Data Center Pricing Schedules: Driving Positive Vendor Behavior

One of the most scrutinized and highly negotiated elements of an IT outsourcing (ITO) agreement for infrastructure is the resource pricing schedule. This forward-pricing matrix specifies data center management costs for billable resource units, such as server instances, database instances, network elements and storage capacity over the term of the relationship. Like a tax table or any other financial schedule, the ITO rate structure has a significant impact on the behavior of those governed by it--in this case, the service provider. To encourage efficient asset utilization, thoughtful definition of billable resource units and measurement, along with supporting contractual terms, are critical in fostering positive service provider behavior.

Variable usage ITO pricing cost is driven by both the data center pricing schedule unit cost and resource usage. The most common practice is to negotiate rates based on baseline resource assumptions and then adjust--up or down--each month based on actual consumption. In practice, limits on variance exist, with unit costs increasing at lower volumes and discounts applied for increased volumes. Of course, other charges and credits come into play, as well.

While this pay-per-use model is intuitively appealing, without diligent asset and vendor management, financial creep is a challenge in this billing approach. In fact, mid-term outsourcing relationship audits (for example, in year three of a five- to seven-year contract) have shown that many ITO clients are running at 20% to 30% over growth-corrected total spend expectations. It is critical to take the following preventive measures to proactively manage pricing overages and drive positive vendor behavior regarding resource efficiency.

1. Don’t reward resource "sprawl": The obvious downside of variable pricing contracts based on resource units is that they motivate the service provider to add resource units. In a perfect world, resources would be responsibly managed to competitive utilization targets. In practice, however, we see clients paying for idle and underutilized resources on a regular basis. Real-world examples include a client paying for backup resources (automated tape library slots) that were 9% in use, a server environment that wasso poorly tuned it was incurring 30% overhead (net additional hardware) and a number of clients paying for storage capacity at less than 40% utilization. For outsourcing contracts with client-owned hardware and software, consider the service provider’s dilemma: Make unreimbursed investments in technology and tuning efforts to increase efficiency and drive down your revenue stream, or maintain the status quo and watch revenue grow with increased overhead. Although most contracts typically include some shared savings incentives and continuous improvement responsibilities, the contract language is often not specific enough to enforce.

To effectively manage the disconnect between service provider revenue generation and efficient asset utilization, end users should consider one or more of the following approaches to get the client-vendor relationship on track from the start

a.) Define billable resource units to align with real usage, not raw capacity.
In this approach, resource units are defined to reflect consumption, not capacity. As an example, the vendor charges only for allocated storage (the storage a server can "see" looking out from its I/O interfaces), not the available capacity of the installed storage array. While some per-unit rates may be higher, if scaled correctly, it is well worth the trade-off. For example, if a service provider is prepared to charge $100/terabyte/month for installed capacity and assumes it can get an effective yield of 60% for client-usable storage, it will seek a "usable capacity" rate of $100/60%=$167/terabyte/month. Going forward, the vendor will have to manage to 60% utilization to maintain initial profit margins. Were effective utilization to drop over time due to poor management, it would be at vendor expense, not client expense. The logic supporting this storage-based example extends to server utilization via exploitation of virtualization and standardization, network resource utilization, and so on.

b.) Define minimum utilization standards for all resource categories.
Here the contract will contain very specific resource utilization and efficiency metrics with penalties for underutilization, or billing relief for missed targets. Be very specific in defining not only what the utilization targets are, but also the specific tools and methods used to measure them. They should be measured on a regular basis--monthly is ideal.

c.) Retain architectural control and ownership of the resource definition and placement process.
In this very simple and direct approach, additions to resource pools are at the client’s discretion. The statement of work (that is, the description of services) contract exhibit specifies that retained client technical resources have the final word on when new resources are created, how they are defined and where they are placed. However, be aware that without control over resource utilization and resource placement, service providers may limit their accountability for service levels around performance and, to a lesser extent, availability.2. Structure RFPs to solicit line-item pricing: The structure of the data center pricing schedule begins with the terms of the RFP, which leads to the nature of the resource quotes in the vendor response. This is then translated to the final pricing schedule structure in the contract. Even if your organization is predisposed to a holistic outsourcingapproach inclusive of support services, facilities and hardware assets, there is merit in structuring the RFP such that it solicits discrete pricing for remote infrastructure management (RIM) services, facilities hosting and asset ownership/lease cost components. This level of detail allows for more effective cost management over time, including an improved forward-pricing discount negotiating position. It also allows clients to more aggressively negotiate facilities costs and lease rate components that have little impact on service quality, while more carefully negotiating RIM rates that may have a more direct impact on staffing levels and service quality. It also provides an ancillary benefit of making the outsourcing engagement more contract-friendly for offshore RIM providers partnering with onshore co-location providers--often resulting in very compelling hybrid proposals.

3. Make provisions for non-production resources: The prevailing practice of gold/silver/bronze service levels--typically associated with availability (for example, 99.95%, 99.9% and 99.5%, respectively)--is becoming antiquated. Virtualization technologies are creating a level of abstraction between logical instances and the underlying hardware, andhardware/OS platforms are becoming more standardized in content and automated in maintenance. As a result, it is increasingly difficult to isolate and price workloads by thinly stratified classes-of-service. Further, for 99.99% and higher availability requirements, special configurations are needed (automated failover, clustering), requiring separate and distinct pricing schedules and support service descriptions.

The more relevant issue to address is production vs. non-production support requirements. In a classic client-server development model, as much as 50% to 75% of server and associated resources are non-production ("sandbox," development and QA instances). These resource environments deserve individual consideration to specify an appropriate level of support services, and this typically results in substantially discounted resource support rates. The bottom line: Don’t force non-production resources into production support service levels and rates.

4. Anticipate requirements for platforms and services currently out of scope: Client organizations are rarely more exposed than when faced with the prospect of negotiating for new support services or new platform support mid-term in a multiyear agreement. This situation may result from an acquisition or a major architectural/technology change in direction. A particularly challenging task, it calls for planning for the unknown; however, there are at least two risk remediation strategies to consider. The first is to anticipate possible platform or technology additions and negotiate rates for these up-front. Even with unknown quantities, vendors will typically be willing to offer reasonable, not-to-exceed rates to win your initial business. The second is to establish a price arbitration or benchmarking clause that sets out specific procedures for pricing of new services with objective third-party oversight.

For "disruptive" technology advances that result in step-function decreases in the cost of services delivered, cost reduction benefit division between client and service provider can and should be negotiated in the contract. However, as always, the devil is in the details of the cost reduction measurement and valuation.

The other side of new service requirements involves project-driven elements. All resource-based variable usage contracts should also contain labor rate tables by job category and skill level, and include contract terms that specifically allow the use of alternative service providers for project activity. Additionally, project hours should be estimated and controlled by the client organization and should not require a change order (otherwise known as a change request or project change request); rather, they should simply represent another billable resource on the pricing schedule. Habitual use, or misuse, of the contract change order process for project work or off-pricing schedule equipment additions is a recurring theme in ITO contract cost overruns--death by a thousand cuts.

At the end of the day, standard cost-containment techniques such as resource usage audits, rate benchmarking, and other IT governance and vendor management practices are must-haves to maintain equitable relationships with service providers. While not an exhaustive list, the aforementioned four key data center pricing schedule and contract considerations will help ITO clients more appropriately define resources and management approaches--ultimately driving positive vendor behavior and optimizing the company’s data center utilization and pricing schedule.

About the Author
Colin Rankine is a senior associate at Pace Harmon, an outsourcing advisory services firm providing proven guidance to Fortune 500 and high-growth middle market organizations on complex outsourcing and strategic sourcing transactions, process optimization and vendor program governance. He has more than 20 years of IT industry experience with a focus on operational efficiency and service level quality, including 10 years at IBM in technical field positions and 10 years at Forrester Research, where he served as VP of the computing infrastructure group.