Cost Minus Pricing Model for SaaS Startups
Recently, we were faced with a difficult problem to solve at SupplyNow. We developed our business model, our ideal customer, our standardized process for onboarding, retaining, and servicing our existing customers, but we were stuck trying to identify how to price our services. Being a Software-as-a-Service provider and having almost no market competition to base our pricing model, we had to find a way to price our services fairly.
This led me to extensive research online to identify the best potential pricing model that would balance cost-savings to our customers and generate revenue for our business. I stumbled upon literature on Cost Plus Pricing. I was familiar with cost plus pricing as it is primarily used in government contracting, but if you are a software business with low fixed overhead and amortized software costs, it is difficult to know what the base point is for cost plus pricing.
Our value proposition at SupplyNow is saving our customers money on their annual purchasing. More specifically, we promise our customers 5% cost savings across their first year. So, I started running some calculations to identify how we could save our customers 5% and still have healthy margins (in this example, our 'healthy margin is 5%).
What the Customer Currently Pays for Contract A: $100
Promised Cost Savings: 5%
What the Customer Should Pay for Contract A with SupplyNow: $95
From here, we know our base bidding price for the customer contract. As we bid out our contract to distributors, we must start at $95, and have distributors and suppliers bid down.
Customer Promised Price: $95
SupplyNow Healthy Margin: 5%
Maximum Contract Fulfillment Price: $90.25
Based on these calculations, SupplyNow would need to sell Contract A to its distributors and suppliers for $90.25, at maximum, to maintain its healthy margins. Should SupplyNow realize greater cost savings, the healthy margin increases.
Contract A Actual Selling Price: $87.75
SupplyNow Margin: 7.6%
And, should SupplyNow reach a contract fulfillment price that is higher than $90.25, its healthy margin will be negatively impacted.
Contract A Actual Selling Price: $91.75
SupplyNow Margin: 3.4%
Under a lower sell price, SupplyNow realizes greater margins. Thus the Tutelman Tax Cost Minus Pricing Model Formula is as follows:
(Current Contract Price - Promised Customer Savings) x (1 - Healthy Margin %) = Maximum Contract Fulfillment Price
(Current Service Price - Promised Customer Savings) x (1 - Healthy Margin %) = Maximum Service Price
With this model, SaaS companies are able to better price their initial service pricing to their customers. Although the Cost Minus Pricing model is great starting point for pricing your services, you will need to test with your customers to identify the best balance between healthy margins and cost savings, and this will take time and experience running your business.