Outcome Based Pricing

Outcome Based Pricing

When it comes to giving the customer their ideal pricing model, there is probably not a better choice than outcome based pricing.  However, it may not be best for the seller!  Let's dig into this topic a bit more to really understand the pros and cons of this alternative pricing model.

What is Outcome Based Pricing?

We should probably start at the beginning with this one as not everyone will be familiar with the term.  When I say outcome based pricing, I mean charging for the desired outcome of a process instead of the individual drivers of the process.  This one is probably easier to understand with an example.

Lets say a car manufacturer is tasked with having 10,000 brochures requested this year with a fixed marketing budget of $500,000.  What will they want to pay per brochure?  Well, of course what they want to pay $50 or less on average as this lets them stay within their budget and hit the target set for them (assuming they get the volume needed!).  

However, this is where it starts getting tricky for them.  What are some standard avenues they can take for marketing?  They could go the standard online display routes.  These will likely be CPM (cost per 1k impressions) or CPC (cost per click, also known as PPC).  The problem for them is that this is a big unknown.  They could spend their $500k on either of these models and they have no clue how many brochures will be requested.  It all depends on the conversion rates from the view/click to requesting a brochure.  They might be able to get 10,000 brochures for less than $500k or they might fall short.  It's a bit of a gamble.  They could also do more traditional advertising like print or radio, but that can be even more of an unknown as there is limited trackability.  Clearly if they have tried any of these avenues in the past and have some conversion metrics then that lessens the risk, but sometimes they have no historical data to go off of and are shooting in the dark.

So what if a company came to them and said they would deliver 10,000 brochure requests guaranteed for $500,000?  If all other avenues were an unknown and they thought this seemed fair, then they may just want to go for this deal.  

Why would a seller consider doing this?

Now clearly, this shifts the risk and reward over to the seller of this service.  If they can deliver the 10k brochures for less than $500k then they can keep the difference as their profit.  Of course, if it costs them more than $500k to do it, then they are at a loss.

So when would you as a seller want to go down this road?  The obvious answer is the correct one, when you are confident you can do it at a low enough cost to make a healthy margin.  In many instances, this is where you have a competitive advantage.  Maybe you have a database of high-conversion leads ready to go.  Maybe you have a discounted advertising rate with agencies.  Maybe you have a more efficient process than average.  If the market rate cost to get a brochure request is $50, but you can do it for $30, then an outcome based model may be good for you.

Of course, there are also some subtle smoke and mirrors going on, which you can benefit from.  Lets say that the customer has in fact done this campaign before and it did cost them $50/brochure.  They will be assuming that it will cost you roughly the same.  Unless you explicitly agree to share volume and conversion metrics with them, they will not have any clue about what cost you were able to do it for.  They will assume they are not making much profit from this, which is clearly a good thing as the seller.

Additionally, should it get leaked to competitors that you are doing this exercise for them.  Competitors won't know what the true situation is either.  i.e. If you are charging $5/CPM, then a competitor knows what rate you are charging and there is market data around the average cost for these rates.  However, in an outcome based pricing model, they will have to make some assumptions around your profitability.  They may even assume you are just doing it at cost for some strategic reason.  I believe the chances of starting a pricing war are less with outcome based pricing.

What are some possible snags?

Even though you might be using this alternative pricing model, it doesn't mean that you should be delivering an inferior service.  If I was getting paid $50 per brochure request, I could generate a campaign that I will pay each person $10 for requesting a brochure and make $400k profit.  Is this what the customer wants?  Of course not.  They want brochure requests from consumers that genuinely have interest in their vehicles.  And, they would figure this out.  This is because while they may not have visibility into how you are generating the brochure requests, they will have visibility into how many of those brochure requests are converting to sales.  If they have an average conversion rate of 5% on a brochure request and on all the ones you've sent them it is 0.5%, you can expect a difficult conversation coming your way.

The other issue here is that it is always a bit of a gamble from your side.  As much as you may think you can definitely deliver the requests for less than the charging price, it will likely be built up on a number of assumptions.  This is even more of a risk if your company hasn't done many campaigns like this before.  You need to be very careful that you aren't setting yourself up to make a loss.  If it's possible to bundle this activity into a combined deal with other definite margin making products or services, then this lessens the risk of the deal as a whole going negative.

In Conclusion

Outcome based pricing can be a customer's dream scenario.  It can also be great for a seller.  However, it can also turn into a nightmare where you've ended up losing money on the deal.  This is one where I would tread lightly, but if you really do have a way to do the project better or more efficiently than others, then it can be a successful model for you.  If you haven't done this before and are considering it, then I'd recommend starting out with a small test project to lessen the risk of a large loss.  I certainly wouldn't be doing a deal for millions if I didn't have a long list of successful similar campaigns under my belt.