Conventional pricing strategies can be problematic, especially in today's rapidly changing business landscape. They often rely on cost-plus or competitor-based pricing, which may not fully capture the value that a product or service delivers to customers. Results-oriented pricing, on the other hand, ties the price directly to the value or results that a customer achieves.
We see a growing shift to results-oriented pricing models. This reflects a broader trend in business, where the focus is shifting from inputs and outputs to outcomes and impact. This article discusses how such a revenue model transformation can unlock long-term growth.
What is outcomes-based contracting?
Outcomes-based contracting is an agreement in which the payment or compensation is based on the outcomes or results achieved rather than the inputs or activities performed. In this model, the focus is on delivering specific results or achieving predetermined goals. This can be beneficial for both service providers and customers as it aligns incentives to successful outcomes.
Models based on outcomes offer a multitude of advantages. During challenging periods, they help businesses by providing more adaptability to their customers. For example, outcome-based contracts often involve a shared risk between the provider and the customer.
Outcome-based contracts encourage innovation and collaboration between providers and customers. Instead of customers bearing all the risk upfront with fixed-price contracts, both parties are interested in achieving outcomes. They incentivize both parties to work together creatively to achieve them. This can be particularly valuable during times of uncertainty, as it reduces the financial burden on customers while ensuring providers deliver results.
Outcomes-based contracting has the potential to drive the development of innovative solutions and approaches that directly address a customer's specific challenges. This not only delivers immediate results but also paves the way for long-term value and competitive advantage for both parties, making it a win-win situation.
Outcomes-based contracting vs. fixed-price
Outcome-based contracts are typically more flexible than traditional fixed-price contracts. They allow for adjustments based on changing circumstances, such as shifts in market conditions, customer needs, or unforeseen challenges.
Outcome-based contracts are inherently customer-centric. They align the provider's incentives with the customer's goals and objectives, fostering stronger relationships and loyalty. With fixed-price contracts emphasis is usually on fulfilling the contractual obligations rather than delivering specific results.
Outcome-based contracts require clear and measurable metrics for success. In contrast, fixed-price contracts typically focus on inputs (e.g., hours worked and materials used) and outputs (e.g., completed project milestones).
Examples of outcomes-based contracting
- Pay-for-performance (P4P) contracts in healthcare. Healthcare providers are reimbursed based on patient outcomes or quality metrics rather than the volume of services provided. For example, hospitals may receive bonuses for reducing readmission rates or improving patient satisfaction scores.
Value-based care contracts in healthcare. Insurers may enter contracts with healthcare providers. Here, payments are tied to a population's overall health outcomes, such as reducing chronic disease prevalence or improving preventive care utilization.
- Managed IT services. IT service providers may offer outcomes-based contracts that guarantee specific uptime levels, response times, or system performance metrics. Clients only pay for the services if these performance targets are met.
Software as a Service (SaaS) agreements. SaaS providers may offer outcome-based pricing models where the subscription fee is based on metrics such as user engagement, active usage, or business impact achieved through the software.
- Equipment availability contracts. Equipment manufacturers may offer contracts guaranteeing a certain level of equipment uptime or reliability. Customers pay based on the actual performance of the equipment rather than just the initial purchase price.
Output-based contracts. Manufacturers may contract with suppliers or service providers based on the output or quality of goods rather than inputs or labor hours. Payment is tied to achieving specified production targets or quality standards.
Why choose outcomes-based contracting?
Revenue models based on usage and business outcomes can accurately measure your solution's tangible value to your customers. Given the mutual advantages, we at Simon-Kucher are convinced that such revenue models can substantially increase long-term revenue. Here's why:
Enhanced customer lifetime value and net revenue retention
A revenue model based on business outcomes is a mutually beneficial arrangement. It synchronizes the objectives of your company and your customers. The more benefits the customer receives regarding cost savings and revenue growth, the more they pay.
This shared interest fosters a strong, long-term relationship between your company and customers. This positively influences two crucial metrics – customer lifetime value (CLTV) and net revenue retention (NRR). Therefore, outcomes-based contracts can lead to superior growth outcomes and a higher enterprise value (EV) multiple.
Reduced customer acquisition duration and expense
The appeal of these revenue models lies in their ability to quantify a specific value or actual usage. When you only bill customers for the value they derive, you lower the purchase barrier and simplify the sales process. Furthermore, these models necessitate data that measures usage and value. This enables you to develop solid case studies highlighting your solution's advantages.
Tighter connection between product and commercial success
A revenue model based on business outcomes depends on delivering a specific financial outcome. In this context, you establish a tighter connection between your products and commercial success. Your product itself starts acting as a growth driver.
The more effective, efficient, and advanced your solution, the more usage and value it creates for customers. This directly converts into higher revenues.
Planning and testing are key to success
When transitioning to outcome-based contracting, there are several factors to take into account and evaluate. Here are three of the most critical ones:
- Quantifiability. You must be able to ascertain with a significant level of certainty that your solution enhances business performance for your customers. Quantifiability also aids in preventing revenue losses as customers attempt to exploit the system.
- Market readiness. Adopting a new form of contracting necessitates a comprehensive communication strategy and ample internal training to validate the calculated and observed financial results. This groundwork also assists in averting customer dissatisfaction and reducing short-term attrition.
- Customer integration: It's vital to ensure that customers utilize the solution effectively. Slow uptake and incorrect usage will ultimately diminish the customer's benefit, thereby affecting your own earnings.
How Simon-Kucher can help
At Simon-Kucher, we empower our clients to thrive in the outcomes-based contracting (OBC) landscape. Leveraging our expertise in pricing strategies and outcomes-based models, we collaborate with businesses to craft tailored solutions that align pricing structures with their long-term business goals and desired outcomes.
We assist our clients in identifying key business outcomes, measuring success over a defined period, and structuring contracts that incentivize performance and drive results.
Looking for support with optimizing pricing to align with specific business objectives or navigating the complexities of outcomes-based contract work? We can equip you with the tools and strategies needed to achieve competitive advantage and long-term success. Reach out to us today.
