Vendors Anticipate Increased Use of Value Based Pricing

6 Pages·1994·0.63 MB·English

INPUT
A Publication from INPUT’S Business Integration Programme - Europe
Vol. V, No. 7 April 1994
Vendors Anticipate Increased Use
Value-Based
Pricing
of
Users currently show a strong preference revenues. This approach has potential
for fixed price contracts in the project benefit for both client and vendor, since,
services market. However, many vendors at present:
perceive that fixed pricing is merely one
stage in the evolution of project pricing • Projects are inadequately linked to
business goals
rather than its ultimate goal. To a certain
may
extent, this be designed to be a self-
Up
• to one-third of projects fail to satisfy
fulfilling prophecy, since vendors would
the client’s business need
like to improve their project services’
profit levels. Fixed price contracts have
• Value-based pricing focuses
typically had an adverse impact on
management attention on the
vendor profitability.
achievement of the client’s business
goals.
Vendors anticipate that the next stage in
the evolution of project pricing will be
Projects are Inadequately Linked
increased emphasis on value-based
Business Goals
to
pricing. Value-based pricing can be
defined as the linking of project price to Exhibit 1 shows an analysis of the major
the achievement of specific business sources of project risk from the vendors’
goals within the client organisation. If perspective.
the project succeeds in achieving these
goals then the vendor is rewarded with a Exhibit 2 show an analysis of the factors
share of the savings or of the increased identified by vendors to be comparatively
low sources of project risk.
©
1994 by INPUT. Reproduction prohibited. BIPR-E
INPUT Research
Bulletin
Exhibit
1
Sources of Project Risk: High Risk Factors
Source: INPUT
Essentially, vendors perceive that the commitment to them firmly in the hands
major sources of project risk lie in the of the client organisation. Only one
front-end stages of a project. However, in vendor suggested that prototyping was
spite of this, vendors still typically seem essential to assist the client in clarifying
to place the responsibility for defining his requirements and developing a
requirements and ensuring user suitable specification.
Exhibit 2
Sources of Project Risk: Low Risk Factors
Very
Negligible Degree Significant
of risk
Sample of 10 leading vendors. Standard error = 0.3
Source: INPUT
2 © 1994 by INPUT. Reproduction prohibited.
The same vendor also suggested that it vendor capability in this area and in the
was a responsibility of the vendor to related area of managing subcontractors.
ensure that the business owner of the
Up
project on the client side fully understood to One-third of Projects Fail to
many Satisfy Client’s Business Needs
the project. In cases, client sign-off
of the initial specification is an
Exhibit 3 shows the average proportion of
administrative procedure, done without
projects, according to vendors that fail
any real understanding of the project’s
because the project:
scope and likely impact on the client
organisation. In addition, few vendors
• Does not meet the client’s business
appear to consider that promoting the
need
virtues of the project to users is an
important way of increasing • Does not reach break-even in terms of
commitment and hence reducing project the vendor’s profitability.
risk.
A
number of vendors interviewed by
Few vendors appear to have consistently INPUT were reluctant to admit that
.
compiled metrics for estimating project projects ever failed to meet the client’s
costs. Instead they tend to base their business need. The typical argument
decisions on two independent, but used by these vendors was that the
internal estimates from experienced customer’s business need would always
project personnel. Vendors claim be met even if project timescales were
confidence in this approach, but the user significantly exceeded in meeting this
community has experienced concern over
objective.
Exhibit 3
Project Failure Rates Vendor Perspective
Proportion of projects (%)
Sample of 8 leading vendors. Standard error = 2%
Source: INPUT
3 ©
1994 by INPUT. Reproduction prohibited.
INPUT Research
Bulletin
Indeed the majority of vendors estimated estimated that it might fail to break even
that the failure rate on this criterion was in more than 10% of projects. However,
less than 5%. There is no reason to doubt the proportion of projects where vendors
these estimates if a very narrow view of fail to meet their target profitability will
meeting the business need is taken. be much higher than this.
However, some vendors provided Vendors still typically price projects
indications that client satisfaction may be based on the combination of cost plus and
lower than this. One vendor stated that the price at which they feel they can win
their customer satisfaction studies the business. Ideally vendors aim for
showed acceptable satisfaction levels for margins of approximately 15%, but, in
approximately 80% of projects. Another practice, this figure is constrained by
major vendor estimated that in the competition. Vendors only decline to bid
strictest sense their projects had failed to for a very small proportion of projects
meet the client’s business need in up to because of the perceived level of project
one-third of projects with a significant risk, typically this is around 5%. The
%
number of projects being over- threat from competitors is a much more
engineered. This is a common criticism serious impediment to bidding.
of major business integration projects.
Value-Based Pricing Emphasises
Although, project margins are under the Achievement of Business
Goals
threat from fixed price projects, the
proportion of projects where vendors fail
Exhibit 4 shows the current usage of
to break even is comparatively low,
pricing mechanisms by leading project
averaging 6%. Only one major vendor
services vendors.
Exhibit 4
Project Pricing Mechanisms 1994 Usage
Proportion of Projects by value (%)
Sample of 10 leading vendors
Source: INPUT
4 ©
1994 by INPUT. Reproduction prohibited.
INPUT Research
Bulletin
Currently, fixed price contracts dominate change within the target price. Hence
the project services market. Value-based this approach should provide the client
pricing is only used in a minority of with more flexibility than a conventional
cases. However, vendors expect the use of fixed price contract.
value-based pricing to increase over the
next two years, reaching a position where The main issue in business integration
it is used in 12% of projects by value in projects remains the difficulty of
1996. This growth will be largely matched addressing the real business need. The
by a fall in the proportion of projects flaw in conventional fixed price contracts
conducted on a time and materials basis, is that they assume that the user can
which will continue to be superseded by specify a precise solution to the business
use of fixed price mechanisms. In need very early in the project. This is
addition, an increasing proportion of frequently a very unrealistic expectation.
However, the trend towards value-based
project services activity will be carried out
within an outsourcing framework as pricing provides the vendors with an
users request vendors to operate the incentive to address business problems
systems they have developed. rather than just minimise their own
commercial exposure while delivering a
Another approach to project pricing has technical solution. The challenge
been developed by Andersen Consulting remains to convince users of the virtues
with a concept called target pricing. This of this approach. Initially, at least, value-
is essentially a fixed price approach but based pricing will typically be used in
one that allows the scope of the project to combination with a fixed price element.
This Research Bulletin is issued as part of INPUT'S European Business Integration Program.
If you have questions or comments on this bulletin, please call your local INPUT organization or
W1X
Peter Lines at INPUT, 17 Hill Street, London, 7FB, [phone].
5 © 1994 by INPUT. Reproduction prohibited.
INPUT Research
Bulletin
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