goals and requirements are not correctly aligned. But clearly, some models of cooperation win over others. Fixed price gives a clear estimate of the budget required for a short-term one-off project, while Time and Material helps address evolving requirements and gives greater control over the end result. A Dedicated Team will do well in narrowly addressing the needs of a large and lengthy project, while an Augmented Team will offer additional competence and boost overall efficiency. There is one model that often takes many names that gets overlooked and under-estimated. We at Smart IT refer to it as Cost and Equity.

Understanding Cost plus Equity

Cost plus Equity is often referred to as Profit and Risk, also sometimes known as Shared Risk-Reward. This model assumes that if the customer makes a profit, the vendor makes a profit as well. The same works in reverse, ergo, both parties are equally motivated and engaged in driving positive results. Of course, the vendor still gets paid to provide part of the services (this is where the Cost part of Cost plus Equity, still plays a role). Contrasted with other pricing models, however, this option significantly raises accountability and distributes risk between both parties.

The immediate concern is that the client automatically acquires an unwanted stakeholder, a third wheel of sorts. The concern is not unjustified if the project is already overseen by several other stakeholders in the form of investors. Yet, there is a different way of thinking about the vendor’s role ‒ that of an interested party. By having a stake in the business, the vendor is directly involved in not only making all the moving pieces work together, but also in squeezing the most value out of them. In practice, this manifests itself in the form of maximum optimization, ongoing consultancy, guarantied expert talent and increased productivity. Moreover, if the job can be done better in double the time, the client ultimately saves a chunk of their outsourcing budget.

The term shared services refers to a centre of expertise (COE) that a company can leverage for internal means. Similarly to a shared service, an outsourcing customer can rely on a vendor to fully service not only the project, but also offer an outside perspective on other aspects of the business. In brief, Cost plus Equity produces an integral unit that can be directed at closing more than just one need.

Risks and perils

More often than not information technology outsourcing companies (ITOs) are notorious for more than just minor offences such as overdue deadlines or production delays. Malpractice is not an uncommon phenomenon, with some companies ready to cross the line to increase their paycheck. Сompanies have been known to relay the work they were outsourced to freelancers ‒ outsourcing squared, so to say. Other instances have seen companies disappear into thin air after taking a generous down payment. Apart from directly affecting the quality of the output, such cutting of corners unfortunately puts a few cracks in the foundation of the outsourcing industry as a whole.

Negligence and “shortcuts” only reiterate why clients lack trust in vendors. Software development companies simply do not share their the same level of responsibility or devotion towards the project or product unless it is their own. This lack of empathy strains relations, exposes the business to unprecedented pitfalls and incurs both loss of time and funds.

Prospecting clients can take the fight into their own hands. Numerous trusted websites populate the webscape, linking trustworthy companies to capable vendors. Reviews by trusted websites consolidate the firms that rock and sink those that do not. Networking and word of mouth are still valid ways of discovering reliable partnerships. And yet, choosing a vendor should not have to be a fight in the first place.

Time to take responsibility

Development companies can go a long way by offering a transparent approach to pricing, but a shared risk model can still make companies reflexively scoff and scowl at the prospects of having to shoulder someone else’s risk. Though a company that does not pass the litmus paper for trust might not be the best match after all. The consideration of, in a way, going Dutch can, after all, turn the tide from finding a good partner to finding the right partner.

Smart IT believes that accountability and enthusiasm should not stifle quality. A project not worth taking, be it for its short-term value or requirement of a different skill set, will more likely be turned down or, better yet, referred to a trusted partner. At the same time, a long-term commitment will always be warmly received and given the attention it requires. To make it stick, Smart IT may even offer to go the Cost plus Equity route, unlike some.

By investing personally and dividing responsibility with a client the vendor can divide risk, maximize profits and acquire a serious helping hand in all things IT and business for many years ahead. The next time it comes to choosing an ITO partner, give the Cost plus Equity approach a try, you can even borrow the name, we won’t mind.

26 November 2019

WRITTEN BY

Pavel Kaplunou , Marketing Communications

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. p.kaplunou@smart-it.io

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