Outcomes-based billing, growing as a share of revenue across the industry and pursued most aggressively by iGate Corp Chief Executive Phaneesh Murthy, is meant to appeal to clients with less-certain budgets in a tough economy.
If the services don't deliver an agreed-upon result, such as reducing the cost of processing a loan or cutting the reject rate in an auto parts factory, the customer pays less. But the strategy also boosts profit margins for IT companies, raising questions about which model is better for customers.
Murthy was a rising star at Infosys as California-based global head of sales before leaving in 2002 after a sexual harassment lawsuit against him and the company, which made headlines at the time and was settled out of court.
"If you look at the external environment, customers don't know exactly what their revenues are going to be, what their volumes are going to be, and therefore passing on that risk to the vendor is a very appealing concept right now," Murthy said in a recent telephone interview.
Traditionally, iGate and other smaller IT outsourcers have competed with Indian heavyweights such as Tata Consultancy Services and Infosys on price.
Murthy, 49, founded a company that was bought by iGate, which is based in Fremont, California, but has the bulk of its staff in India. In 2011, he teamed up with buyout firm Apax Partners for iGate's $1.2 billion purchase Indian rival Patni Computer Systems, which was more than twice its size.
Murthy has been an outspoken critic of the industry's traditional billing model, known as time-and-material. In a marketing campaign, iGate dismissed the model as a "criminal" practice that has "swindled" billions from large companies.
iGate took out an advertisement in The Economist magazine in January that read, "If this ad does not deliver results, we're not paying The Economist", marking a rare foray into mainstream media for an outsourcer.
While the company's irreverent tone is striking for an industry that tends to be staid, part of it is bluster: Outcomes-based pricing accounts for just a single-digit share of revenue. Most of its business is billed in the traditional way.
Murthy wants to grow the share of outcomes-based billing at iGate to 15-16 percent this year and 30 percent by 2017. By comparison, the industry may earn about 22.5 percent of revenues through that billing model by 2018, predicted Ray Wang, principal analyst at Constellation Research based in California.
India's $108 billion-a-year outsourcing industry got there by throwing hundreds of thousands of bodies at everything from selling credit cards by phone to processing mortgages and managing complex computer networks from remote locations.
Peter Bendor-Samuel, chief executive of Everest Group, a U.S. consultancy that advises clients on outsourcing, said outcomes-based pricing is more opaque than the time-and-material model.
"In the short term, that creates margin opportunities. Over the medium to long run, clients recognise that and the way they deal with that opaqueness is to introduce competitive pricing, and what does competitive pricing do? It compresses margins."
"Complicated models lead to mistrust, and also complicated models are much harder to scale," he said.
Murthy, however, believes outcomes-based billing lends itself to the move towards providing services through technology and away from deploying large numbers of people.
If a company can deliver results with fewer people, costs come down. Margins for outcomes-based work are 7-8 percentage points higher than for traditional work, Murthy said.
The time-and-material model encourages IT companies to add people because they bill based on man hours.
Sundararaman Viswanathan, a Bangalore-based manager at consultancy Zinnov LLC, said iGate's campaign to push outcomes-based billing is good for the industry: "It's a game changer because they are forcing everyone to start talking more openly about the pricing models."
Analysts expect iGate's earnings to grow the fastest among key rivals including Infosys and U.S.-based Cognizant Technology <CTSH.O> over three to five years at a compound average annual rate of 19.5 percent, Thomson Reuters data showed.
Chandrashekar Kakal, senior vice president and global head of IT services at Infosys, said that while outcomes are important to customers, Infosys views them as a part of its overall offering and not as a driver of pricing.
"Pricing model could be anything, so you keep it aside," Kakal said on the sidelines of an industry event on February 14.
Murthy, who still owns Infosys shares from options he received when he worked there, argues that outcomes pricing is a better deal for clients and enables him to answer questions he said frequently arose at his earlier employer.
"When I was in Infosys, while it had a great model, the four or five questions which customers always asked me, which I couldn't find an answer to were: you learn at our cost, you are putting junior people on the job, you are getting paid whether we are successful or not, you are getting paid whether the project meets its business case or not," he said.
But for some clients, simpler may be better.
"I think that model which he's espousing, while attractive or sounding attractive, is going to be increasingly hard," said Everest's Bendor-Samuel. "If you've got a simple model operating right next to it, the larger market will opt for simplicity."
(Copyright Thomson Reuters 2013)