I was speaking with an entrepreneur the other day about contingency pricing. On one hand it aligns both the customer and entrepreneur on a common goal with limited risk for the customer and upside for the startup. However, there are many practical challenges for making it work effectively that can lead to lack of trust, lumpy revenue, and out of control processes. Here are three things to consider to help maximize success of contingency pricing.
Clearly Defined Rules/Triggers
The first thing to define is what metric are you tracking to make contingent payments on: cost savings, new leads/closes, satisfaction, etc. Hopefully this metric is aligned to your customer’s value proposition. Next, what are the rules and triggers that define when and how contingent payments kick in. As an example let’s assume you are optimizing cost savings: until cost savings reach $1M annually there are no contingent payments. When cost savings go above $1M, the startup gets a contingent payment for 20% of total cost savings. When cost savings go above $5M, the startup gets 10% contingent payments for any savings above $5M. You would also want to define the time period (i.e. evaluated every calendar year, a defined rolling monthly/quarterly schedule, etc.). The goal here is to clearly decide up front when and how the payment work so there is no confusion once you get going.
Direct Access to Data
Let’s assume you do a great job setting up the rules/triggers, now how do you track it? First, is that data readily available and clearly defined? Continuing in the example above, what if you don’t have any visibility or access into the cost savings? From experience, this can make it incredibly difficult to track and prove! Not that the customer is devious or untruthful, but without access to the data there are no checkpoints, no ability to discuss results, and an easy way for customers to re-classify things on their own or make exceptions for why things don’t count. You absolutely need direct access to the data to track the key metric to ensure both parties are aligned and working off the same data towards a common goal.
Integrated into Workflow
Lastly, even if you have access to the data, it is best to put it into a defined workflow that automatically collects, calculates, and processes the contingency payments. If you just collect reports that require lots of manual interventions, it will take lots of time, become hard to scale, and create many human errors. Getting this data into the workflow makes tracking much easier, but also ensures you can easily justify the product ROI! Need help calculating ROI? Check out our sample calculator!
Whether or not to use contingent pricing can vary based on the nature of your product/industry. But regardless, having a clearly defined and transparent model that integrates into the workflow is critical to making it work.