IT Pricing Ready for a Makeover

Enterprise IT is in an exciting phase. Old norms are being broken and consumption models are getting redefined as companies seek more value for every penny spent. CIOs are looking at flexible and cost effective ways of procuring IT. And with the vendor landscape gaining more maturity, we are seeing a range of new IT delivery options coming up. Amidst this, it is inevitable that pricing models are also getting a makeover.

From licensed purchases to accessing software over the cloud, from resource-based to performance-linked models, IT pricing is clearly witnessing a transition of some sort. What’s driving this we may ask? Reasons are quite apparent. Enterprise IT budget has been shrinking, thanks to a gloomy economic scenario that refuses to change. Clients are expecting that ‘little extra’ from their vendors, and vendors in their effort to control their shrinking revenues, are looking at new possibilities of offering the same to the clients.

If we look at the IT services space, traditional pricing models were based on the time or the effort that the service provider puts in. This is shifting as clients want service providers to assume some risk and ownership. The focus is moving to ‘outcomes’ and payments are being linked to performance. All these changes are giving way to new set of pricing models broadly called outcome-based models.

Harnath Babu, CIO, Aviva India says, “Customers expectations have changed from being satisfied by conventional delivery of IT services to benefits beyond cost savings and service improvements. Pricing models have moved from traditional Time & Material (T&M) and fixed price to managed services or outcome based.”

Linear pricing models had their own disadvantages such as lack of ownership on the part of the vendor, or no incentives for performance. The fixed price model was brought in to overcome the challenge of T&M model. This was a low-risk model as time and budget was clearly laid out and projects had to be delivered within that.

Outcome-based models, including revenue-sharing or risk-reward model, is much more evolved form of pricing. The vendor assumes greater risk and is rewarded based on the performance.

On the face of it, outcome-based pricing and its variants would look like a win-win situation in the prevalent market conditions. It has the potential to offer higher benefits to both clients and vendors. Clients benefit in terms of outcomes and vendors benefit in terms of revenues.

According to Milan Sheth, Advisory Partner & Leader, Technology Services, EY, in quantitative terms, the primary benefits are cost savings (up to 20-30%) and higher service levels. Business innovations that the partner brings in due to the new forms of pricing are additional benefits.

Hence we are seeing the evolution of a set of non- linear, performance-based pricing models that are based on enterprises’ growing needs for agility, flexibility and better efficiency.

Although the IT services industry has known to be pioneer in adoption of new pricing models as the market is relatively more mature, there is a shift in pricing in the enterprise software space also.

Technology vendors are seeing SaaS as a great opportunity and are investing big. There are numerous niche players coming up and competition is rife. Hence pricing ways are changing. Abhilash Purushottaman, Sr Solution Strategist & Head of Service Assurance Business (India & Saarc), CA Technologies says, “As cloud services become more prevalent in the market we have to evolve our pricing models. Vendors need to be agile and flexible in pricing.”

With cloud technologies gaining strength, enterprises are moving from on-premise software to as-a-service or SaaS model of software purchase. Sumeet Kapur, Chief Executive Officer, Global Groupware Solutions says, “The legacy pricing model for software products has been a license-based price which is an upfront payable amount for ‘perpetual usage’ license. Even today this is the more prevalent pricing model in the industry although the scenario is rapidly changing in favour of a ‘Subscription Fee’ pricing model.”

CLOUD IMPACT

With Cloud, enterprises have the opportunity to convert their capex investments into an opex model. “If you are a start up being on cloud is going to be a natural corollary. The cost structure will be far lower and you can quickly enter the market with your products,” Sandeep Ladda, India Technology Leader, PwC says.

According to Sundaraman Vishwanathan, Manager, Consulting, Zinnov for enterprise support software like HR, financial management, CRM, etc, CIOs are increasingly looking at subscription-based models. Core applications are still mostly license based as enterprises prefer keeping it in-house rather than moving to a public cloud.

PwC’ 2014 report PWC Global 100 software leaders states that although traditional software vendors still earn the lion’s share of their revenue from licenses, enterprises are changing their buying habits. IDC estimates that by 2016 about 25% of new business software purchases will be service-enabled software.

In the hardware space too there is some movement to cloud but it is not that significant as in SaaS. For desktops and laptops, pricing is largely unit-based or consumption based. For the rest of the hardware, constituting storage or servers, CIOs are making a choice whether to move it to the cloud or keep it in-house. Apparently, as-a-service delivery model in Infrastructure, popularly known as Iaas, is happening but to a low extent.

For large enterprises the preference is more for private clouds and pricing models in this case would vary from company to company, though private cloud does not offer much flexibility in terms of pricing.

Are You Ready to Experiment?

So as pricing models continue to evolve, this is the question facing all CIOs. Will new pricing models like subscription-based and revenue-sharing or risk-reward models really work for all? Most CIOs refuse to agree. Some are moving closer towards it, some are at a thinking stage, and some are stepping backwards. There is some shift from traditional models to as-a-service models, as cloud adoption picks up and cloud service provider landscape gains maturity but pricing based on ‘outcomes’ still looks like a distant dream.

Ashok Cherian, CIO, JK Cements says, “The biggest change in terms of pricing is going from capex to opex.” He asserts that SaaS offers a different way of pricing and is growing significantly with the adoption of cloud. Leasing is a preferred option for procuring hardware. “We have done a lot of stuff in leasing. All hardware deals can be executed through leasing,” he adds. According to him leasing and SaaS are the first levels of new pricing that can further make way for newer models. “The next opportunity is to get onto a partnership model that is an evolved situation and is really going to take more time,” adds Cherian.

In the IT services space though there has been a lot more hype around outcome and transaction-based models, a large part is still dominated by fixed price model. Vishwanathan says, “In services, around 95% revenues is coming through fixed price and T&M together. In this around 55-65% is fixed price model. Only the remaining 5% is coming from varying models, broadly called outcome-based models.”

In the non-services space too these models haven’t caught on much. The question being asked by many CIOs is whether the risk is worth being taken. N Varadarajan, Assistant Vice President, Ramco Cements says, “I am afraid to go for new pricing models, unless I have strong trust and understanding with the vendor. I am going more towards traditional than new models. It gives lot of protection.” He clarifies that unless there is a lot of trust and understanding there will be no new models in the hardware space, though scope is more in software to build models linked to outcomes, this is not happening much right now, but in the long term it can work.

Traditional models are considered more safe and predictable. For service providers it guarantees fixed payment and for enterprises it gives more predictability and simplicity in allocating their IT budgets.

As uncertainty prevails, CIOs seem to be trying out different combinations. Babu points out, “Indian IT Executives have been trying out both linear and non-linear pricing models based on specific requirements or projects.” Pricing models could vary depending on the size of the company. Sunil JNV, Senior Vice President (Delivery), Aspire Systems says, “Start-ups and small funded companies are open to trying out revenue-sharing models. These models give them some protection against possible failures in their business models and also help them manage the cash outflows,” he says.

What are the roadblocks?

For the service provider or technology vendor to let their payments vary on the basis of realization of outcomes is a big risk to take. Domain knowledge is very essential on the part of the vendor to confidently venture into new pricing models. In most cases vendors do not have adequate knowledge or understanding of the specifics of each customer.

Clients might benefit when payments are tied to outcomes, but the whole process is not that simple. It requires strong vendor-client relationships and maturity on both sides. Also if the service provider is offering to share risk, he will more likely charge a higher price for that. In such a scenario, CIOs might be reluctant to move away from traditional pricing.

For outcome-based pricing to work, long-term partnerships are essential, as outcomes can’t be clearly quantified and measured over short term. Varadarajan opines, “In short-term deals, there isn’t much scope for new pricing models, because it usually takes three-four years for results to shape up clearly.”

In subscription-based pricing models too there needs to be certain considerations. Each model will have its own implications and it is important to understand the difference. The PwC report states that different subscription-based models would function differently. With SaaS, prices typically don’t go down but vendors keep offering premium features that add value and cost extra. With PaaS, however, prices do usually drop over time as more customers come onto the platform.

Road Ahead

IT Industry experts suggest that as every organization’s needs could be unique, no single model might work for all. Hence, this is a decision that shouldn’t be made based on hype or popularity around any form of pricing, but based on specific enterprise needs. Like, for say, subscription-based or consumption-based pricing models work best where the customer’s demands tend to fluctuate. It gives the desired flexibility to scale up and scale down as per seasonal demands.

Revenue sharing and risk-reward are more evolved and complex forms of pricing and CIOs need to be cautious and understand the maturity of the vendor before foraying into such models. In most cases it is advisable to start with traditional models and gradually progress towards these models as trust builds up.

Clearly, new pricing alternatives carry a higher element of risk and it could be difficult for enterprises to move out of established mindsets. But these can be tackled by bringing in more trust and transparency into the buyer-vendor relationship. Babu points out, “It is important to agree on defining and measuring SLAs during the initial phases of the project and use this as baseline for rest of the engagement.”

Maturity on the part of technology vendors and IT service providers is still low and there is not much clarity on how they are going to plan and structure these models. Vendors need to be more willing to take risks and invest in building their capabilities around new models.

CIOs too need to be more flexible and ready to experiment. Prasanth Puliakottu, CIO, Sterlite Technologies, believes that CIOs have a significant role to play to enable the transition. “Heterogeneous nature of the market and other complexities will be there in the case of new pricing options, but it also depends on how you adapt. If you are very clear how to architect your IT enterprise landscape aligned with business goals your decisions will be more accurate and will be easy to sell.”

Evolved and innovative ways of pricing are the need of the hour as organizations stride through tough times and struggle to show more value from their IT investments. If not now, more sophisticated forms of pricing, be it outcome or partnership-based models or evolved ways of cloud-based subscription models, will be a reality sometime soon and it pays to start preparing for the future. The change has to come from both sides and vendors and clients will have to work together. As Puliakottu says, “This is a time of collaboration. You cannot do anything on your own.”