Setting the Stage for Profitable Pricing Strategies
Pricing for Managed Service Providers (MSPs) isn’t a one-size-fits-all scenario. It’s a complex landscape where setting rates too low could eat into your profit margins, while aiming too high might drive clients toward your competitors.
To establish the right pricing strategy, you need to grasp the value of your services, assess the market, and understand your competition. Every MSP has its own unique blend of factors, making pricing a challenging puzzle.
In this guide, we’ll dive into strategies for handling this complex issue. We’ll stress the significance of knowing your cost margins, choosing optimal pricing models, and skilfully communicating price adjustments.
Contents:
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Section 1: Understanding Profitable MSP Pricing Strategies
Finding the Right Path Beyond Benchmarks
Many MSP businesses worry about losing clients when considering price hikes.
The notion of losing clients due to price adjustments might seem daunting, but sometimes, it’s a positive shift. Those unwilling to adapt may undervalue your services, while improved margins from retained clients can fortify transitions and pave the way for new opportunities.
A promising trend amidst the economic downturn is an increasing number of companies planning to outsource their IT to MSPs in 2024.
The strongest and longest-lasting relationships between clients and suppliers are the ones that bring significant value to both sides. It’s all about creating a win/win scenario where both parties benefit. Ideally, your strategies and services not only contribute to your client’s financial success but also positively impact their own customers.
There are three common pricing strategies businesses follow:
- Market-Based: This is a common approach used to set prices. However, it hinges on two misleading beliefs: that being in line with market pricing is necessary for competitive success, and that competitors adhering to market prices are automatically profitable and successful. Roughly one quarter of MSPs in every market are losing money.
- Cost-Based: Cost-based pricing often arises after losses from market-based strategies. This shift typically triples prices compared to market-based rates.
- Value-Based: Commonly employed by top-performing businesses. This strategy shifts the pricing focus from what the business charges to the benefits gained from the service and the costs and risks the client faces without the service. It emphasises the value delivered rather than solely following industry benchmarks, pricing should reflect your costs and required margins for profit.
Section 2: Crafting Effective MSP Pricing Strategies
Unpacking Influential Factors in Pricing: A Numbers Game
Profitability isn’t just about what’s left over at the end of the day – it’s a strategic equation. Let’s break down the numbers:
According to Service Leadership Inc, you should aim for the gross margin on your services to be 50%. Why? Best-in-class gross margin for labour-based services sits at 30% (2.5 times taxable wages, while on Cloud services, aiming for 4.5 times or better is ideal). This leads to a net profitability of 20%, meaning your service should cost you 50%.
Here’s the snag: when discussing the pricing of services, the conversation usually veers toward what others are charging for similar services. This mindset turns your services into commodities, placing you in a price war with other MSPs.
Instead, the focus should shift to your internal costs. Take backups, for instance.
- If the license costs £20 a month and
- labour costs £30 a month, plus
- back-office expenses like marketing and invoicing add a further £10, then
- the real cost totals £60.
- So, to achieve a 50% margin, you’d need to sell the service for no less than £120.
So, how do you tackle this challenge?
Rather than adjusting prices based on competitors, you delve into your costs. You can either negotiate better terms with vendors, enhance service efficiency, or pivot your client base to align with your service offerings.
Download our FREE Service Profit Planner here. This tool is your key to ensuring profitable services by meticulously planning deal volumes, pricing strategies, cost insights, and tailoring services to perfectly suit your client base’s needs.
When considering price increases, it’s crucial to know your service’s profitability. If your service gross margin sits below 40%, it’s time to evaluate costs and possibly increase prices. Sometimes, the service might not fit your client base, warranting a change in either the client segment or the service itself.
Start by analysing each service’s cost margin for the last 12 months. Can you optimize it internally? Ensure you have a clear view of fully burdened costs—more than just salaries, it includes rent, fuel, license fees, and more. This data informs smart pricing strategies.
- Top Tip: An essential rule: don’t wait for contracts to end; monitor and assess costs regularly. It’s not just about increasing prices blindly. If your sales team isn’t generating seven times its cost, your back-office expenses might need fine-tuning.
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The Pivotal Shift: Value vs. Cost-Based Pricing Strategies
Determining price increments as an MSP can be challenging.
Value-based vs. cost-based pricing approaches create contrasting narratives. The former aligns prices with unique service benefits, while the latter centres on cost coverage. The crux lies in a strategy resonating with client value perceptions while ensuring costs are met—a delicate equilibrium between service worth and delivery costs.
Deciding how much to raise prices can be difficult. Some businesses base it on rising expenses like increased wages, while others consider the perceived value to clients.
- Top Tip: Balancing these strategies is crucial. It’s not just about reacting to rising costs; it’s about reflecting the true value of your service in your pricing and communicating that effectively to your clients.
Section 3: Navigating MSP Price Adjustments and Challenges
Beyond the Numbers: Why Simply Raising Prices Isn't Always the Answer
The knee-jerk reaction to dwindling profits of a price increase isn’t always the answer.
Seeing profits drop from say 10% to 5%, and assuming the remedy is to simply charge more for your services, is an over simplistic response. In reality: competing solely on price won’t make you a contender in the MSP arena.
Consider this: a competitor offers similar services at a lower price. Does that automatically mean you should lower yours? Not necessarily. They might have a different business model, operate on a smaller scale or service a different location. We have seen businesses try to match competitors’ pricing, which then led to multiple players being on the brink of collapse.
Would you want a failing business managing your IT needs? Probably not.
It’s about value, not just cost. When someone tries to engage in a price conversation, flip the narrative. Break down the real cost versus what they’re paying. If they’re expecting top-notch service for a price that barely covers a tech’s wage, it’s a wake-up call. Would you pay another vendor a fraction of what they’re worth? It’s the same principle – quality comes at a price.
Moreover, not every client is the right fit for your business. Some need cost-effective solutions and are willing to compromise on service quality. Others demand high-end security and governance and are prepared to pay to mitigate risk. It’s not about good or bad; it’s about compatibility.
Sometimes, parting ways with a client is the best choice for both parties and there’s power in knowing when to walk away. Just as businesses evolve, so do client needs. Holding onto a client that no longer aligns with your services, or attempting to serve someone outside your expertise can be detrimental.
In essence, it’s about knowing when to stand firm on your value proposition and when to strategically step away.
- Top Tip: It’s not always about the price tag, but rather about finding the right fit between your services and your clients.
Regular Price Adjustments: The Smart Move for MSPs
Here’s a crucial thing many MSPs overlook: price adjustments need to be frequent, not a once-in-a-blue-moon event.
Why? Because when you skip these adjustments for years, the eventual rise becomes a major conversation, catching clients off guard.
Picture this: Missing three years of price increments means you’ll likely need a whopping 12% increase. That’s a hefty jump, especially for clients who haven’t budgeted for it. It’s like those small increases in your mobile bill that don’t bother you, versus a sudden large hike that makes you consider switching providers.
We’ve learned that averaging out your client base helps. By showing clients how their usage compares to your average profitability, ROI, and client satisfaction – it’s no longer about simply raising prices. It’s about aligning their costs with what’s standard across your entire client base. It makes the conversation more about maintaining fairness across the board.
So how do you do this?
One strategy we’ve found effective, as discussed in our previous blog, involves assigning a lifespan to services (e.g., ‘2023′ Edition).
Instead of simply announcing a 6% price increase, consider introducing it as the end-of-life for that particular service. You’re essentially creating a new service package that includes enhancements, which naturally comes at a 6% higher rate.
This approach offers flexibility in how you present it to your audience. For instance, let’s say your MSP has been providing services without a defined service catalogue. Your technical team might be exceeding the agreed-upon contract, delivering more than what was initially specified.
In this case, instead of raising prices, a thorough analysis might reveal that the additional 30 hours of service rendered each month should be billed separately as project work, thereby solving the issue without necessitating a price increase.
- Top Tip: The key here is understanding your client’s perspective. They might appreciate the value-adds or extra services as part of a separate project, rather than a sudden price increase.
Overcoming Pricing Challenges: Strategically Approaching Price Increases
When it comes to implementing price increases, it’s crucial to strategise and choose your battles wisely.
Testing the waters with a price adjustment isn’t about diving into the deep end right away. Instead, it’s about choosing the right clients for this conversation.
Select your clients thoughtfully. Start with those where the conversation is more straightforward, perhaps avoiding the trickier ones initially. Some MSPs opt to initiate price changes with new clients, where it’s less about change and more about setting the initial terms.
Alternatively, targeting existing clients might be a better fit, especially if your pricing structure has remained unchanged for an extended period. But here’s the difference: for new clients, it’s setting the norm, while for existing ones, it’s about managing a significant shift in their expectations.
The decision between existing and new clients should also consider your business’s growth trajectory. If your focus is on rapid expansion, adjusting pricing for existing clients might not align with your goals. Conversely, if new client acquisition isn’t your primary strategy, it might be prudent to test price changes with existing ones.
Ultimately, the approach depends on your unique circumstances—how quickly you want to implement changes, the balance between existing and new clientele, and the tolerance level of each client segment for such alterations.
Evaluating Service Delivery Costs: Accounting for Comprehensive Pricing
Travel expenses, often overlooked, play a crucial role in service delivery costs for MSPs.
Surprisingly, many MSP businesses don’t factor in travel time or expenses, leading to an incomplete picture of their service costs. If your engineers aren’t recording their travel time and related expenses, such as fuel, in your Professional Services Automation (PSA) tool, you’re potentially missing a significant portion of the total cost.
As for suitable tools or databases to manage this aspect, PSA software can be highly effective. You can create separate activities within the system – one for on-site work, and others specifically dedicated to travel etc. This way, even if you’re not reimbursing your engineers for travel or charging your clients for travel expenses, you’re still accounting for it within your system.
- Top Tip: Accurate time tracking is critical, especially regarding technical activities. Without this precision, your cost analysis won’t reflect the complete expenses incurred during service delivery.
Conclusion: The Path to Sustainable MSP Profitability
Ultimately, there’s no universal pricing fix for MSPs.
Using the tips outlined above will help you understand your capabilities and set prices effectively. If your MSP business isn’t making enough profit, it’s time to review whether your services are profitable.
Making these changes might be tough, but they’re crucial for boosting margins and creating a sustainable, profitable MSP business that provides real value to your clients.
If these challenges sound familiar and you’re seeking guidance on evaluating and setting your pricing, please feel free to reach out.
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This tool is your key to ensuring profitable services by meticulously planning deal volumes, pricing strategies, cost insights, and tailoring services to perfectly suit your client base’s needs, and add value without pricing yourself out.
- Optimise profit: Align services with labour hours for accurate margin calculation
- Plan growth: Forecast customer acquisition and ROI over 5 years
- Enhance marketability: Assess if services meet client needs
