Assessing the value in value-based pricing: Page 2

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Edward Burke, an Andersen Consulting partner: "I have on occasion used a third party to help create a partnership agreement."

Indeed, a consultancy could earn 10% of the overall revenue captured on a project like the one Andersen did for the Massachusetts DSS. In a case like this, though, the overall benefit to the state and the taxpayers far outweighs the hefty fee.

Because you might end up paying as much as 10% of your total revenue earned to a systems integrator, Campbell recommends creating tiers in your payment structure. "The early dollars are easier to get," he says. "If you have a flat percentage arrangement, there's no incentive for the vendor to go after the [harder to attain dollars]."

Lessons learned about value-based pricing
Ray Campbell, general counsel for the Commonwealth of Massachusetts' information technology division, has the following advice for CIOs and other IT managers considering value-based contracting for systems integration:

Give careful consideration to how you structure the payments.

Be very careful in your selection of partners.

Be prepared to work closely with the vendor. "If you think the results will magically appear, you will be disappointed," Campbell says. You have to be in the mindset to "truly partner" with the vendor by committing human resources, he adds.

Massachusetts' information technology division has done a number of value-based integration projects with Chicago-based Andersen Consulting, Boston-based Public Consulting Group, and other consultancies. In one engagement with Andersen, the state received an additional $120 million in revenue it would not otherwise have earned.

For example, in a contract such as the one with the Massachusetts DSS, a consulting firm might be paid 1% for the first zero to $50 million in reimbursement received from the federal government, then a higher percentage for $51 million to $75 million, and a still higher percentage for $75 million on up. "That way the vendor gets past the easy revenue collection and starts working on difficult things," Campbell says.

Value-based contracts where the client makes no up-front investment and the vendor is paid on the overall results are more common in the public sector, according to consultants, analysts, and CIOs. Companies in the private sector, meanwhile, are able to invest money up front and are more likely to enter into deals that combine some traditional time-and-materials billing methods with value-based pricing.

Here's an example of a value-based formula used by New York City-based consultant Ernst & Young LLP in a supply chain contract. It involves three tiers of payment:

Keys to success

Users and vendors alike note the importance of the contract in value-based pricing deals. Lawyers are always involved, as are other advisers in many cases. "I have on occasion used a third party to help create the partnership agreement," says Andersen Consulting's Burke. "That helps make the contracts beneficial to both sides. It has to be an organization that understands the business situation and is able to act as a go-between, an honest broker between the parties."

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