The industrialization of services with AI machinery has destroyed the age-old and terribly convenient time-and-materials (T&M) pricing model. T&M has been the gold standard for tech, legal, consulting, agency, audit, tax, and recruiting services for generations. And for good reason: Under T&M pricing, you pay for labor by the hour. It’s simple, familiar, broadly applicable, and makes for easy comparison among suppliers in a competitive market. But it’s also deeply flawed, as it:

  • Creates perverse incentives. Providers make money when they work. This means that — instead of investing in ways (like better tools or more upfront scoping) to reduce hours — they’re motivated to prolong projects to benefit from increased billing.
  • Prices inputs, not results. T&M pricing terms can’t ensure a quality result or business impact: The mythical 70% failure rate in digital transformations is testament to that. Pricing labor by the hour won’t, by itself, motivate anybody to deliver results.
  • Penalizes providers that invest in equipment. Why would a provider invest in tools, platforms, and assets that make their people more efficient? That just reduces the number of hours they can charge you for.
  • Fails in the face of AI-powered service delivery! When machines do the work previously done by people, it no longer makes sense to pay for people’s time — you must also pay for the use of the machine. In the previous wave of industrialization, if you wanted a field plowed, you learned to pay for the tractor — not just the farmer. Or you just paid for the plowed field. The same is true in services. Time no longer has meaning as a unit of work — only results matter.

GenAI Creates A Tipping Point For The Industrialization Of Services

AI is driving the industrialization of services. Today, service providers build machines that improve worker productivity by as much as 20–50%. Accenture’s GenWizard, Cognizant’s Flowsource, IBM’s Consulting Advantage, and Thoughtworks’ AI/works are just some examples of AI-powered delivery platforms in software engineering. McKinsey’s Lilli platform hands even junior consultants the power of McKinsey’s knowledge assets. KPMG’s AI-powered audit platform expands the audit to every transaction and automates the work of many associates.

And we’re just getting started. At a recent conference we attended on the future of software development, some practitioners claimed that — with AI agent orchestration in software development — they’re seeing as much as a threefold improvement in throughput and expect a tenfold or higher improvement in the future. Under this force of industrialization, charging for a developer by the hour makes little sense. Motivate providers to invest in AI machines, knowledge assets, and solution assets to deliver lower cost, higher quality, and more predictable results. Then pay them for it — it’s how a mature services supply chain will work.

It’s Procurement’s Time To Shine

We expect the shift to results-based pricing to happen over the next few years, accelerating as both enterprises and providers grow more confident that alternative models can deliver better results. We’ve written a handbook for procurement professionals to navigate this tricky shift from pricing labor to pricing results before service providers give up on T&M pricing altogether — something that may sound absurd but could happen quite rapidly, even without explicit collusion. To ease the transition, procurement professionals can:

  • Bring legal, finance, and the economic buyer in early. Even as you grow more comfortable with alternative commercial models, your legal and finance teams will probably not be. Coach them toward this results-based pricing paradigm.
  • Ask providers for bids with traditional and alternative commercial models. If you get three T&M bids and one alternative pricing bid, ask the T&M stalwarts to bid using the alternative. It won’t be long before providers resist offering T&M bids, so it’s good practice to start now.
  • Negotiate with a trusted supplier. In a managed service deal or phase three of a three-part platform consolidation project, ask the provider for an alternative pricing model. The trust will be there, so the negotiations can start from a higher plane.

It’s Time For A Services Pricing Institute

We hereby declare the need for a new trade group, a services pricing institute that unites sourcing executives, service providers, and academicians to create new commercial models that support the industrialization of the services supply chain. It starts with standardized models to pay for results, not just for people. The goal is to create pricing standards, valuation catalogs for common services, and reusable contract terms to ease the burden for both procurement and service providers.

Give us a shout if you’re wrestling with an alternative pricing model or want to tap into our Forrester brain trust to navigate the shift to a mature services supply chain. In our first conversation, we’ll share our thoughts on the catalog of alternative pricing models that work and a way to decide which ones to prioritize for your scenario.