Wary Of Blended Rates

Recently one my acquaintance, who is working in the vendor management function of a mid-sized American corporation, contacted me with a specific question. The American corporation that he is working already has couple of existing IT vendors and currently they are renegotiating contracts to push for more savings. One of the vendors has suggested going for blended rate for invoicing of the effort spent by the vendor team. The vendor has explained to him that “the blended rate is simple and efficient way to manage the invoicing and cash flow calculations. Besides, the senior resources would be charged at the discounted rates which is a fabulous low rate that you can get anywhere”.

My acquaintance was baffled and could not make a clear decision one way or the other and that’s when he reached out to me. Below are the pointers that I had shared with him:

  • Evaluate outcome based contracts first
  • Explore handing over the entire service delivery to the vendor by entering in to outcome based and service level based arrangements. This way the sourcing organization need to only define the scope of the service, specifications of the service, service level expectation, governance framework and the commercials. The rest of the operational stuff – how to do’s – is left to the vendor to manage. IT is the core business of the IT vendors and they have the technical expertise, operational know-how, process excellence, past experience and the scale to deliver the best. The sourcing organization need to leverage those stengths through the right engagement model. Further, the execution risk is transfered to the vendor as well in this arrangement.

  • Explore staff augmenting as the last option
  • Adding more staff to the existing IT team(i.e. staff augmentation) from the vendor need to be last option, in case the other matured options of outsourcing can not be exercised due to various business and corporate constraints.

    In the staff augmentation engagements, vendors are usually paid on the T&M (Time and Material) model. The below two pricing models are prevalent in T&M engagements.

    1. Traditional T&M Pricing model (A la carte)
    2. Every hour of effort spent by the consultant, along with any material procured in the process of rendering the service, would be charged to the sourcing organization in this model. During the service agreement with the vendor, the sourcing organization would agree to a rate card (aka rate matrix) showing a specific onsite and offshore rate for the combination of the skill and experience level.

      Sample Rate Card*
      Experience / Skill Java Developer DBA
        Onsite Offshore Onsite Offshore
      2 to 4 years $55 $20 $65 $25
      5 to 7 years $65 $25 $90 $35
      8 to 10 years $80 $35 $110 $50

    3. Blended T&M pricing model (Combo)
    4. Here, the vendor will offer one rate for all the resources in a skill-pool irrespective of their experience levels and/or location. For e.g all Java resource would be offered at $40/hr irespective of their experience and the location. Some vendors offer one blended rate for both onsite and offshore, while some others offer one blended offshore rate and a separate blended rate for onsite depending on the voulme, resource spread and future growth visibility.

      Sample Blended Rate Card*
      Experience / Skill Java Developer DBA
        Onsite Offshore Onsite Offshore
      All Levels $60 $25 $90 $40

Is the blended rate is boon for the customer? I would advise not to go for blended rate. Go for the traditional model of T&M pricing. What are the reasons?

  • Blended rates camouflage the real resource mix that is deployed in rendering the service. It’s tough to ascertain the actual savings that you are making from the blended rates. Further, in some cases you may be paying more if the resource mix is skewed towards junior resources.
  • Usually the vendor loads more senior people during the project initiation phase, due to the transition and the steep learning curve involved. However, once the learning curve is surmounted and the project is in steady state, more junior resources would be brought in to replace senior resources.
  • While it may appear beneficial in the beginning, the vendor will be the beneficiary in the long run due to realization of higher billing rates for junior resources and/or offshore based resources.

Skip the combo. Go for a la carte.

* – Indicative


1 Response to “Wary Of Blended Rates”

  1. 1 Kesavan July 14, 2009 at 4:50 am

    I see value in blended rates, if the contract clearly specifies the time lines and service levels and suitable reward and penanlty is built-in in the contract. As long as the given job is completed as per my requirement, It should not be a problem if they use junior or senior resources – in fact it will act as an additional incentive to the vendor.

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