2010

AN EVEREST RESEARCH INSTITUTE WHITEPAPER

Transaction-Based Pricing Nirvana for FAO?

Role of Transaction-Based Pricing in FAO

Vikash Jain, Associate Partner

Abhishek Menon, Senior Research Analyst
Copyright 2010, Everest Global, Inc. All rights reserved.

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TRANSACTIoN-BASEd PRICINg NIRVANA foR fAo?

Introduction
Suppliers are using a wide-spectrum of pricing models in the BPO industry
FTE based, transaction based, outcome based, and hybrids created by
combining pricing models. FTE-based pricing has been the most prevalent
pricing model in finance and accounting outsourcing (FAO) due to its ease of
application. However, a pure FTE-based pricing regime cannot cope with the
increasing buyer sophistication and competitive intensity in the FAO market as
it does not align pricing with business needs/outcomes, often making it
difficult to deliver impact beyond cost arbitrage. Consequently, the FAO
market is now experimenting with transaction-based pricing and other more
evolved pricing models.
While transaction-based pricing delivers some key benefits, it is not applicable
to all buyer situations. As with all pricing models, transaction-based pricing is
not a nirvana for all pricing woes and needs to be applied selectively based
on the buyer-supplier situation.
The purpose of this white paper is to educate stakeholders about
transaction-based pricing, highlight situations where it is applicable, and
introduce a framework for implementation of transaction-based pricing. The
paper discusses:
The spectrum of pricing models and their prevalence in the FAO market
The challenges faced by FTE-based pricing, and factors promoting
adoption of more evolved pricing models such as transaction-based
pricing
The framework for implementation of transaction-based pricing and best
practices, illustrated with a case study

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Spectrum of Pricing Models

Pricing model refers to the mechanism by which a supplier determines its
charges to a buyer. This includes the type of pricing units, degree to which
elements are fixed versus variable, impact of volume fluctuations on the total
charges, and the mechanisms used to adjust prices over time. We can classify
the spectrum of pricing options into three broad buckets as illustrated in
Exhibit1.
EXHIBIT

1
Input
model

Spectrum of pricing models

Output
model

Hybrids

Labor

Hybrids

Outcome
model

Payment

Source: Everest Research Institute

Material

Process

Invoice

Facilities

Business
outcomes

Claim
Pricing Mechanisms

Per unit
of input
Less
Vendor

Input-based pricing,
output-based pricing, and
outcome-based pricing

represent the spectrum of

available pricing models

Transaction based pricing

(Fee for service)
Supplier risk/reward
Supplier relationship model

Value
share
More
Partner

Input-based pricing. This is based on the suppliers units of resource input

to provide services. An example is FTE-based pricing measured on an
hourly rate per FTE.
Output-based pricing. This is based on the buyers units of
consumption/volume of transaction in a billing period. An example is
transaction-based pricing measured as per invoice processed, per expense
claim processed, per journal entry, etc.
Outcome-based pricing. This is based on the suppliers contribution to the
business outcome achieved. An example is incentive-based pricing
measured as DSO reduction, improvement in working capital, increase in
collections, etc.

In addition, we also find hybrid pricing models created from a combination of

the above pricing models.

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FAO Pricing Models are Evolving

Increased buyer sophistication

and supplier competition-driven
differentiation are driving

As shown in Exhibit 2, 85 percent of all FAO contracts leverage FTE-based

pricing. The following factors contribute to the high adoption of FTE-based
pricing in FAO:

adoption of more evolved

pricing models

Ease of understanding. FTE-based pricing is easy for the supplier to

explain and easy for the buyer to understand. The buyer can relate to the
current state and how things will change from the current state, thereby
leading to a lower risk perception. Given this ease of understanding, FTEbased pricing engagements can help reduce the number of iterations in
data collection and validation, thereby reducing the sales duration.
Ease of benchmarking. It is easy for both buyers and suppliers to compare
the pricing levels in the market.
Ease of implementation. It is possible for the supplier to implement
FTE-based pricing with limited information about the buyers current
process maturity, transaction volumes, etc.
Ease of tracking. Tracking performance and reporting are fairly easy based
on easily measured parameters. Buyers have higher visibility into how
suppliers deliver processes and how it relates to the pre-outsourcing state.

However, interest in leveraging more evolved pricing models is now increasing

(Exhibit 2).
EXHIBIT

Prevalence of pricing models in

fAo contracts over time

Prevalence of pricing models in FAO contracts over time

Frequency of inclusion

FTE based
Transaction based

87%

Incentive based

82%

Source: Everest Research Institute

54%

26%

26%

Overall

31%

2009

Increasing buyer sophistication and increasing competitive intensity is pushing

and pulling the FAO market towards more evolved pricing models.

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Increased buyer sophistication. While labor arbitrage is still a very important

value-creation lever in FAO, it is considered table-stakes. Focus on process
effectiveness and business impact is now part of the FAO value proposition.
FTE-based pricing can deliver direct-cost benefits such as labor arbitrage, and
one-time improvements driven by consolidation. However FTE-based pricing
does not align closely with business needs/outcomes, making it difficult to
deliver business impact or strategic impact. Further, FTE-based pricing does
not allow for effective risk-sharing with the supplier, making it difficult to incent
the supplier to reduce costs and deliver business value.
On the other hand, transaction-based pricing encourages both buyer and
supplier to drive process improvements by creating tangible incentives.
Transaction-based pricing helps identify areas of improvement, by leveraging
end-user expertise and supplier best practices. This enables clients to focus on
initiatives that provide the required return on investment. As transactions are
aligned with business, it is easy to measure the value of the service provided
by the vendor. For example, a supplier implementing transaction-based
pricing was able to identify high efficiency end-users and adopt the best
practices developed by these individuals as part of the standard process to
increase the process efficiency.
With increased comfort levels with outsourcing, buyers are implementing
multi-tier governance structures, rather than micro-managing based on
parameters not linked to outcome, which is a behavior inherently encouraged
by FTE-based pricing.
In the current economic scenario, buyers are looking for more flexibility and
variability in pricing as opposed to high up-front fixed costs. Buyers want to
pay only for the activities executed and are always asking the question is my
team getting fully utilized, and can I reduce costs. Transaction based
pricing can allow for a closer linkage between business activity and costs.
Increased supplier competition. FAO is a mature market, with 20+
well-established suppliers. It is fast becoming a buyers market. Everest
classifies these 20+ suppliers as leaders, major contenders, and emerging
players, based on a multi-dimensional assessment of market success (annual
revenues from FAO) and delivery capability (combination of scale, scope,
technology, and delivery footprint).
It has now become increasingly difficult to create intra-group differentiation
among suppliers based on their capabilities. The top five suppliers accounted
for nearly 53 percent of FAO contracts through 2006 but account for 40
percent of the contracts signed between 2007 and 2009. Clearly, the
competitive intensity in the FAO market increased.

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Hence, suppliers are trying new and innovative methods to create

differentiation in the market. New market segments such as the mid-market
and new source geographies like continental Europe and Asia Pacific are now
emerging. Moreover, industry-specific FAO, as opposed to horizontal finance
and accounting (F&A) services is gaining momentum. Suppliers are launching
end-to-end process offerings for Source-to-Pay, Order-to-Cash, and Recordto-Report as opposed to piecemeal solutions for accounts payable, accounts
receivable, and general accounting.
With the increasing competition, suppliers are looking for new avenues to
drive non-linear business growth and, in turn, maintain higher margins. To
achieve this objective, suppliers are investing heavily in add-on tools like
workflows and application wrappers and pioneering platform-based FAO. To
enable such differentiated products and offerings, suppliers need to introduce
more evolved pricing models to replace FTE-based pricing. For example,
realizing benefits from a platform-based FAO offering is not viable in an
FTE-based pricing regime. Platform-based FAO promises a move towards ondemand pricing that converts fixed costs to variable costs for the buyer, but
FTE-based pricing in a platform-based engagement would defeat this
purpose.

Is Transaction-Based Pricing the Nirvana for all FAO

Pricing Woes?

Process characteristics, stability

of transactions, buyer-supplier
relationship, and structured

Though transaction-based pricing can deliver tangible benefits,

transaction-based pricing is not universally applicable in all client situations
and buyers should evaluate its suitability on a case-by-case basis. Following
are some critical factors that buyers need to evaluate to ensure successful
implementation of transaction-based pricing.

implementation plans are vital

for successful transaction-based

pricing

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Appropriateness of process. The outsourced processes should be standard

or can be standardized through reengineering efforts. The processes
should be well defined with a clear beginning and end, and the processes
should involve frequent repeatable transactions. For example, a process
like accounts payable, with standard repeatable transactions, is more
amenable to transaction-based pricing compared to a judgment-intensive
process like analytics.
Stable and measurable transactions. Transactions should be aligned with
the buyers business and easy to monitor and measure. The buyer needs to
commit to a minimum number of transactions to reduce supplier risk of
uncertain volumes. Availability of baseline volume data is a prerequisite for
transaction-based pricing implementation.

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Everest has developed a

comprehensive and measured
approach from strategy
development to final roll-out for
implementation of transactionbased pricing

EXHIBIT

Established good buyer-supplier relationship. There should be clear

understanding of transaction-based pricing on both sides. The parties
should design transaction rates fairly to ensure that both buyers and
suppliers share a common interest to maximize the value of the deal.
Structured implementation plan. The buyer and supplier need to work
together to create a well defined implementation plan covering all aspects
of transaction-based pricing. The internal charging mechanism needs to
be an integral part of this overall plan.

The Art of Implementing Transaction-Based Pricing

Once the advantages and appropriateness of transaction-based pricing for a
given buyer situation are established, the buyer and supplier need to address
various factors to ensure a successful implementation. Based on the
experience gained from advising multiple clients on transaction-based pricing
implementation, Everest developed a comprehensive approach to
implementation of transaction-based pricing (Exhibit 3).

3
Change Management and Communication

Everest structured approach to

Strategy
development

implement transaction-based
pricing

Source: Everest Research Institute

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Understand

implications of
transactionbased pricing
Define

processes in
scope
Develop
Spend
high-leveldata
goals

management
Develop an
implementation
plan

Resource
units
definition

Volume
baseline &
forecasting

Design
Define
appropriate
baseline
resource
volumes for
units
each of the
resource
Develop
units
measurement
criteria for
Forecast
each
volumes for
Strategic
resource unit
each year of
the contract
Develop sourcing
process for
Modeling of
management
associated
of resource
costs
units

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Tariff set-up

Pricing
model
validation

Roll-out

Define rate
Detailed plan
Implementation
cards, deadincluding
of transactionbands, and
dependencies
based pricing
volume
from supplier,
adjustment
internal
mechanisms
business
for each of
units and
the defined
other
Day-to-day appropriate Accounts
resource
units
purchasing stakeholders Payable
for parallel
Establish
run of
process and
transactionconditions for
based pricing
changing
regime
tariff in the
future

TRANSACTIoN-BASEd PRICINg NIRVANA foR fAo?

The following case study illustrates how a transaction-based pricing solution

was implemented following the basic tenets described above.
Case study: Global electronics company
Buyer details:
Revenues:US$25-30 billion (2009)
Industry: Electronics
Countries of operation: Worldwide

Situation:
Buyer had existing shared service centers
for finance & accounting (F&A)
processes
Wanted to concentrate on core business
and outsource non-core aspects such as
F&A and procurement

Solution:
Supplier bought the shared-service
centers
Followed a fixed-price model for the first
year
During this period, the supplier studied
the existing processes and identified
appropriate resource units for each
process
Based on the baselining exercise in year
one, rate cards for each resource unit
were agreed upon for the entire contract
period
Multiple shadow runs were done to test
the working of the model and to identify
any improvements
Output-based pricing was successfully
rolled out from year two

Contract details:
Seven-year agreement originated in
2007
Annual contract value of US$35-40
million
Outsourced processes include accounts
payable, accounts receivable, general
accounting, management reporting &
analysis, treasury & risk management,
tax, and internal audit
Geographic scope includes North
America, EMEA, and APAC
Pricing model is primarily transactionbased pricing, with some aspects of
FTE-based pricing and gain-sharing

Results and program highlights:

Direct impact
Output-based pricing provided a much
closer link between business activity and
outsourcing costs
Business impact
Buyer benefited financially from process
changes that directly impacted
transaction volumes
Future technological investments are
driven by the insights gained by
implementing the new pricing model
Strategic impact
Incentives for moving towards
simplification initiatives are more clearly
visible

Along with a structured approach, buyers and suppliers should keep in mind
the following best practices for a successful implementation of
transaction-based pricing.

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Focus on value creation. Buyers and suppliers should be clear regarding

the value that each can derive from the engagement. Where possible, they
should quantitatively articulate the values. They need to develop scenarios
of demand management and re-solutioning to demonstrate additional
impact.
Build a proposition that creates trust and sharing of control. The parties
should proactively address issues around benchmark-ability and lack of
visibility into the suppliers cost structure. They should explicitly articulate
mechanisms that give buyers control, transparency, and value such as
benchmarking, managing end-of-term transition, competitive pricing, etc.

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Demonstrate credible capability that backs up the proposition. Suppliers

need to demonstrate a robust methodology, market references and
examples that are critical in building confidence and comfort. They need to
proactively address concerns and solve key issues critical to the
operational and business stakeholders, e.g., seasonality, variable charges
to business P&L.
Focus on executive buy-in and change management. Executive buy-in is
critical in driving transaction-based pricing. Proactive change management
should cover operational stakeholders and upstream businesses that are
likely to be impacted.
Adopt a phased approach to implementation. In cases where there is lack
of information/data or where the buyer-supplier relationship is not yet well
developed, it makes sense to start the engagement with FTE-based pricing
and gradually move to transaction-based pricing in a phased manner. The
phases would be based on the data collected by the supplier and build on
the relationship established between the buyer and supplier over time.

Conclusion
Though transaction-based pricing clearly has some advantages over
FTE-based pricing, it is not applicable to all client situations and processes
and needs to be applied judiciously. Also, the implementation of transactionbased pricing requires more diligence, time, effort, and buy-in at multiple
levels.
Though there is considerable interest in the market regarding transactionbased pricing in FAO, with some notable successes (as illustrated in the case
study), the verdict is still out on its successful adoption, implementation, and
governance.

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About Everest
Everest Group is a global consulting and research firm that comprehensively serves the
sourcing market. An industry leader since creating the sourcing consultancy practice in
1991, Everest has earned a worldwide reputation for ongoing innovation by helping
clients capture optimum value through the development and implementation of
sourcing strategies and implementations, including captive, outsourced and shared
services approaches. We help companies create strategies and sourcing relationships
that deliver total value improving performance and results while effectively managing
risks.
Since its inception, Everest has forged over 600 major outsourcing relationships,
advising clients on complex sourcing issues in more than 30 key business processes
worldwide. Our experience spans numerous Fortune 500 clients in industries including
banking, energy & utilities, healthcare, hospitality, insurance, manufacturing, media &
entertainment, retail, and telecom.
The Everest Research Institute serves as a central source of independent and objective
strategic intelligence, analysis, and actionable insight for leading corporations,
suppliers, technology providers, and investors in the global outsourcing and offshoring
marketplace. Our research analysts address both business process and information
technology sourcing topics, providing the global sourcing community with information
that empowers highly productive, sustainable sourcing strategies and relationships.
Through a uniquely integrated consulting and research delivery model, Everest offers
its clients the flexibility and scalability to support a broad scope of business situations,
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Everest is headquartered in Dallas, Texas, and has offices in New York, Toronto,
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please visit www.everestgrp.com and www.everestresearchinstitute.com.

for more information about Everest, please contact:

Everest Research Institute
+1-214-451-3110
info@everestresearchinstitute.com
for more information about this topic please contact the authors:
Vikash Jain, Associate Partner
vjain@everestgrp.com
Abhishek Menon, Senior Research Analyst
amenon@everestgrp.com

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