Services Procurement

Compensation for a Job Well Done

Compensation methods: Fixed or Reimbursed? 

Let’s make it personal, setting aside the occasional longer than usual work day, when was the last time you volunteered to work for your employer? The lucky person will say they’ve found their passion when they believe that they would continue to do what they do even if no one paid them.  For the rest of us, a paycheck is validation that we’ve delivered value from our effort. 

No matter how special your company, a supplier expects to be paid for the work they deliver.  And, the Client expects to pay a fair amount comensurate with value received. Selecting the proper compensation method therefore is critical to the success of your Service engagement.

There can be as many pricing and payment model varieties as there are buyers and sellers in the world – we all seem to add some special sauce that makes the deal we’ve just negotiated the exact set up to get what we both want.  Despite the wide variety, there are only 2 fundamental ways a supplier is compensated.  The Reimbursed method (either Time & Materials or Cost Pass Through) infers that the Supplier is compensated for all the costs incurred to deliver the services over time.  The Fixed method infers that a price is agreed up-front and includes all elements to produce the agreed result over a given time period.  These compensation models are best used under certain conditions and should be designed based on the business environment.

Compensation Method

What is included?

Best Used When:

Reimbursed:

1. Time and Materials: Financial compensation for some discreet time period, typically an hour, required or requested to complete the work.

  • Rates per worker or worker type; rates are typically loaded which means they include the cost of benefits and taxes.
  • Materials – The physical equipment, tools or supplies used to deliver the end product or end result.
  • Both the Material and Rates are marked up by a percentage or an actual cost to cover the Supplier’s overhead & profit margin.
  • The Buyer needs extra resources whose work is directed by the Buyer.
  • The Buyer wants flexibility and control of the money spent.
  • There is uncertainty in the final objective.
  • It is not possible to estimate the desired business outcome.

2. Cost Pass Through:  Financial compensation for the various components used to deliver the final product or performance.

  • Costs for labor and management to deliver the performance.  Could be based on rate per hour or rate per unit of work output.
  • The cost/invoice from all Subcontracted effort incurred.
  • The management fees associated with overseeing the performance and delivery of Subcontracted effort.
  • Service provider overhead and profit.
  • Performance delivery is clear but Buyer prefers to retain ownership or decision rights on how Services are delivered.
  • How work being performed is complex, particularly in the case of early Outsourcing deals, such that the Buyer has claim to savings associated with optimizing service delivery.

Fixed:

Fixed Fee:  An all in price to deliver the business objective.

  • All fixed and variable costs associated with the agreed performance, service output or business outcome.
  • An assessed cost to cover any unknown (risk) elements not considered in the cost to deliver at the time of estimating.
  • The business situation is stable and predictable
  • The pricing scheme is straight forward with little complexity.
  • The work is clearly defined and communicated.
  • Service Provider competency is high.

Variable or Incentive Fee: 

  • This compensation can be applied to Fixed or Reimbursement type compensation methods.
  • Provides a way to compensate the Supplier in a way that is disassociated with transaction volume.

For simple Service engagements, once you have aligned to the cost of the Service and determined the Compensation Method, you can proceed to order.  For more complex engagements, you should spend time defining the other elements of the Financial Model such as incentive schemes, investments, Foreign Exchange/currency assumptions, cost of financing and the allocation of Risk.

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