It’s extremely common to be at a thought leadership event and have the question of commoditization comes up. In fact, it’s almost a certainty. The usual response is a simple ‘no.’ Taking this scenario a little further, the next comment that ensues is, “I keep getting underbid by lesser MSPs. So, how can you tell me it’s not being commoditized?” Long story short, if you’re getting outbid by ‘lesser MSPs,’ then you need to understand that there’s no way they can stay in business while maintaining such low prices. Economically, they’re not making enough to keep the lights on in most cases.
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Price-Makers vs Price-Takers
This leads me to the discussion of how important it is to be on the proactive side of the support process. Recently in my master’s Accounting course, we reviewed companies that are price-makers and those that are price-takers. In the MSP industry, it’s insanely difficult to be a price-maker, and we, therefore, must price our services dictated on market conditions. This doesn’t mean that you can’t still be in control of the pricing and bottom-line revenue you bring in. This just means that being in control of your costs is even more important.
Rein in Your Costs
Let’s take a look at an average MSP’s price to cost comparison. I’ll be focusing on per-user-based billing, but these concepts can be applied to however you bill. The first thing we need to do in the comparison is to break all things down into the factor so that we’re comparing ‘apples to apples.’ This means if you bill per user, any tech wages, hardware, licensing costs, etc. need to be calculated to a per user metric. So, let’s say for our example, we bill a customer $100 per user (I like to keep the math simple). Then you have a total support cost of $35 per user. This includes your vendor fees, tech salary, and other costs associated with your service offering. With these details, we’re about to now compare our price to cost and get our gross margin of 65% ((price – cost)/price). This is a decent margin to bring in for a managed service provider. This level of margin is only reached by running a ‘well-oiled service team.’ This owner most likely has worked diligently to perfect their process, implement automation when available, trained their team well, and educated their customers on the technology they use. Many of these proactive activities allow you to improve your process and bring additional margins in. These are crucial to not only keep the lights on but grow and scale your business.
Now, let’s take a look at a ‘lesser MSP,’ who hasn’t invested efforts in perfecting their service delivery. Let’s assume their sales price is discounted to $85 per user. Which from the looks of it is going to be better we get concerned, but what we’re going to find is that they will have a higher cost associated with their per user rate. Let’s hypothetically say they’re at $60 per user. I’m going to suggest this number due to the sheer fact that if they’re a ‘lesser MSP,’ then they wouldn’t have things operating in such a way to gain those efficiencies that are needed to bring it down to your rate. When we make the same comparison, we find that their gross margin percent is less…a lot less (29%).
The Math Behind Competitive Pricing
Determining how to compete with the ‘lesser MSP’ takes us yet again to accounting concepts. Assuming you have done your homework and found out what your minimum margin is to maintain your level of customer satisfaction, maintain growth, keep the lights on, etc., you can determine what your level of competitive pricing is. As an example, let’s assume you need at least 50% margins. In the above calculation, we can now determine what our minimum price to our customer should be: ((Price -35)/Price) = 50%. Factoring this down a little, we get the simpler calculation of (Cost/(1-GM%)). When we add your cost and gross margin percent into this, we get a total of $70. This number is the bare minimum you can charge your customers and continue to meet the goals you’ve set for yourself. If we did this calculation for the ‘lesser MSP,’ we would get a minimum price to the customer of $120.
In the end, there are two main take-home points here. The first, although it doesn’t benefit you to decrease your prices, when in a competition it may work in your favor to decrease your prices. As stated before, if the price drops below our ‘bare minimum,’ you would definitely turn down the price decrease and sadly offboard the customer. However, don’t fret! Just as was stated at the beginning of this article, the ‘lesser MSP’ can’t stay in business. We’ve discussed how the math works in your favor. If you happen to lose a customer, don’t say ‘goodbye,’ but more of a ‘see you later’ as it’s only a matter of time before the ‘lesser MSP’ reads this article and finds out they can’t stay in business with such low margins. They’ll then be faced with the choice to raise prices or close up shop. That’s when previous customers go back to what they know…you!
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