At Elaxtra Advisors, we invest in business and technology services companies. These talent-based organizations rely on professional services to deliver value to customers. Examples include consulting and implementation companies, software product development companies, and digital transformation offerings.
Engagement with professional service organizations can vary depending on the type of service offered, the length of the service, plus multiple other factors. We will attempt to summarize the most common engagement models in technology professional and managed services and the type of revenue these organizations generate from these engagements.
From a tech services provider risk spectrum, we will start with the riskiest approach, joint ventures (JVs), then move on to fixed-price projects, fixed-price per sprint/story point, and end with the lower-risk approach, the traditional time and materials engagement model (T&M).
Joint Ventures (JVs)
JVs occur when a services provider partners with a customer to develop a product or solution and receives revenue upside or equity in consideration for their services. An example of this engagement model could be when a services provider develops a tech platform for an industry-specific company and has the right to receive a percentage of revenue generated by the platform. The initial investment is made by the services company for no cash, with the goal of enjoying significant upside value once the platform starts to generate revenue. Ideally, these partnerships yield significant future value to the services provider, with a high degree of uncertainty. Meanwhile, the services provider must fund the initial platform development, taking on risk.
Fixed Price Projects (FP)
Sometimes, customers may not have technical teams or fully understand the nuances of creating software products. They are ready to pay a price for a custom development with little to no say in creating the custom product. In this case, the services provider defines a price for the product, typically with an upfront payment, and milestone-based payments upon completion of the product development. These payments are not linked to the passage of time or efforts but are tied to progress on product completion. FP projects can be high-margin initiatives for service providers who know what they are doing or have most of the product already developed (experts in “change orders”) but can be a margin drag for those companies that cannot interpret the scope of the project (scope creep). A FP engagement type can be appropriate if a project has been fully scoped, and no changes are expected.
Fixed Price per Sprint (FPPS) or Fixed Price per Story Point (FPPSP)
A variation of the prior engagement type, but for smaller and more frequent scope definitions, can be what we summarize as a Fixed Price per Sprint (or per Story Point). In agile development methodologies, a sprint is a time-boxed period of time (usually two weeks) where a team of software engineers, product managers, designers, architects, and testers get together to develop specific features during that timeframe. Story points are an abstraction of effort units during a sprint. Depending on the number of professionals and the complexity of features that need to be developed during a sprint, many story points are available to divide among the team.
A services provider can define a fixed price per sprint to provide visibility and predictability to their customer. This engagement type does not guarantee that the product will be accomplished to the quality level or timeframe defined by the customer. Still, it guarantees that a team will be available to tackle feature development without exceeding the sprint-based pricing the provider defined. Similarly, a fixed price per story point can be agreed to, and every two weeks, the provider defines the efforts required to develop the functionality requested by the customer and, therefore, the overall cost for that sprint. In this case, the customer needs to be comfortable with an agile software development methodology due to the constant scope definition that will occur every sprint.
Time and Materials (T&M)
Finally, the most common engagement model is time and materials, where the service provider charges their customer for their team’s time allocation. Typically, different rates are charged for distinct seniority and skill levels. These time-based rates can be hourly, daily, weekly, or monthly. This is a low-risk engagement type from a service provider standpoint, and it allows the utmost flexibility as to scope changes from a customer’s view.
Are you interested in exploring how we can support your business growth? Please contact us at Elaxtra Advisors to start the conversation.