Pricing risks arise as soon as the parties agree upon the service terms, conditions and pricing.
For the enterprise customer, the “pricing risk” is that the marketplace will provide better pricing than contract pricing, whether for insourced or outsourced services. Benchmarking and other techniques commonly used to manage or mitigate this risk.
For the service provider, the “pricing risk” is that the benchmarking process or other price adjustment will result in a loss or significant reduction in profitability and an inability to recapture the investment made in capturing and transitioning an enterprise customer to the outsourced business process platform. The service provider can never stand still, though, since if it fails to make ongoing investments in process improvement and cost containment, upon the expiration of the contract, it will cease to be competitive for new customers.
The art of outsourcing includes identifying and providing commercially reasonable solutions for both parties.
Commercial and financial transactions contain pricing risks at many levels.
Enterprise Customer’s Risks
The enterprise customer has many risks the need to be addressed in the services agreement:
- a future decline in market prices for the contracted services;
- a future increase in market prices that is not limited by the contractual commitment to fixed fees;
- a risk of loss of competitiveness by future discriminatory pricing by the service provider that favor other clients of the service provider who compete with the enterprise customer; or
- a possible need to pay the service provider’s “standard market rates” for services that are not in scope, or are required only on the basis of a separately priced project.
Service Provider’s Risks
Similarly, the service provider faces similar risks that might make its services uncompetitive over the long term, or unprofitable under foreseeable circumstances. Such risks include:
- a change in scope of services at the customer’s request;
- a change in the legal environment that imposes new conditions, costs or restrictions upon the manner of providing the services, the means by which the services are delivered to the enterprise customer or the right of the enterprise customer to purchase such services in its home country;
- a change in the volume of the services being consumed, either to
- increase (requiring additional hiring and perhaps a change in business process) or
- decrease (resulting in sub-optimization of dedicated resources, or reallocation of resources across multiple enterprise customers without any decrease in SLA commitments).
- an early termination that occurs before the service provider has earned out the sunken costs of pursuing and capturing the contract opportunity and paid the unpaid startup and transition costs.
The design of contracts to manage and mitigate pricing risks is an art form. Multiple techniques are available, each with its own limitations and additional risks.