Priced to Win: Build an Optimized Pricing Strategy
IT service providers must optimize their pricing strategy to maximize profit margins and add value to customers.
- Lack of competitive intelligence and market insights to support decision making around pricing
- Lack of dedicated staff with pricing skills and management processes
- Misalignment between the cost of offerings and the value they provide
- Lack of knowledge about how pricing works
- Lack of understanding of internal and external factors that impact a pricing strategy
Our Advice
Critical Insight
- Cost-based pricing strategies dominate the price of products and services among ITSPs
- ITSPs must broaden their input horizon to optimize a pricing strategy
- Packaging and bundling offerings improves value delivery and profit margin
Impact and Result
- Optimize profitability, business growth, and customer satisfaction
- Align with strategic priorities, market share growth, and expanded margin
- Determine the right price for offerings based on the customer and market
- React to supply chain issues or changes in consumer demand
- Stay competitive among peers in the market
- Maintain and improve profit margin, a 1% improvement in pricing can increase 11.1%
Priced to Win: Build an Optimized Pricing Strategy
IT service providers must optimize their pricing strategy to maximize profit margins and add value to customers.
Analyst Perspective
Price your offerings using optimized pricing strategy
How you price your products and services will help determine the success of your organization. To win in your market the pricing strategy must consider:
- The cost to produce, market, and distribute your product or service.
- The value of what you are offering to potential clients.
- The competitive pricing environment.
- Packaging and billing models for your offerings.
- Market forces that may shift the demand for your product or service (and if supply chain issues could disrupt getting your product or service to market).
The right pricing method or strategy can do wonders for IT Service Providers (ITSPs) by greatly increasing profit margins. Unfortunately, pricing is one of the areas where organizations have struggled due to a lack of dedicated resources, skills, and internal inconsistency.
The key to creating effective and successful pricing around your offerings that drive maximum profit is to have dedicated resources and skills to build an optimized pricing strategy. This storyboard will assist you to develop your repeatable pricing strategy based on various external and internal factors which influence the strategy at the different stages. Further, this storyboard strategy will help you to align your engagement types with the right pricing strategies.
Brijesh Kumar
Research Specialist, Industry Practice
Info-Tech Research Group
Executive Summary
Challenge
You are having difficulty pricing your products and services. Most IT service providers leverage the cost-based pricing strategy because it is easy and simple to implement.
You lack an effective or optimized pricing strategy. Not having an effective and optimized pricing strategy can cause misalignment between the cost of products or services and the value they provide to customers. This could potentially result in losing profit margin and additional revenue opportunities.
Obstacles
There are many unknowns to discover. ITSPs must understand what factors can impact their pricing strategy and eventually the price of offerings.
Pricing strategy often fails due to a lack of competitive intelligence and knowledge of customers willing to pay for offerings.
Most of the ITSPs lack dedicated staff with pricing skills and management processes, which leads to ill-informed decisions and a gut-driven approach to price products and services.
Info-Tech Approach
Understand the challenges and opportunities to optimize your pricing strategy.
Follow the three-step method guide to align your pricing strategy with your offerings: pricing strategy, packaging, and billing models.
Improve Net Income After Tax (NIAT): ITSPs must keep customers and value addition at center stage while building an optimized pricing strategy for their offerings. This will help ITSPs to follow a customer-first approach and differentiate their offerings from competitors.
Info-Tech Insight
For business profitability, organizations have mostly focused on cost-cutting, acquisition, improving operation processes, and product innovation. The need to have dedicated resources and skillsets to build an optimized pricing strategy have been overlooked long enough.
Insight summary
An optimized pricing strategy is key to desired profit margin
Price is one of the key pillars among the other P's (Product, Promotion, Place) in a marketing strategy and drives revenue and profit of companies. Business and technology leaders leverage different pricing strategies/methods but face multiple challenges to building an effective and optimized pricing strategy that is aligned with the value of products and services and customer willingness to pay. An optimized pricing strategy is crucial for any organization to generate the desired profit margin while continuing business growth.
Cost-based pricing dominates
Different models of pricing (hourly rate, project based, daily rate, value based) are commonly used across the IT service providers industry. However, the most common strategy employed is cost based because this strategy provides straightforward calculation and lower effort to price products and services.
Broaden your input horizon to optimize pricing strategy
Pricing your product and service is not as simple as we think sometimes. It needs input from customers and thought-out research around external and internal factors that influence the pricing of the offering. Lastly, how much profit margin one will make depends on how differentiated your product is among competitors, its value to the customer, and the customers' willingness to pay.
Packaging and bundling improves value delivery and profit margin
ITSPs do not price every product and service based on value because different customers assign different values to alike products. However, it is possible to add more value to all the offerings of ITSPs which can differentiate you in the market among peers. (Examples: adding some education, training, consulting, or engagement hours with the client.)
Pricing is part of a marketing strategy
Pricing is an important part of the overall marketing strategy
A marketing strategy is vital for any business and includes four P's:
| Product | A good or service that addresses customer needs or solves problems. |
|---|---|
| Promotion | Differentiate your product from competitors. |
| Place | Where customers will find the product. |
Price | A price is based on the value of the product. |
"Pricing is by far the biggest tool for earning improvements."
– McKinsey, 2019
"Pricing is the only revenue-generating element in the marketing mix (the other three are cost centers – that is, they add cost to a company's cost)."
– MaRS
"Prices are now transparent. Partly because of this, the price has become perhaps the most important pillar."
– Prisync, 2021
Pricing influences profitability
Pricing is a key lever to optimize profit
Impact of change in different factors on profitability
"Pricing has three to four times the effect on profitability than other improvements."
– Richard Hayes and Ranjit Singh
Source: Deloitte, 2013
Effect of pricing profit
"As you raise your price (moving left to right), your profitability goes up – to a point. It's at the point where you've raised your price by too much that your profitability goes down."
– Eric Dolansky
Source: BDC
ITSPs struggle to price their offerings
ITSPs face challenges and make decisions that affect profit margin
CHALLENGES | |
|---|---|
Understanding their market | Lack of competitive intelligence, including pricing |
Lack of ability to assess the value of offerings | |
Understanding their clients | Lack of client/market insights to support decision making around pricing |
Lack of understanding of drivers that impact pricing strategy | |
Understanding pricing optimization | Lack of pricing experience in evolving market |
Lack of knowledge of how a pricing strategy works for their offerings |
MISTAKES | |
|---|---|
Overlook profit and pricing | Focus on revenue largely ignoring factors that impact the cost |
Hold prices at the same level for too long | |
Using a sub-optimal pricing model | Attempt to achieve the same profit margin across different offerings |
Companies fail to segment their customers for appropriate value propositions. |
"Many companies focus on acquisition to grow their business, but studies have shown that small variations in pricing can raise or lower revenue by 20-50%. Despite that, even among Fortune 500 companies, fewer than 5% have functions dedicated to setting the best price possible."
Source: ProfitWell, 2021
"Pricing is a balance of art, math, and psychology, and generally, people are brought up in one discipline or another and can't balance the inputs. So, there are very few people who have experience or skills broad enough to consider all of them when pricing a product or service."
– Eric McCullough
Source: LinkedIn, 2019
Factors that impact price of offerings
EXTERNAL FACTORS | |
|---|---|
| Competition | helps to determine a price range of similar offerings based on the competitive landscape |
| Market | create an understanding of the specific needs of customers and position your offerings |
| Demand | influence the pricing of offerings depending on demand in the market and global disruption in the supply chain |
Perceived value | determine a price range based on customer willingness to spend based on the value of offerings |
Price anchoring | initial price can determine the perceived value and influence demand for future price change |
INTERNAL FACTORS | |
|---|---|
| Uniqueness | helps to determine a price range of similar offerings based on the competitive landscape |
| Margin | create an understanding of the specific needs of customers and position your offerings |
| Cost to serve | influence the pricing of offerings depending on demand in the market |
| Revenue goal | determine a price range based on customer willingness to spend based on the value of offerings |
- Pricing Strategy
- Cost to build
- Revenue goal
- Market
- Competition
- Margin
- Uniqueness
- Demand
- Price anchoring
- Perceived value
ITSPs need an optimized pricing strategy
An effective pricing strategy not only helps you to increase profitability
but also:
- Increase repeat purchases/loyalty
- Improve brand perceptions
- Portrays better product value
- Builds trust
- Increases confidence in products
- Higher satisfaction
Pricing strategy
Definition:
- A pricing strategy is a method that helps you to place a dollar number on any product or service based on:
- the cost to create the product or service and add a mark up with an intended profit.
- perceived value of the specific product or service by the customer.
Paybacks of an optimized pricing strategy
- Optimize profitability, business growth, and customer satisfaction
- Align to strategic priorities, market share growth, and expanded margin
- Determine the right price for offerings based on the customer and market
- React to supply chain issues or changes in consumer demand
- Stay competitive among peers in the market
- Maintain and improve profit margin, a 1% improvement in pricing can increase the profit 11.1%
Source – ProfitWell, 2022
The five most common pricing strategies
An organization may choose one or more strategy to price their offerings
- Cost-based pricing
- Calculate the total cost to build an offering and add a mark-up
- Value-based pricing
- The price is based on perceived value and what customers will be willing to pay
- Competitive pricing
- Determine the price based on what competitors are charging for the offering
- Penetration pricing
- Set a low price to enter the competitive market and increase the price later
- Skimming pricing
- Start with a high price of product and lower the price as the market evolves
Cost and value options are primary choices
Cost-plus and values-based pricing strategies are the most popular choices among IT service providers
- Cost based is most popular: 65% of ITSPs leverage a cost-dependent approach to price their products and services.
- Value based is not often used: Only, 17% of the ITSPs utilize value-based pricing, which indicates either they are not aware of the value of their offerings delivered to customers, or they struggle to align a value-based pricing strategy with their offerings.
- The same billing method can be cost plus or value based: Hourly, daily, monthly, and project-based billing can be cost plus or value driven, but is most often cost plus among ITSPs.
Info-Tech Insight
Most businesses end up using cost-based pricing because it is easy and requires the least effort to build price offerings for products and services in comparison to value-based pricing and other strategies.
Different billing methods used by ITSPs
Use Info-Tech's three-step method to create an optimized pricing strategy
- Pricing strategy: How do you set the price?
- Packaging: How do you present the offering to customers?
- Billing models: How do you bill the customers?
An optimized pricing strategy is key to increasing profit and delivering value to customers.
Pricing strategy:
How do you set the price?
Cost-based pricing: a classic and one-dimensional model
The price of an offering built upon cost is a common strategy
What is cost-based pricing?
It is a method for pricing a product or service when the company desires to make a certain percentage of profit over the total cost of that product or service.
Cost-plus pricing
Add markup to the cost of your product or service, generating profit from the beginning.
Example of cost-plus pricing
Example of cost-plus pricing | ||||
Fixed dollar increase | Percentage-based increase | |||
Unit cost $100 Units sold 150 | Fixed dollar increase amount | $20 | Mark-up % | 20% |
| Unit selling price | $120 | Unit selling price | $120 | |
| Gross revenue | $18,000 | Gross revenue | $18,000 | |
| Gross margin | $3,000 | Gross margin | $3,000 | |
Rule of Thumb:
To generate a higher profit, ITSPs must focus on profit margin rather than revenues. The benefit of this approach is that it covers fixed cost primarily and then a markup is added.
Info-Tech Insight
A markup of products and services is common among ITSPs because of the nature of some of their offerings. This strategy appears straightforward, still, IT service providers should periodically revisit the price of offerings and cost-based pricing strategically, considering external and internal factors to maximize profitability and business growth.
Ensure you capture all costs
The inventory list will help you to cover all the overhead and offerings associated costs
- Fixed Costs
- Rent
- Utilities
- Permits
- Employee salaries
- Taxes
- Equipment
- Buildings
- Variable Costs
- Packaging
- Marketing
- Royalties
- Sales taxes
- Travel
- Products and Services Costs
- vCIO/vCTO/vCISO
- Technology business review
- IT processes assessment
- Office 365 license
- Network support
- Security solutions and services
- Training personnel
- Time for consultants
Rewards and risks: Cost-based pricing
The benefits and rewards to both the parties delineate success of your pricing strategy
ITSPs | |
|---|---|
Rewards | Risks |
Easy pricing structure | One-dimensional |
Invariable profit | Internally focused |
Transparent | Money on the table |
Client | |
|---|---|
Rewards | Risks |
Easy to understand | Low-cost driven |
Predictable forecast | Poor quality offering |
Pricing comparison | Limited choice |
Cost-based pricing discards value
The cost-based pricing of an offering includes the total cost to build and serve to customers but often ignores the perceived value of the offering to the customers
Cost-based pricing | Value-based pricing |
|---|---|
 |  |
| Final Price of Offerings | Final Price of Offerings |
Adding the Right Value: Building Cloud Brokerages That Enable
The price of an offering built upon value is a preferred strategy
What is value-based pricing?
"Value-based pricing is the method of setting a price by which a company calculates and tries to earn the differentiated worth of its product for a particular customer segment when compared to its competitor." – Utpal Dholakia
Subjective Interpretation
The value of a product or service is interpreted by future benefits to be accrued, external factors recognizing additional value, and customer willingness to pay for the benefits and added value.
Example of value-based pricing | |
|---|---|
Fixed dollar | |
Unit cost $100 Units sold 150 | Customers' willingness to pay $150 Profit margin $50 Gross revenue $22,500 Gross margin $7,500 |
Thumb Rule:
For value-based pricing, ITSPs should never charge for offerings more than what the customer is willing to pay, but the price should not be much lower than the perceived value.
Info-Tech Insight
To mark a successful pricing strategy, understanding how customers perceive value is imperative to sell products and services on value rather than price. The perceived value is the driver of the tradeoff between perceived benefits for the customer and the price for purchasing the offering that delivers benefits and outcomes. Always remember that adding value is about solving the client's problem with tangible and intangible outcomes/ROI, not just selling products or services.
Know your cost and value before you price
Cost
- Expenditure required to create and sell products and services
- Ascertained by the perspective of the producer of product and service
- Results in the outflow of money
- profit/margin not included in the cost
- Mark-up is calculated based on cost
- Business aims to reduce the cost
- Cost is ranked before determining the price of products or services
Value
- Client willingness to pay for an offering
- Benefits and advantages of a product and services to clients
- Competitive differentiation contributes to the value of a product and service
- Being a brand and trusted partner in the marketplace adds more value to your offering
- Tangible and intangible outcomes and ROI increase the value of an offering
Price
- Amount of money expected from consumer or customer in exchange for a product and service
- Ascertained by the perspective of the consumer of product and service
- Results in the inflow of money
- Profit/margin included in the price
- Margin is calculated based on price
- Business aims to increase the price
- Price is ranked after determining all the costs and value associated with products or services
Info-Tech Insight
A mindful and well-researched discussion to determine the cost, value, and price of products and services can result in an increase in profit growth.
Determine perceived value and all costs
The inventory list will help you to cover all the overhead and offerings associated costs
Perceived Value
- Outcome
- ROI
- Customer satisfaction
- Peace of mind
- Improve business operations
- Increase revenue growth
Fixed Costs
- Rent
- Utilities
- Permits
- Employee salaries
- Taxes
- Equipment
- Buildings
Variable Costs
- Packaging
- Marketing
- Royalties
- Sales taxes
- Shipping
Products and Services Costs
- vCIO/vCTO/vCISO
- Technology business review
- IT processes assessment
- Office 365 license
- Network support
- Security solutions and services
- Training personnel
- Time for consultants
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