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What is Outcome-Based Pricing (and How to Tackle it)

by
in
Maciej Wilczyński
Managing Partner, Founder Valueships
July 8, 2024
pricing
strategy
ecommerce

Curious about how a pricing model could perfectly align with the success of your business? Imagine a world where you only pay for results, not effort.

That's the magic of outcome-based pricing.

This pricing flips the traditional model on its head. Instead of paying a fixed fee up front, you only pay based on the results you achieve. However, it's not a one-size-fits-all solution, and you'd better understand its entire concept before using it.

So, today, we'll talk about this type of pricing and reveal its promises and pitfalls.

What is outcome-based pricing?

Outcome-based pricing is a model where payment is directly linked to the achievement of specific business outcomes, rather than the efforts or resources expended.

Benefits of outcome-based pricing

And what are some key benefits of this solution?

Aligns payment with business goals

First, in this model, payments are made only when defined business goals are met. This alignment incentivizes service providers to deliver the highest quality work, as their revenue depends on successful outcomes.

✅ For example, a software company might charge based on the performance improvements their solutions bring to a client.

Enhances customer satisfaction and retention

By focusing on achieving specific outcomes, businesses can better meet customer expectations and needs. This approach often leads to higher satisfaction and retention, as clients see tangible benefits from the services provided.

✅ For instance, a marketing firm could adopt this model by charging clients based on the increase in customer acquisition or sales conversions.

Promotes risk sharing between parties

One of the key advantages of outcome-based pricing is the shared risk between the provider and the buyer. Here, both parties are equally invested in the success of the project.

✅ A classic example is in the healthcare industry, where providers might be compensated based on patient health improvements rather than the number of treatments administered.

Drives innovation and efficiency

Outcome-oriented models encourage providers to innovate and find the most efficient ways to achieve the desired results. This can contribute to many cost savings and improved service quality.

✅ For instance, in the tech industry, a company might leverage machine learning and artificial intelligence to develop solutions that enhance operational efficiency and meet outcome-based contract requirements.

Offers pricing flexibility

Outcome-based pricing structures offer greater flexibility compared to traditional fixed price models. They allow for adjustments based on performance metrics and external factors, making it easier to adapt to changing business environments.

✅ For example, a consultancy firm might use key performance indicators to adjust their pricing based on the economic impact of their advice on the client’s business.

Whom outcome-based pricing is best for?

Now let's look at who this type of pricing is best for and why. Some groups may be particularly interested.

Innovative technology companies

For companies in the software industry, this model can drive significant value. These companies often have the internal capabilities to accurately measure and deliver on specific outcomes. By aligning their pricing and revenue models with the success of their clients, they can create a competitive advantage and create stronger relationships.

Healthcare organizations

Healthcare providers can benefit greatly from outcome-based pricing, especially when focused on improving patient outcomes. These models incentivize high-quality care and efficient service delivery and lead to better patient experiences and health results. So, a hospital could adopt a pricing structure where payments are tied to patient recovery rates and readmission reductions.

Marketing and advertising agencies

Next, marketing and advertising agencies can utilize outcome-based monetization models to align their interests with those of their clients. By linking payments to metrics such as customer acquisition cost, revenue growth, or increased brand awareness, they can demonstrate their value...well, more clearly.

Enterprise customers with complex needs

Some customers often have complex and evolving needs that traditional pricing models might not effectively address. On the other hand, outcome-based models allow for more flexibility and alignment with business objectives, ensuring that both the buyer and the service provider are equally invested in achieving success.

These models can be particularly beneficial for large-scale projects where end to end control and the ability to adapt to changing circumstances are crucial. For example, a large corporation might enter into a contract with a consultancy firm, where the fee is contingent on achieving specific organizational changes or efficiencies.

Startups and new ventures

Startups and new ventures can leverage outcome-based pricing strategies to manage costs and mitigate risks. By structuring payments around achieving key milestones or business goals, these companies can conserve cash flow and ensure they are only paying for results that drive business development.

This approach can also be attractive to investors, as it demonstrates a commitment to measurable success. For example, a startup might agree to pay a business development consultant based on the achievement of specific funding rounds or market entry targets.

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The double-edged sword of outcome-based pricing

Implementing an outcome-based pricing model might seem like a no-brainer for those looking to align payment with results, but it still comes with its own set of challenges.

In a nutshell: “When you do it badly, no one wants to pay you. But when you do it well, no one wants to pay you.”

Why does this happen?

The problem lies in human nature and business psychology. When results are achieved, especially impressive ones, clients often forget the effort and expertise required to get there. They might feel the service provider was “lucky” or that the results were inevitable. This can create disputes and reluctance to pay large sums for what is perceived as past performance, even if those results were exactly what was promised.

Consider Elon Musk’s situation with Tesla’s market cap growth.

Musk proposed a bold outcome-based contract: “If I can 10X the market cap of Tesla, can I get my share?". The board agreed, likely thinking the target was unrealistic. When Tesla's market cap soared from $50 billion to $650 billion, Musk delivered on his promise.

However, the ensuing bonus dispute highlighted a key issue: stakeholders were reluctant to reward Musk for what, in retrospect, was seen as unattainable.

In other industries we can notice similar patterns. Recruiters, for example, often face delays in payment despite meeting or exceeding hiring targets. Their success might be attributed to market conditions or the perceived ease of the task, rather than their own efforts.

What are some solution strategies?

  • Payment escrows: Utilizing an escrow service can help manage expectations and ensure payment upon the achievement of agreed outcomes. This method provides security for both parties and reduces disputes.
  • Clear KPIs: Establishing clear, measurable key performance indicators (KPIs) at the outset can help define success and ensure both parties have a mutual understanding of the expected outcomes.
  • Phased payments: Structuring the payment in phases, with partial payments at different milestones, can help maintain cash flow for service providers and make large final payments more palatable for clients.

So, outcome-based pricing models can indeed be a win-win approach if both the provider and the buyer work closely to establish trust and clear agreements.

However, you'd better understand the potential pitfalls and prepare strategies to mitigate them. They are crucial for the successful implementation of such a contract.

Myth busting: Common misconceptions about outcome-based pricing

For now, let's check some of the myths that have arisen around this method of pricking.

Myth 1: Outcome-based models guarantee less risk for service providers

Reality: While outcome-based models share risk between both the buyer and the service provider, they do not necessarily reduce risk for the provider. In fact, if the specified outcomes are not achieved, the service provider might incur significant costs without payment. Therefore, one of the key considerations for implementing this pricing strategy is understanding and managing the potential risks involved.

Myth 2: Outcome-based pricing always delivers maximum value for business outcomes

Reality: The perceived value of outcome-based pricing can be high, but it does not always translate to maximum value for all parties involved. This pricing strategy works best when both parties have clearly defined goals and a mutual understanding of success metrics. Without these, it can pose challenges and lead to disputes over what constitutes a successful outcome.

Myth 3: Outcome-based pricing models improve customer retention automatically

Reality: An outcome-based model can align incentives and improve customer satisfaction, that’s right. But it does not automatically guarantee customer retention. The success of such a model depends heavily on meeting specific customer needs and expectations consistently. Additionally, the service provider must continually adapt to changing usage patterns and service levels to maintain client loyalty.

Myth 4: Traditional models are outdated and ineffective

Reality: Well, traditional models still have their place and can be highly effective, depending on the context. They offer predictability and simplicity, which can be crucial for some business models. Despite this, an outcome-based model may not be suitable for every scenario, particularly when it's difficult to control outcomes or measure success accurately.

Myth 5: Outcome-based pricing is the right choice for all new clients

Reality: Not all new customers are suited for outcome-based pricing. The buying decision for this model should consider various factors, such as the specific outcome expectations, the ability to measure results, and the internal capabilities of both parties. For some customers, a hybrid pricing model or a traditional model might offer better clarity and stability.

Outcome-based pricing model examples

And what about examples for this model? We have some ideas:

Healthcare industry

In the healthcare industry, outcome-based pricing is used to incentivize providers to improve patient outcomes. For example, hospitals might be paid based on patient recovery rates or reduced readmission rates, encouraging them to focus on high-quality care.

Digital marketing agencies

Digital marketing agencies often use this pricing to align their services with client goals. For instance, an agency might charge based on the number of leads generated or the increase in website traffic.

Software as a service (SaaS)

SaaS companies can implement outcome-based pricing by tying fees to their client’s success metrics. An example is a CRM software provider charging clients based on the increase in customer retention rates or sales conversions achieved through the use of their platform.

Consulting firms

Consulting firms can adopt outcome-based pricing by linking their fees to the achievement of specific business objectives. For example, a management consultancy might be paid based on the cost savings or revenue growth realized by the client as a result of their strategic recommendations.

Energy sector

In the energy sector, companies might use outcome-based pricing to promote energy efficiency. As a result, a firm providing energy management solutions could charge based on the reduction in energy consumption achieved.

IT services

IT service providers can use outcome-based pricing by tying payments to system performance improvements. Therefore, an IT firm might charge based on the reduction in system downtime or the improvement in network speed and reliability.

Education and training

Educational institutions and training providers can implement outcome-based pricing by charging based on student success metrics. For instance, a training company might be paid based on the job placement rates of their graduates, ensuring their programs effectively prepare students for the workforce.

Construction industry

In the construction industry, outcome-based pricing can be used to ensure project success. For example, a construction firm might receive payment based on the timely completion of a project or the achievement of specific safety and quality standards.

Key takeaways

We've covered a lot of this, so let's summarize the most important information from the article in a few bullet points.

  • Outcome-based pricing models align payment with specific business outcomes and incentivize high-quality results.
  • These models can help manage costs incurred by linking payments to measurable achievements.
  • Services-based businesses can benefit from outcome-based pricing by focusing on delivering concrete results.
  • This pricing strategy can significantly enhance the customer experience by ensuring satisfaction through achieved goals.
  • Outcome-based pricing requires providers to offer solutions that directly address clients' needs and expectations.
  • It's important to consider other factors like market conditions and client capabilities when implementing such models.
  • Establishing the right price is crucial for balancing risk and reward between providers and clients.
  • A main limitation of outcome-based pricing is the potential for disputes over the definition and measurement of successful outcomes.
  • Flexibility and clear communication are essential to mitigate the challenges and main limitations of outcome-based contracts.
  • Providers must work closely with clients, define KPIs, and measure results for successful implementation.

Last words

As you can see, understanding the nuances of outcome-based pricing models is essential for making informed decisions that align with your objectives. By debunking these myths, you can better evaluate whether this pricing strategy will help you achieve success and deliver the right value to customers.

If you're not sure what pricing strategy to choose for your business, reach out to us at valueships.com/contact, and we'll be happy to answer all your questions.

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Maciej Wilczyński
Managing Partner, Founder Valueships

Expert in B2B pricing, monetization and value-based selling strategies. Over the past year, he has completed over 40 consulting projects in Europe. Prior to founding Valueships, he worked at McKinsey & Company, mainly in the TelCo, software, and banking industries. He completed his doctorate in pricing in SaaS start-ups at the University of Economics in Wrocław, where he also lectures.

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Maciej Wilczyński
Managing Partner, Founder Valueships

Expert in B2B pricing, monetization and value-based selling strategies. Over the past year, he has completed over 40 consulting projects in Europe. Prior to founding Valueships, he worked at McKinsey & Company, mainly in the TelCo, software, and banking industries. He completed his doctorate in pricing in SaaS start-ups at the University of Economics in Wrocław, where he also lectures.