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Complex services: Alternative pricing models.

MarketingCategory managementConsulting Services

In this guest post, the latest in a series on tackling complex spend, Procurement Leaders invites Vantage Partners' Danny Ertel to look at routes to greater value in purchasing services through using pricing strategies. 

 

In this series on engaging reluctant stakeholders to improve the value equation in complex professional services, we have started to dig deeper into the procurement toolkit to add demonstrable value to stakeholders without starting by asking them to stop using their trusted advisors. This month we'll consider ways to help meet some of their budgetary concerns with pricing models that do a better job of aligning incentives.

 

Implement alternative pricing models 

 

Consulting and legal services have typically been paid for on the basis of the seniority of the staff delivering the work and the amount of time they have spent. Such measures are more closely aligned with providers' costs than with value to the client, and they leave most risks – including for outcomes and the efficiency with which they are achieved – with the buyer. Similarly, marketing and advertising agencies have earned their fees as a combination of the time and materials they invested in the work and a percentage of the client's money they spent on placing their work with media outlets. 

 

While those pricing models enabled buyers of these services to make some superficial comparisons among rates charged by competing providers, they create disincentives to making efficient use of budgets.

 

Procurement can help a business unit or function get more value for its complex services budget by exploring pricing models that create better alignment between the needs of the business and incentives for vendors. As leading procurement organizations well know, there is more to strategic sourcing and effective supplier negotiation than trading volume for discounts. 

  • Analysis of consumption and spend patterns can suggest ways in which models based on outcomes (e.g. success fees) or outputs (e.g. unit pricing) may be more effective than pricing based on inputs (hours spent). 
  • Fixed fees for projects or portfolios of work can also significantly change incentives (and encourage adoption of better scope management practices).  
  • Different kinds of risks, including that of the effort required to achieve an outcome, can be shared with hybrid pricing models such as fee collars; and pricing portfolios of work instead of individual engagements can enable providers to bear more risk. 

It's not just about volume discounts anymore

 

Among law departments, FMC Technologies is widely touted as having been successful at managing performance-adjusted hourly billings. They typically hold back 20% of the contracted hourly rates and then pay either a fraction or a multiple of the holdback based on a performance scorecard.  In retainer-based relationships and long-run projects, FMC links payment of between 0 and 200% of the remaining 20% to a holistic performance evaluation.  For litigation, FMC will pay between 0 and 300% of the holdback as a bonus based on success and efficiency in service delivery. 

 

Performance metrics have been improving over time, and most law firms serving FMC are now achieving better than 100% of their standard rates. Jeffrey Carr, General Counsel of FMC Technologies calls this approach a win-win, stating: "We intend to pay a higher effective hourly rate—we just want to buy fewer hours and achieve success. Law firms like the new arrangement because it frees up 'inventory' to sell to other clients."

 

Alternative pricing models offer buyers of complex professional services an opportunity to prioritize what's most important to them, be it certainty, savings, risk management, etc. With some creativity,  such arrangements can also get client and trusted advisor out of the zero-sum game of haggling over discounts, and back to working together in an aligned way.

 

 

Danny Ertel is a partner at Vantage Partners.

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