Service providers should maintain a cautious approach to deploying a non-linear pricing model in IoT engagements

In 2012, Rolls Royce celebrated the 50th anniversary of its “Power-by-the-Hour” service offerings. Power-by-the-Hour, a Rolls-Royce trademark, is a complete engine and accessory replacement service Rolls-Royce offers on a fixed-cost-per-flying-hour basis. It enables operators to remove risk related to unscheduled maintenance events, and it makes maintenance costs planned and predictable. There has been a recent surge in the “as-a-service” model, including shared mobility offerings from Uber and Lyft. With the advent of IoT, the performance, availability, and other factors of any connected “thing” can be recorded and assessed, fueling the deployment of the as-a-service model based on certain KPIs (Key Performance Indicator) instead of owning the assets. HFS recently published the HFS Top 10 IoT Service Providers report, in which we provided several exciting examples of the as-a-service model. This business model is challenging for service providers because enterprises are asking for non-linear-pricing-based service offerings. In this PoV, we analyze the present pricing landscape of IoT engagements and how service providers can prepare themselves for non-linear pricing models.

Fixed-price and T&M models dominate IoT service revenue

As a part of our recently published IoT services top 10 report, we analyzed the different types of pricing models service providers are using across IoT engagements. We observed that fixed-price and time and material (T&M)-based pricing constitutes more than 75% of the overall IoT services revenue. The non-linear-based pricing model includes outcome-based, IP licensing, royalty-based, and hybrid (a combination of any of the above).

Exhibit 1: More than 75% of the overall IoT services revenue comes from fixed-price and T&M models

Source: HFS Top 10 IoT Service Providers, 2019

Hybrid pricing is also becoming popular in IoT engagements. In these engagements, a part of the deal is fixed-price or T&M-based pricing, and the rest is non-linear-based pricing. These engagements are typically long-term deals with a wide scope.

The IoT landscape is maturing slowly for non-linear pricing

As IoT solutions and offerings are still in the early stages of maturity, IP licensing and royalty-based pricing models are rare. Enterprises are primarily asking for outcome-based pricing models. We observed several common challenges for non-linear pricing:

• Lack of standardization: IoT is used in several industries, including retail, hospitality manufacturing, each with its own complexity; a common standardized model is missing. Even enterprises from the same industry have different levels of maturity and ways of working. With so many variations in parameters across industry value chains, it is a challenge to define and quantify the desired outcomes.
• Integration challenges: The IoT landscape is flooded with different protocols, gateways, and platforms. As no common technology standards are available in IoT for pricing, it is a challenge for enterprises to integrate disparate systems and decide on combined cost and revenue impacts.
• Absence of baseline comparison: As IoT connects legacy OT systems (old machines, equipment, etc.), it is hard to benchmark the performance of those assets because their calibration, efficiency, and performance depend on their age, rating, and other factors. So, no benchmark data is available for constructing the pricing model.
• Projects stuck in PoC or pilot phase: As several IoT engagements are stuck in pilot and PoC stages due to both technical and business challenges, it is risky for service providers to agree on a non-linear pricing model. With so much unpredictability around production deployment, service providers are not ready to try new pricing models with a risk of potential failure around the corner.

Four points are imperative for service providers moving to a non-linear pricing model

• Domain understanding: IoT engagements demand a business-first approach enabled by technology. Service providers need to understand the business landscape, including processes and regulations, to assess the scope and complexity of engagements. For example, the presence of too many legacy systems can be a deterrent for the non-linear pricing model. Also, if the business processes demand too much customization of technology solutions, it can be a challenge for innovative pricing models.
• Solutions maturity: Most service providers’ solution offerings have been in the market for a few years. Service Providers need to assess the maturity of the solutions by examining both technical and business aspects, such as KPI benchmarking related to industry-specific and use-case-specific deployments, to assess the maturity of the solutions. This benchmarking is a reliable basis for more forward-looking decision-making.
• Hybrid pricing model: The hybrid pricing model can be a good alternative for service providers. Traditional pricing models can be a starting point as inputs and feedbacks are needed in the beginning, and at a later stage, certain outcomes can be linked to a non-linear pricing model. This hybrid pricing model has the best features of both the models—T&M and fixed pricing mixed with an innovative pricing model.
• Leverage best practices: Service providers need a strong internal knowledge management system to capture the scope, technology details, business outcomes, and other aspects of IoT projects across industries. This repository can be helpful for comparing the scope of any new project with similar projects from the past and to estimate the possible outcome KPIs, building the fundamental assumptions for non-linear pricing models.

The Bottom Line: Deployment of non-linear pricing models is a differentiator for service providers, but they need both business understanding and technology maturity to be successful.

Non-linear pricing models carry substantial risks for service providers due to the uncertainty regarding the business model innovation. It is becoming increasingly clear that enterprises need alternate pricing models beyond the traditional ones (fixed price and T&M) to enable the “as-a-service” model for their customers. Service providers need to understand their customers’ business challenges in great depth so that technology can be leveraged to realize desired business outcomes. Service providers should prioritize both the business and technology aspects to come up with a non-linear pricing model.