Today, blended rates have become a popular way to hire outsourced talent in the applications development arena. However, two senior consultants warn this may not be the best way to find the appropriate labor at the correct price. “Buyers are not able to see the real cost competitiveness of the mix of skills with blended rates, because the detail is hidden behind the blended rate,” posits Homan Haghighi, senior consultant, ProBenchmark.
The answer is to know the effective rate, according to Haghighi. The effective rate takes into account the cost of the level of skill the buyer needs and the amount of hours the buyer uses of that particular skill:
Sum of all (price of the skill given the level of experience x hours worked) / total hours = effective labor rate.
Buyers need to benchmark this effective rate with the equivalent effective rate from the market,” says Haghighi. For example, the blended rate may be $700, but the effective rate may be $600 or $800. The $600 rate may be the appropriate effective rate; however, the buyer is losing out when paying the $800 blended rate, he explains. “Buyers lose the ability to understand if they are getting a good deal with blended rates,” he adds.
“Blended rates make it difficult to calculate value,” continues Andrew Sauter, also a senior consultant for ProBenchmark. An avid cook, Sauter compares the situation to having everything in the produce department cost $2 a pound. “You are really making out like a bandit if you’re using shitake mushrooms, which sell for $16 a pound. But the supermarket is gouging you if you are buying yellow onions, because they cost 50 cents a pound,” he explains. “Most companies buy many different roles that have various years of experience and technical capabilities,” continues Sauter, “and you want to ensure you are paying the right price for each.” The added complexity of shifting technologies, markets and the other influences create additional pricing pressures that cannot be reflected in a single rate.
The Blended Rate Challenge
In the old days (like seven years ago), service providers created rate cards for applications labor. The cards listed specific skills and their rates. They prepared rate cards for each country where they offered labor.
To make things simpler (often times at the request of the buyer), the service providers have been bidding more projects with a blended rate. The buyer paid a set price per day, regardless of whether the most senior programmer or the new college grad worked on the project.
Sauter says blended rates have two major challenges:
- The buyer doesn’t know who is working on the project. Did the service provider remove all the high priced senior labor to boost its ROI on the project? This makes it impossible to determine if the company is paying a fair rate for the labor because the buyer remains clueless about the actual workers.
- Blended rates make it difficult to benchmark. Sauter says the only way to correctly benchmark an ADM deal is to determine the effective rates of every type of engineer on a project and amalgamate them before comparing any rates to the market.
Unbundling the rates is the best way to go, he submits. That way buyers can determine:
- What they are really paying for applications development
- What kind of labor they actually need from the service provider
The consultants believe this is the wisest way to spend application development dollars.