IT firms' time & material revenue halves to 35% over 20 years as clients demand accountability, innovation

IT firms want to move into models where they have ownership of outcomes.

The contribution of time & material (TNM) contracts to information technology (IT) firms' revenue has halved to 35 percent over two decades due to a shift towards fixed-price and outcome-based models, signalling a shift in the way the industry works.

Enterprises also want pricing models that are accountable, risk-sharing and innovative.

In 2004, TNM contracts accounted for more than 62 percent of revenue for the top four tech services companies, according to the latest opinion piece from consulting firm Zinnov accessed by Moneycontrol.

The IT industry has three broad models: TNM, fixed price and outcome-based projects with many subtypes.

The TNM model was the most popular one, as it is linked to billing hours. TNM contracts were widely in use, as the client bore the risk if project costs or the scope of work increased.

Enterprises now seek partners who can co-innovate and share risks, Zinnov CEO Pari Natarajan said. "This calls for outcome-driven pricing models that align the goals of service providers and customers. The decline in TNM contracts reflects this shift," Natarajan said in the piece.

Premji Invest CEO and industry veteran TK Kurien recently criticised the TNM model for allowing tech companies to pass inefficiencies to customers while profiting from them.

"It’s (TNM) a wrong economic model," Kurien said at the CNBC-TV18 and Moneycontrol Global AI Conclave on November 22. IT companies should refactor their pricing points as the TNM model would be disrupted completely, he said.

While the client bears the risk in the TNM model, a fixed-price or outcome-based model shifts the responsibility to the service provider or the IT company, which must deliver the project at a predetermined cost regardless of resource usage or changes.

TNM is also often equated with low-end work, one where the service provider doesn't have accountability or responsibility.

“You are just following orders of the client, which is a model that most service providers, including Indians, want to move away from,” said Yugal Joshi, leader - technology services research, at management consulting firm Everest Group.

IT firms want to move into models where they have ownership of outcomes. “So there are multiple of those aspects but that's where most of the services companies want to move away from time and material type of engagement model,” Joshi said.

Not all experts are on board with the model shift. “While there is plenty of talk of a shift towards outcome-based models for many years to break away from linear revenue models, adoption remains limited and is generally exploratory,” said Gaurav Parab, a principal research analyst at consulting firm NelsonHall.

The Gen AI disruption

Experts, however, agree on Gen AI playing a pivotal role in enabling the transition from TNM to other models.

A recent Zinnov-Ness Generative AI benchmarking study shows that generative artificial intelligence (Gen AI) significantly enhances the productivity of senior talent compared to juniors, fundamentally reshaping the traditional talent pyramid.

“As a result, customers will increasingly prefer senior talent in their TNM contracts and accelerate the shift to fixed-price contracts. This shift disrupts the traditional ODC profit model, which relied heavily on leveraging junior talent for profitability,” Natarajan said in the note, referring to offshore development centre.

Also read: Indian IT cos struggle with Gen AI rollout delays amid rising compute, cloud cost

Parab said that even with associated costs like licences, Gen AI tends to accelerate effective delivery. “As providers mature in AI-driven application development, they are gaining better control over budget estimations, paving the way for fixed-price engagements and newer outcome-based models," he added.

These nascent technological changes will bring the long-promised move to non-linear models in the next couple of years, he said.

The potential in code generation is immense but at this stage, Gen AI excels at generating code in "bits and pieces" rather than handling the entire process, as it involves managing a significant amount of "engineering debt".

Nevertheless, the models are shifting, as is visible from the declining revenue share of TNM contracts.