Buyers and suppliers are increasingly drawn to the benefits that a pricing model such as output-based pricing can bring. The move to control costs has seen many buyers transition their existing input-based model into an output-based model while some buyers are turning to new suppliers or setting up entirely new outsourcing relationships that are based on output-based pricing.

Here, SQS Software Quality Systems, the largest independent provider of software testing and managed testing services, outlines the motivations behind moving to output based pricing, benefits and challenges that must be overcome, including the mechanisms needed to handle demand variation and improved SLAs.

Over the last few years, as the cost impact of poor quality software products and applications has risen, the need for specialisation in testing has been accepted within the IT industry. Outsourcing and off-shoring of testing has become the norm. However, there is room for improvement in the way outsourced testing is implemented today.

While outsourcing has delivered cost reductions and flexible access to skilled technical resources, many companies today are seeking outsourcing providers that will work with them as true partners taking greater ownership of the outsourced work and delivering results rather than bodies and processes.

The incentive model in most engagements can be an issue and common head-count based pricing models work against the concept of partnership. So, is there a viable commercial model that encourages long-lasting effective partnership without compromising quality? Possibly the best answer to this is output-based pricing.

Benefits of output-based pricing

The biggest benefit of pricing on the basis of output is obvious – the customers pay only for what is delivered. But this mechanism brings about a complete change of mind-set in both the customer and the vendor.

Output-based pricing shifts risk away from the customer. In head-count based pricing, the risk is predominantly with the customer, as the vendor is paid for resources used on the project at a pre-determined rate. There are of course SLAs to cover the risk, but on the ground it is extremely difficult to design and execute these SLAs. In an output-based pricing mechanism, the SLA is built-in.

There is a more subtle, but extremely important benefit that output-based pricing provides. The head-count driven vendor has no interest in increasing efficiency – the way to grow business is to increase head-count, not decrease it. Conversely, in output-based pricing, the vendor is incentivised to increase efficiency.

The vendor tries to increase output with the same team-size, or even reduce the team-size by using automation and improving processes. Customers benefit too, as vendors can offer year-on–year benefits, increasing their units of delivery per unit of cost.

Truly, a win-win for both parties, which is very difficult, if not impossible to achieve in a head-count based engagement.

The requirements of output-based pricing

An initial calibration phase is critical for output-based pricing engagements. During this phase both parties agree on a unit of testing deliverable (at SQS, they are known as Quality Points), and on the rate for each unit.

To maximise benefits, the engagement needs to be planned over multiple years, giving the vendor the confidence to plan and invest in building efficiency in the service offered. By signing up for multiple years, customers get year-on-year efficiency benefits.

Of course, reviews must be planned to track performance and ensure that the output-based pricing is in line with the objectives of the outsourcing.

Example of output-based pricing, as applied to Test Automation

It turns out that Test Automation is an area where output-based pricing can be applied successfully. In this paradigm, the rate card only mentions prices for test cases delivered, executed and maintained. To be able to prepare the rate card, in the initial calibration phase a sizeable number of test cases of representative size and complexity are taken up for automation and delivered.

The output-based rates are calibrated based on the efforts taken on the automated test cases as well as release plans of the application under test. The engagement is necessarily over multiple years covering many releases and thus repeated executions of the test automation suite.

With the delivery responsibility completely with the vendor, backed by output-based pricing for guaranteeing the delivery, this mechanism delivers on the promise of a truly managed testing service.

Author: Gireendra Kasmalkar, SQS India

Gireendra is the MD and CEO of SQS India. Gireendra had founded VeriSoft, one of India’s leading independent testing companies. VeriSoft was acquired in July 2008 by SQS Software Quality Systems AG, the global leader in independent testing. SQS is headquartered in Germany, has operations in 15 countries and is listed on the London Stock Exchange.

Through SQS Managed Testing Services, businesses only pay for what is tested, have access to a global delivery team and work with a pure-play independent testing consultancy, so benefitting from a clear division between implementation and testing teams.

Gireendra is a Mechanical engineer from the Indian Institute of Technology, Mumbai, India (1987) and University of South Carolina, USA, (1989).