At Alten Capital we invest in business and technology services companies. These talent-based organizations rely on professional services to deliver value to customers. Examples of these can be consulting and implementation companies, software product development or digital transformation offerings.
Engagement with professional services 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 done by the services company for no cash, with a goal of enjoying significant upside value once the platform starts to generate revenue. Ideally, these partnerships yield significant value to the services provider in the future, with a high degree of uncertainty. Meanwhile, the services provider needs to fund the initial platform development, taking on risk.
Fixed Price Projects (FP)
In some instances, 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 on the way the custom product is created. In this case, the services provider defines a price for the product, typically priced 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 linked to efforts, but are tied to progress on product completion. FP projects can be high-margin initiatives for services 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). If a project has been fully scoped, and no changes are expected, a FP engagement type can be appropriate.
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 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 complexity of features that need to be developed during a sprint, an amount of story points are available to divide up 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, but 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 skills levels. These rates are time-based and 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.
At Alten Capital we want to understand the type of revenue the companies we invest in have. These engagement models also reflect the risk levels company operators are comfortable taking. Please reach out to us to learn more about Alten Capital and ways in which we can partner.