What is Outcome Based Pricing?
Outcome Based Pricing for input suppliers is based on achieving a certain yield for a given input or seed. It is an emerging business model driven by new ways of managing information (including digital agriculture predicting performance of interventions in a specific location) combined with existing agricultural technologies (e.g. seeds, chemicals, equipment). For example, Bayer’s Seed Advisor uses information on precise locations to recommend choice of the most appropriate hybrid seeds.
Why is Outcome Based Pricing an attractive business model in agriculture?
Providing a yield or performance guarantee is particularly attractive to farmers or owners concerned about downside; it is used to manage climate risks (e.g. Syngenta’s Agriclime refunds costs of inputs if rainfall is lower than predicted) or provide customised insurance products based on detailed field data (e.g. FarmersEdge and PartnerRe agreement).
Effective Outcome Based Pricing requires specific expertise
While this Outcome Based Pricing can offer distinct benefits, there are several challenges:
- The pricing structure can be one-dimensional – even though yield (and even more so financial returns) depend on multiple factors
- Perverse incentives can be introduced by focusing on a specific outcome at the expense of others
- The success of outcome-based pricing depends on how a farmer makes decisions and manages risk; some will not look favourably on an approach that locks in upsides
- Approaches require a level of data accuracy in order to tailor inputs to each individual field; this can be difficult with new crops and with the changing environment
- The approach may struggle to incorporate uncertainty related to weather events, activities of neighbouring farmers, management approach, buyer requirements (or risk becoming overly complicated)
- The combination of separate inputs or technologies into an ‘average return’ may not result in an accurate understanding of performance
The importance of an integrated approach to the full value chain
Nevertheless, there are ways whereby outcome-based pricing can extend to a wider range of crops and geographies, depending on the farmer, owner, the farm manager or the supplier:
– An important starting point is having an integrated approach to map key factors underpinning revenues and cost of production for companies positioned across a value chain.
– This map can be used to understand the risks of not achieving the outcome (or potential for exceeding it). This includes assessing what needs to be true for a given risk to become reality.
– There are a number of approaches to mitigate each priority risk (or enhance a positive outcome). This includes working with technology suppliers, insurance providers, governments with the agribusiness financial model to inform:
o Business structure (e.g. Structure of the Special Purpose Vehicle; inclusion of offtakers in business)
o Capital Stack (e.g. convertible debt, strategic investors, equity investment).
o Risk management or risk transfer instruments (e.g. guarantees, insurance)
Once these measures are in place, a company is in a much better place to consider how they can use outcome-based pricing. This manages issues of data availability, complexity etc. through the use of a structured approach for managing risk.
The basis of an outcome-based approach can capture the key decisions being made by farmers and can integrate multiple parties on what is often a fragmented value chain. It is also possible to understand the tension between benefits for farmers /owners and suppliers.