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Step 3. Setting Prices:

Though an essential part of the outsourcing process, pricing decisions remain a sensitive subject. Outsourcing arrangements customarily run from millions to even a billion dollars over the course of the multi-year agreement. Further, when the relationship involves purchasing assets such as data centers and staff, a substantial investment is made by the outsourcer based on client accounting, resource quality, ability to integrate client facilities into the provider's existing data centers, and a host of other considerations. Accordingly, price setting itself is both complex and iterative.

In general, contracts can be written on a fixed-price basis or on more flexible terms. In fixed-price arrangements, the provider takes on the risk of absorbing cost variability in order to provide cost certainty to the client. While setting fixed prices helps reassure clients of predictable final costs, it may have adverse effects if the agreement is not carefully crafted. When set too low, fixed prices diminish the outsourcer's flexibility and motivation to respond to changing business objectives or emerging technologies, because of the potential investment requirements and profit impact beyond what has been incorporated into the contract.

The opportunities for creativity and balance are greater under variable pricing, in which price may be based on straight service usage, on the sophistication of services used, on risk sharing, or on a combination of approaches. Risk-sharing relationships enable the outsourcer to share in benefits generated for the client, thus ensuring aligned objectives and perspectives. However, while allowing variable prices or incentives may motivate appropriate change, it may also create misunderstandings if and when costs exceed expectations, especially if scope and accountability are ill defined. The communication process established in the governance discussion helps avoid and resolve potential conflicts over price arising from these and other issues.

Increasingly, a combination approach to pricing is taking center stage in outsourcing relationships in an effort to strike the right balance between cost predictability for the client and profit protection for the outsourcer. In these arrangements, for example, transactional services may carry a fixed price, while more strategic services like Web development, hosting, and communications infrastructure may be priced to better reflect value, risk, and technical sophistication.

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