April 21, 2016

An Old Recurring Revenue Model Gains New Converts

By Tom Dibble

An Old Recurring Revenue Model

Due to a range of market forces, a recurring revenue model that’s been used for decades in industries such as airplane manufacturing is undergoing a resurgence. Widely referred to as outcome-based pricing, output-based pricing, and performance pay, it offers companies a compelling way to stand out in a crowded field. Here’s a quick look at what it involves and what it takes to make it work.

With outcome-based pricing, people don’t buy products and services. Instead, they purchase the results those products and services make possible.

It’s not a new idea. For example, the concept of “Power by the Hour” for jet engines first arose in the 1960s. Customers no longer had to buy engines. Instead, they bought the outcome of owning an engine: guaranteed hours of operational performance. As part of the agreement, the engine makers took care of all maintenance and repairs.

Rolls Royce uses the same pricing method today with its TotalCare program, as do other engine manufacturers such as GE and Pratt & Whitney.

Why outcome-based pricing works

In today’s age of soaring customer expectations and increasing product commoditization, the idea of paying only for results is taking off. For companies, it provides more than ongoing, predictable revenues. Because they’re directly responsible for positive outcomes, it also deepens their relationships with customers in ways other pricing models don’t. It makes them collaborators in their customers’ success.

Here are a few examples of how various industries are using this strategy in new ways:

  • IT outsourcing and managed technical services. Traditionally, customers of services such as outsourced network management pay for labor and resources (aka “time and materials”). But increasingly, through the use of performance-based contracts (PBCs), they now have the option to pay for quantifiable results, such as the number of security Vulnerabilities patched or mobile devices supported or the average network uptime achieved.
  • Printing services. With Managed Print Services from Xerox, customers no longer have to pay for printers, toner, and maintenance. Instead they buy only what they really want—successfully printed copies. Xerox takes care of everything else. This same output-based pricing model is found in many “as-a-service” industries today.
  • Heating and air conditioning (HVAC). For years, Trane has offered customers an alternative to up-front capital expenditures for HVAC equipment and services. Through its PACT™ contract (Performance Agreement for Comfort from Trane), customers pay instead for guaranteed annual energy savings. Trane handles all project management, maintenance, and performance monitoring.
  • Truck fleets. With MAN, a German truck and bus manufacturer, fleet operators don’t have to purchase vehicles or deal with maintenance. Instead, for a small fee per kilometer, they get the outcome of truck ownership—access to trucks that are always available, in top condition, hassle-free, and fuel-efficient.

Key considerations

For all of its benefits, outcome-based pricing works well in only certain circumstances. For example, outcomes should be quantifiable and not subjective (e.g., cost savings, specific tasks performed, or benchmarks reached). Here are a few more criteria to consider if you want to know if this strategy is worth pursuing:

  • Direct connections. A direct line of connection needs to exist between a service and the business results it delivers. Determining precise cause and effect can be murky with complex services involving multiple suppliers and vendors.
  • Detailed agreements. Agreements must cover such granular details as what constitutes a successful outcome, who makes that determination, and what happens when outcomes fall short.

If your business can take advantage of outcome-based pricing, it’s well worth exploring. It gives you unique leverage in creating long-term repeat revenues. After all, when you offer customers positive outcomes, chances are they’ll want to buy them over and over again.

By Tom Dibble

Tom Dibble

Tom Dibble is President and CEO of Aria Systems, a proven leader with more than 20 years of experience in the high technology market. He joined Aria Systems in 2009 from Oracle Corporation where he served as vice president of worldwide channels and alliances, as a result of Oracle's acquisition of BEA Systems in May of 2008.
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