How MSPs Should Price Their Service Offerings
I get asked regularly about how to establish prices for managed services offerings. I hear stories from MSPs of a competitor that has won a deal over them “based on price.” Most feel tempted to drop their price to win the next deal if necessary. But how do they maintain margin? How does the other firm price so low? This experience in the marketplace is important but very distracting from a major problem that plagues the MSP industry:
Most MSPs underprice their service offerings.
How do you solve for this? You must understand clearly what you do well and for who you do it well. You need to skip those shiny objects that don’t fit what you do well. Only after that can you price it to the value you provide those businesses and stay above a minimal acceptable margin. And here’s a hint: You will never make up for bad pricing with volume!
Industry peer groups, like IT Nation Evolve, teach introductory and even master level classes on this topic and are a great place to build maturity in pricing your offerings. Right now, I hope to whet your appetite for looking at your pricing of services offerings. And don’t be afraid to ask for help, it is out there!
How MSPs Should Be Pricing Their Service Offerings to Maximize Profit
First things first: At least 25% of MSPs are making little to no EBITDA. They may be paying the owner/manager a salary but have little left over for reinvestment or to save for a rainy day. The good news is that those in the top quartile are making +20% EBITDA. So, what is the difference? And how does that relate to pricing using value or pricing using margin?
I won’t be addressing many of the pieces of the puzzle to become a top performing MSP, like service delivery efficiency, choosing markets to serve, standardizing your offerings, differentiating your offerings, selling, hiring and retaining talent, or choosing to create or outsource your own services. These are all important, but the bottom line is: If you get your price wrong, it is almost impossible to get to a rewarding (or even positive) profit number no matter how hard you work at everything else in the business.
Figuring out your MSP pricing
Great MSPs charge for the VALUE they bring to their clients…but first they understand what a minimal acceptable margin is for their services. We know that great MSPs, large and small alike, make +20% EBITDA! That means:
(Services Margin – Cost of Sales – Business Overhead)/Revenue = 20% or more profit (roughly EBITDA)
(If you want to learn more on how to make +20% EBITDA, check out this webinar when you get the chance.)
Good MSPs average about 15% of revenue on business overhead (general and administrative expenses). This includes executive and administrative staff salaries, rent, office supplies, etc.
They also spend about 15% of revenue on cost of sales, like sales and marketing expenses (including salaries and proportion of executive salaries spent selling).
To make 20% profit you need a services margin of at least 50%.
50% Services Margin – 15% Cost of Sales – 15% Overhead = 20% Profit
Making a 50% services margin is simple (at least the math is). You just know (estimate) your costs and multiply by 2 to get the price you need to charge to meet that margin target.
Services Margin = (Services Revenue – Cost of Services Delivery)/Services Revenue
Here’s where that firm undercutting your MSP pricing is making a fatal mistake! They don’t understand their costs or they can’t deliver good service…or maybe both. So, they won’t keep clients that you would want.
Understanding the cost of your service offerings
What are the costs of your service offering?
- People: Technical services staff, dispatchers, and management (loaded labor costs). Don’t forget other perks and incentive plans.
- I recommend you also include the cost of underutilization, think 20 – 30% of unproductive time…just take the loaded labor cost and divide by .75.
- Tools: Your software stack used to run the services business plus the tools (like vehicles and equipment) used to deliver the services. This is a growing list, especially with the required focus on security. Count them all!
- Outsourced Services: With staffing shortages and the challenges of keeping a full-time person busy as they grow, many companies are using outsourced helpdesk, device monitoring and management, and backup services. Note: Another benefit is that you automatically inherit their scale and operational maturity, which is easier than building it. You also share the risk of delivery all at a variable cost.
You can see the costs really add up fast. Most MSPs don’t do the hard work to really understand the true cost of providing great service offerings. And you must provide great service. Most MSPs I know do!
Start by doing this math across all your managed devices as a quick test of your pricing.
(Total Services Revenue –Total Services Delivery Cost)/Total Services Revenue = <50%, then it is time to look under the covers and see where you may be priced too low.
Take another look at what we discussed above:
- People: Figure out your average cost per labor hour for each group: engineers, dispatch, etc., and check that utilization to see where hours are leaking out. How many hours are you spending on each contract? Always measure over a quarter or more since hours per customer can change dramatically from one month to another.
- Tools: Individual offerings and the tools/labor to support them, tools that aren’t being used any longer, and tools that have been added or prices have risen without you changing your price to clients.
- Outsourced Services: Understand if you are using the services fully that are in your contract and that you are using all the units you are paying for.
Your PSA tool is a wealth of information – you can get your hours spent per device/per client, and most allow you to load the cost of employees and tool costs so you can see your profitability by contract.
You will soon be able to look at your costs and associated revenue on a very granular level and know right where changes need made. Then, you must have the guts to make those changes!
Do not be surprised if you find that you should be charging $140 or more per hour for your engineering time. Believe it or not, it is easy to get to $70 per hour cost:
- $30/hour average for a tech
- $10/hour underutilization factor (67% billable utilization)
- $20/ hour cost of dispatch and management – all needed overhead
- $10/hour for perks, benefits, vehicles, etc.
At the end of the day, it’s all up to you
You can’t fix what you don’t know is a problem! As I said before, it will take guts to fix your MSP pricing. My experience is that many MSPs are afraid of asking for more money for their services and exaggerate the anticipated backlash from clients. Remember, they depend on you to keep their businesses up and running. You have incredible value.
I consider everything you charge above the minimal acceptable margin of 50% as value-based pricing. As you gain confidence and experience in the specific markets that you choose to serve, you will understand that value you bring. You will speak their language and they will understand what an incredible and irreplaceable part you are of their success. They will understand that you reduce their business risk and enable them to pursue new opportunities that they could not pursue without you. You will be valuable and able to charge premium rates to claim some of that value for yourself.