SOW Pricing Needs An Upgrade
The contingent labor industry is experiencing a program-driven expansion into SOW (statement of work), and by association into the broader services procurement space. The spend management effectiveness and operational scalability of the contingent labor program governance model is giving experienced organizations the confidence they need to bring other high volume transactional spend types, similar to temp labor, under program management. This new programmable spend potential represents material new revenue opportunity for MSPs and VMSs.
Programmable SOW spend is 3-10X that of temporary labor.
Why the large range? Part of the reason is the lack of visibility into SOW-based spend and vendor data – it is hard to accurately quantify something that is not being at least minimally managed. A more likely reason though is that organizations are not yet sure how to gauge the value proposition of SOW management via the MSP/VMS lead program so they don’t know how much of their SOW spend to classify as programmable.
The same but different
It is tempting, but no less false, to assume that just because the program model is the foundation for industry change that all SOW spend can be managed in virtually the same way as temporary labor – same processes, same program resources, etc. The genesis of this false thinking is quite logical: most program expansions into SOW start off as an extension of the client’s staff augmentation supply channel, not as an extension of strategic sourcing and non-labor category management. But managing strictly labor-based SOW transactions as an extension of the staff augmentation category, as all programs eventually realize, is materially less complex than managing SOWs for outcome-based projects and services.
There is a lot of SOW vs temp labor fodder here for a geek to chronicle and opine upon; and of course I look forward to doing just that in future posts. But this article is about a specific aspect of SOW and I don’t want this important topic to be unnecessarily muddied.
At the core of the SOW pricing issue
SOW-based projects and services are acquired and consumed differently than staff augmentation – sourcing process, term, contract development, dollar amounts, engagement risk, delivery risk, service levels, etc. These differences exist not simply because of the use of an SOW, but because of the underlying type of spend the SOW is being used to govern. The governance required for a staff augmentation engagement is dramatically different than the governance required for an ADM project or an outsourced business process. Therein lies the great value of managing SOW via the MSP/VMS lead program: the flexibility of one channel type (SOW) to be uniquely configured to support multiple distinct, segmented spend types.
So, if no two, segmented SOW-based categories are (or should be) configured the same (i.e. levels of technology and service support), then why is it that most programs are still pricing all SOW spend off the same percent of spend fee structure?
Percent of spend
Percent of spend is a transactional pricing tool. Typically transactional pricing is used when the amount of the underlying transactional characteristic identified to drive the fee (in this case spend or dollars) is a fair and consistent representation of the relationship to the amount of support services being provided or utilized. The application of the actual fee being charged – represented by percentage or basis points – converts the amount of transactions (number of dollars) into revenue for the program providers and costs for the client (or suppliers depending on funding model).
SOW transactions vary
Percent of spend is well suited for all varieties of temporary labor (i.e. IT, finance, marketing production, audit, etc) because there is very little deviation from the cost of hourly workers and the standard set of activities to support them (i.e. standardized and automated recruiting process, hourly rates, low delivery and engagement risk, weekly time cards, 1-2 year tenures, etc). However, SOW transactions vary a lot relative to the underlying spend. Consider not only the following list of SOW transactions, but the variety of different service activities and tasks to support them:
- $100MM in Facilities Management spend, all going to one vendor on one SOW that has a 3 year term
- $100MM in annual Management Consulting spend, going to over 200 different suppliers across 500 unique SOW transactions
- $100K SOW for an independent IT contractor doing the same kind of work as all the other IT staff augmentation contractors.
- $100K SOW for a landscape management firm to maintain landscaping at all company locations (mow grass, trim bushes, snow removal, etc) for 1 year.
- $500K SOW for full back office financial operations support; a single provider with 3 year term and SLAs.
- $500K SOW for a consultancy to deliver an ADM project with specific deliverables, project management requirements and fixed dates.
So, how does a common percent of spend fee get uniformly applied across all of these different types of underlying spend? (Note, the object of that sentence is the spend and not SOW.) A uniquely configured service and support layer should be in place to govern each of the above SOW scenarios. This necessary diversification of category services and support is not well served by a one-size-fits all percent of spend pricing structure. However, a number of programs are still priced this way, and the question is why? The flippant answer used to be “because we can” which is not a great answer, but also not a surprise in this kind of evolving and dynamic territory where market rules and norms are still being sorted out.
The pending impact of a new stakeholder set
The days of monolithic SOW pricing structures are limited as the emerging stakeholder set for the expanded program, Procurement and Sourcing, are starting to do what they do best: seek price / value / risk equilibrium for their organizations. It should not surprise anyone when they do not see the value justification for paying the same percent of spend fee on a $10M SOW as they do on a $100K SOW. Even accounting for volume-based, tiered pricing that most program providers offer (fees drop as spend volume builds), the logical extension of the decreasing amount of support services on “big SOWs” does not align with the accumulating total fee across the full term of the SOW engagement. There has to be some percent of spend fee flexibility or an entirely new fee structure to gain long term buy in to the SOW value proposition, which leads me to my concluding thoughts on SOW pricing…
What is constraining SOW pricing innovation?
- Inflexible fee assessment and invoicing functionality within most VMSs.
Many SOW programs are priced as percent of spend not because it is the pricing method of choice for both parties, but because of system and operational constraints to price and manage SOW in other acceptable ways. Keep in mind this is a carryover from the temp labor side of the program that effectively ‘defaulted’ for SOW. Transactional pricing is not inappropriate for SOW per se. For instance, charging the fee based on # of SOWs or # of invoices or # of service utilization credits or some hybrid mix of all may prove better allocation of value / costs than spend alone. Some VMS providers are moving toward a subscription or license model and that seems appropriate and attractive; except when …
- Program fee assessment and program funding are too closely tied together.
The inability to maintain a separate supplier-funded model, regardless of where the program fee is being paid from, and regardless of whether there is a subscription or license in place, is a constraint to pricing (and funding!) flexibility and innovation. Both VMS and MSP firms need to invest / innovate more to enable separate, stand-alone pricing and funding models within the same program. (Two sentences here woefully underserve this critical topic – more to come in later posts.)
- MSP support at the upper end of the services range for SOW is still evolving.
Most MSP firms provide either no SOW support or only the administrative layer of SOW support. There are a few who have invested in the operational capabilities and resource skill sets to provide full sourcing and true SOW management support within the MSP economic model context. Needless to say, there is not an abundance of data available from this segment of the market yet. However, since this SOW service layer innovation is a direct sell to the procurement and sourcing stakeholder set, I am confident that market appropriate pricing will follow suit.
SOW pricing is where it should be, given how our industry has evolved. To suggest otherwise would be to ignore natural market forces at work. Tension, relative to pricing, or any misaligned structural component in an industry, is necessary to progress. It is encouraging that some companies are leading the way with new services and new functionality, moving the level of industry support and the pricing / value conversation forward. I would be more concerned if this tension did not exist for that may indicate either a rejection of the value the innovations are intended to deliver or the identification of an alternative channel for clients to obtain the value they seek.