Pricing IT services can be tricky. Price yourself too high, and your prospects and customers may balk (or walk). Price too low, and you'll leave money on the table — or worse, lose money. This is a challenge that IT Service Providers (ITSPs) — and managed service providers (MSPs) in particular — face on a daily basis.
For those who want to price right and increase profits on the IT solutions and services they deliver, here are four tips to help improve pricing strategies:
- Understand your costs. Before a company can price services for profit, it must first understand its costs to keep the business running. If you understand your costs, you can plan your profits for all services in your catalog. Costs include all the business expenses on your financial statements, with a particular focus on overhead expenses. Knowing how much money is going out versus coming in is a critical component to pricing services and solutions. It impacts how you calculate hourly rates for billable staff. Five key variables go into calculating hourly rates, including:
- Number of working hours in a year. Typically, an employee works 40 hours per week for 52 weeks per year, for a total of 2,080 hours. But, in reality, the math isn’t that straightforward. Your accountant or financial adviser can decide on a different weekly and yearly number for working hours based on local laws (e.g. overtime allowances). Once you determine this number, use it as a starting point to calculate your hourly rates for individual resources.
- Burden. ITSPs typically don’t look at burden because it is rolled into an overhead number. But, looking at it separately provides insight into the true cost of an employee. Burden can be a specific number but usually is expressed as a percentage. Burden is the total amount of fringe benefits and taxes you pay your employees above base compensation. You need to account for payroll taxes, healthcare coverage, social security costs, 401k contributions, and other costs that ultimately factor into an employee’s total compensation. The burden rate varies by company simply because some components of burden are discretionary and others are based on variable tax rates. In working with service providers over the last couple of decades, I have seen burden range from in the teens to 30 percent or more.
- Utilization rate. This is a forecast of the billable time you can expect from an employee as a percentage of the number of working hours in a year. In an ideal world, every employee would be billable for 2,080 hours per year, but some of their time undoubtedly will be spent on non-billable activities. Non-billable time includes vacation, holidays, training, and other time spent not working. The key impact on pricing and profitability relates to forecasts. If you forecast an 80 percent utilization rate and do not hit that metric, you will be compromising your path to profitability. It is better to forecast a reachable utilization target, say 60 percent, that you meet and exceed.
- Overhead. Control your overhead by understanding what it costs to keep the lights on. This includes everything from leasing or buying communications and collaboration tools and office space, to the coffee maker in the kitchen. Don’t spend unnecessarily. And be sure to work with your accountant or financial resource to understand what belongs or does not belong in this bucket. Costs like direct labor, direct materials, and direct outsourcing do not fall under overhead.
- Profit. Understanding your costs is the first step to planning your profit and achieving it. You can plow profit back into the business or into your pocket if you are the owner. You can even dole it out as a bonus to those billable resources that helped to make it happen.
- Determine costs and profits associated with the break-fix IT services model. It is necessary to understand the breakdown of how resources are allocated to efficiently deliver services. For example, how long does it take a billable technical resource to setup a new desktop, laptop, or mobile device for one of your users? Or, to make a repair on a broken device, patch a line of business application or operating system? Outside of tracking your time in a notebook, using a business management solution with automated time collection and analysis features enables businesses to see the time it takes, or has historically taken, to deliver a service. This allows them to set new pricing or adjust pricing on future projects or services delivered in order to increase profitability.
Once you establish how long it takes to deliver a service, you can use your calculated hourly cost to help determine costs and profits for certain services. The other key result for evaluating how long it takes to deliver a service is to have an opportunity to see how much of that time can be eliminated via automation. Automating service delivery is key to reducing costs and moving to more of a managed services recurring revenue business model. In my many years in the industry, I’ve seen customers experience a 15 to 25 percent increase in billable revenue from understanding resource usage and reallocating accordingly.
- Determine costs and profits for automated managed services. Just as with the break-fix model, when it comes to delivering automated managed services, companies need to understand the costs and profits associated with each service delivered. Your first consideration is to take some of those break-fix services you may have been delivering for years, such as patching a desktop OS, and automate the delivery of that service. You need to find the right tools to do this and you can choose from a variety of options including an IT business management platform and a remote monitoring and management (RMM) tool. Automation allows companies to scale their services, while greatly reducing the cost of labor associated with the break-fix business model. Companies can apply the insight from the break-fix model to help price their automated services by costs per user or device managed, desktop, printer, server, etc.
- Apply break-fix and automated managed services pricing strategies to cloud and outsourced services. Companies can leverage their pricing model for break-fix and automated managed services and apply it to their cloud and outsourced services as well. When pricing for cloud and outsourced services, factor in the costs of the third-party provider you contract work with to ensure you take full advantage of the potential for profit. For example, labor will still be expended if you are selling a third-party email box. Not only do you need to understand what the third party is charging you for that mailbox, but you need to know how much time it takes your resources to set it up and onboard the end user before they can use it. You also need to understand what it takes to include this data in the reports that you share with clients.
No longer do you have to set prices by throwing a dart against a wall, or wonder if you will be profitable when pricing compared to your competition. Armed with these four tips, you can make positive strides towards pricing your services for profit, reinvesting in your business — or taking a nice vacation.
Len DiCostanzo is senior VP of community and business development for Autotask. He has more than 25 years of experience in the IT channel and has worked with hundreds of service providers around the world. You can view a webinar on pricing your IT services for profit here.