Why is pricing important?

Why is pricing important?

FinancialForce
Jo Birtle

In a labor-based business like professional services, profit comes from the right balance of revenue and costs.  PSOs have a very high fixed labor cost so the two primary profitability levers are either lowering cost (sourcing strategies, limiting benefits and overhead, virtual business models, limiting discretionary spending on IT, travel, training and recruiting) or increasing revenue (higher bill rates, higher revenue per person, higher billable utilization).  During three recessionary years most PSOs have focused intently on the cost side of the equation and are running very lean.  Now with a glimmer of economic improvement it is time to focus on growing revenue through a combination of rate, market expansion and productivity enhancements.

Pricing Strategies

The percentage of time and materials priced contracts across all markets and geographies was reported to be 58.8%. Each year a greater proportion of contracts across all verticals and geographies are fixed price reflecting client interest in shifting more risk and accountability to service providers.  A comparison of pricing strategies across PS vertical markets reveals IT Consultancies and PSOs within software companies depend heavily on time and materials based pricing strategies.  Hardware and Networking providers and SaaS PSOs have shifted the majority of their work to service packages and fixed price contracts while Management Consultancies favor time and materials based contracts but may include performance guarantees.

Interestingly, the percentage of fixed price contracts increases corresponding to the size of the organization.  Presumably this is because larger organizations have more mature estimating and change management processes or because their larger enterprise clients demand this pricing structure. The smallest organizations offer the highest levels of shared risk or performance-based contracts which can be disastrous if they do not have adequate change provisions or tight scope control.  For many professional service engagements, establishing a shared risk or performance-based model may be very difficult. From the PS Maturity™ Benchmark, shared risk projects are still in the minority with this pricing strategy deployed on less than 3% of all contracts. 

Service Performance Insight Founder and Managing Director, R. David Hofferberth, P.E., has over 25 years experience in information technology (IT) serving as an industry analyst, product director and consultant. Hofferberth’s research is focused on the services economy, and in particular, on white-collar productivity issues and the technologies that help people perform at their highest capacity. 

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