Sink or Swim—Together

In today's economy, you'll need to share risk to reap potential rewards from customers.

Whenever the economy goes south, it seems corporate clients start questioning the big fees theyre paying IT consultants. They may ask consultants to tie fees to performance and share some of the risk or, as Brent Habig, president and founder of Tigris Consulting, says, "Put some skin in the game."

Putting skin in the game typically takes one of two forms: value-based pricing or shared savings (a.k.a. shared revenues). Theres not a lot of difference between the two. With value-based pricing, the consultant is partially compensated based on certain benchmarks being met—benchmarks that can be used to calculate a return on investment (ROI).

With shared savings, the consultant or integrator gets paid according to revenue and/or savings generated resulting from the consultants efforts. As an example, Tigris typically takes a 10 percent to 20 percent cut of the clients savings. This approach is similar to investment hedge funds that only get a fee if they make money for their clients.

Jerry Mechling, director of strategic computing and telecommunications in the public sector at Harvards John F. Kennedy School of Government, says the shared savings approach is gaining popularity in the public sector, as limited government IT budgets work to adopt e-government initiatives. "The California Franchise Tax Board entered into an arrangement whereby the IT consultancy got a cut on the extra revenues generated as the result of an online payment initiative," Mechling explains.

A number of states today only deal with consultants and integrators on a shared savings basis.

Meanwhile, value-based pricing is gaining traction in the corporate world, says Alden Cushman, VP of research at Kennedy Information. The only problem: Many of the top consultancies dont have the methodology in place to apply benchmarks suitable for todays e-business-oriented IT infrastructure. As a result, Cushman says, the Big Five consultancies, EDS and IBM are trying to establish benchmarking methodologies for guaranteed returns. "Theyre all doing pro bono work to get up to speed in developing benchmarking methodology," he says.

Value-based pricing isnt restricted to consultancies. Some software vendors, such as i2 Technologies and Tivoli Systems, have adopted value-based pricing models. From both the software vendor and IT consultant perspective, tying fees to results provides a means for retaining existing clients that need to show an ROI; it also allows them to develop a level of trust with new clients.

In the past, when the economy rebounded, IT consultants typically forgot about performance-based compensation and reverted to the fixed-fee approach. This time around, that may not be the case. To truly partner with their customers, consultants are going to have to keep some skin in the game.