PricewaterhouseCoopers’ Paul Zabakly shares some tips on adopting a winning pricing strategy when it comes to bidding for Information Technology outsourcing contracts.
Many corporates have outsourced or are considering outsourcing Information Technology & Telecommunications (IT&T). There are two main reasons behind this - firstly, IT&T is a non-core business process for most companies, and secondly, it is very complex to manage. By outsourcing IT&T corporates can regain control of service delivery, realign IT&T with business requirements and importantly rein in costs.
Many well known organisations have outsourced IT&T, including major banks such as CBA and Westpac, Telstra, Woolworths, Australian Tax Office and Amcor.
Service providers invited to tender for multi-million dollar outsourcing deals are typically required to respond within a short period of time, and often based on less than ideal tender information. Selection of a “winner” is based on a number of criteria, and not surprisingly, price is a critical component.
Given the complexity of outsourcing deals and the pressure facing all parties to finalise the contract, it's not surprising that some outsourcing deals come unstuck. In many cases the problems are related to misunderstanding the scope of work and/or the inadequate pricing of services. Such problems can lead to the demise of service, triggering breach of service level conditions, penalty payments and possibly contract termination.
So, what are the major problems encountered by outsourcers attempting to price large scale bids? Fundamentally, the problems are usually connected with lack of information, inappropriate resourcing of the finance team, a lack of project management skills and poor commercial skills. The most common problems are grouped below:
Information
lack of information presented by the vendor
fear of asking questions to vendors which may appear to compromise the service providers’ capabilities or competencies
insufficient market information to benchmark comparability of pricing
Resources
lack of qualified/experienced financial resources
lack of time to develop appropriate costing models
finance team changes creating discontinuities
inability to cope with the vendor’s constant change around tender specifications without time extensions
Team dynamics
lack of internal co-ordination and /communication between the solution/delivery and finance team
the finance team asked to participate too late into the project
lack of independent solution and financial due diligence/review/challenge
Commercial reality
not matching the costs and the price for service delivery to the statement of work, service levels and risk associated with service level penalties
inability to communicate pricing on terms that make business sense to the vendor
gaming the financial model by reducing costs to meet internal hurdle rates around Net Present Value (NPV) or Internal Rate of Return (IRR).
The result of the above is usually a poorly constructed cost model, one which does not adequately reflect the reality of the intended outsourcing contract and one which cannot be used with any confidence to gauge contract profitability.
Nobody wants to win a bid only to discover that a satisfactory return is not possible, and similarly, nobody wants to lose a bid due to being way out of step with competitor bid prices, or by failing to present the financial response in a compelling manner.
A successful outsourcing bid is dependent on its finance team delivering against three objectives: understanding and accurately modelling cost dynamics and risks, developing a pricing regime that demonstrates risk transfer, and is innovative and compelling while delivering appropriate returns, and communicating the benefits of the pricing regime to the vendor effectively so they are understood and valued.
Ultimately, it is the finance team's responsibility to instil confidence in the project team that the pricing is sound and deserves to get the service provider to the short list or the negotiation table.
To meet the objectives, the finance team must possess a number of important characteristics, as follows:
1. A competent person is required to lead the finance team and interact effectively with other project team leaders. This person needs to be well-versed in the preparation of bids, understand the disciplines of cost modelling and financial engineering.
2. The finance team needs to have a prominent position within the overall bid team to be able to provide feedback on status and information gaps in the cost gathering and pricing process. Any "red flags" signalled by the finance team must be seen actioned as a priority.
3. The right resourcing is critical. By this we mean getting individuals with the right skills and the right number of people. No point getting people who are not qualified to do the work or getting too few qualified people.
4. When choosing individuals for the team they should be briefed on the likely work environment to avoid departures through lack of suitable commitment. Staff must be proactive, have good operational knowledge, and be able and willing to challenge the solution designers on key assumptions. Of course, there can be a real danger in pulling staff away from their normal jobs to work on these assignments. In such circumstances they end-up with two masters and ultimately three dissatisfied parties, including themselves. So make sure that these people are able to commit 100%.
5. Where possible have only one or two individuals responsible for developing the financial model. Importantly, the model framework needs to be challenged to ensure it will be able to withstand the tug of war it is likely to experience through-out the bid process. Have a process in place to control the many versions of the model which are likely to be created. Financial modelling can be a complete disaster if the modelling is left in the hands of inexperienced analysts.
6. Document all the assumptions made, as this will make the financial challenge sessions much more effective. With successful bids, the bid model becomes the performance benchmark and it is helpful to be able to explain variances to bid model assumptions.
7. The finance team should provide the solution designers with a framework to develop their costings, and the designers should take “ownership” of the results. The tool should also double as an effective interface to the financial model and allow for assumptions to be documented.
8. Challenge, challenge, challenge! Staff need to be constantly challenging the assumptions solution designers make about the mode of operation, support costs and capital expenditure requirements. The challenge sessions should be undertaken by subject matter experts not on the core tender team. Alternative modes of operation should be thoroughly discussed before being discarded.
Having assembled a robust cost model, ideally based on a value driver or an activity based costing approach, the bid team is now ready to tackle vendor pricing.
It sounds obvious, but pricing of services should be put to vendors in terms that make most sense to them. In an outsourcing process, vendors usually like to see their fixed cost structures presented on a variable basis to provide them with operational flexibility. This requires the pricing team to have an intimate understanding of their cost structure/behaviours and undertake a fairly rigorous risk/return assessment of the vendor’s business strategy, and how the activity that will form the basis for charging is expected to change over the contract period.
For example, if the charging activity is based on a volume measure such as number of users, number of calls, or number of devices, then the pricing team needs to contemplate how costs for the service provided change in relation to this charging activity. Based on this analysis, an appropriate charging methodology can then be developed.
Unless the services offered are unique, prices should always be vigorously compared to the market. By reconciling differences from market pricing you can gain valuable insights into how appropriate the solution and its costing assumptions are. If market prices are less you need to ask why; is it because your solution presented is inefficient, or are higher solution service levels required, or is the scope of services different?
To summarise, there is no doubt that working on multi-million dollar bid is one of the most demanding and intensive experiences a person can undertake. For it to be a worthwhile experience, a winning pricing strategy is critical, and the best way to achieve this is by assembling the best finance team you can afford.
