Managed services pricing models: Per-device vs. SLA-based approach

Pricing strategies is a hot topic among managed service providers (MSPs), and for good reason. But it's not all about the bottom line. The pricing model an MSP adopts can impact much more than revenues and margins. It can also have an effect on the potential for business risk and commoditization in the marketplace. Unfortunately, the strategy offering the most protection is also the most difficult to implement.

"Depending upon the business maturity model of the solution provider, and the sales and marketing acumen of the provider, we see several different [pricing] models," said Erick Simpson, senior vice president and CIO, of Orange, Calif.-based SPC International, a business improvement and training resource for service providers. "We see a per-device model, where I'm going to charge you per PC or per server that we manage. Some providers start in that model, but as they grow in maturity, they sell more on value than on a point price."

Value-based pricing is a more complex way of pricing [than per-user/per-device], but you can end up with bigger margins in the end.

Raymond Vrabel,
Continuum Managed Services

Of the managed services pricing models in place today, per device and per user are the most common, according to Charles Weaver, CEO of the International Association of Cloud and Managed Service Providers. But they also provide the least protection. "Per user/per device is easy. Compared to SLA-based pricing, it's a lot easier and no one can deny that, but the ease does not outweigh the risk and potential harm to the MSP by locking themselves into a commodity-based pricing model."

Weaver explained that managed service providers are in high demand and money spent on managed and cloud services is projected to go up. But MSPs using per-user/per-device pricing are likely to be pressured to lower their prices and their margins. "The per-user/per-device models make it easier for the customer to play you off of another MSP. … One of the best ways to combat that is to go to SLA-based pricing where you can't be shopped around by a customer who says, 'This MSP can do it for that,'" he said.

A per-user/per-device MSP pricing model also makes it more difficult to raise prices. "There's very little you can do to increase margins other than simplify the back end. But when you raise prices, it's very hard because it's transparent to everyone," Weaver said.

As MSPs mature, they tend to adopt a more sophisticated pricing strategy. Experts use various terms to refer to strategies that are based on the potential risk of bringing on a new customer and the value the MSP delivers. Weaver calls this SLA pricing. He explains: Two customers may each have an identical server, but one may have higher security and redundancy requirements. The company that needs the server available around the clock and protected against unauthorized access, for example, has a lower risk tolerance than the other company. If that server is breached or goes down, the MSP is at greater risk and potentially carries a greater liability.

"[SLA-based pricing is] customized based on the risk to the MSP and what they take on on behalf of the customer," Weaver said. In the example above, "one customer is willing to pay more for the management of that device from the same MSP, and the MSP should spend more and take more risk with one customer than the other." Logically, that means higher margins.

"There are far better margins and revenues to be made from SLA-based pricing than anything else. That fact alone should help MSPs make that shift," Weaver said. It also allows MSPs to more easily raise prices based on the value delivered. If an MSP provides services to organizations in a highly regulated industry, such as healthcare, and new laws are enacted that guard against data breaches, it's a much easier sell to raise prices to cover additional protections, because the customers need them, he said.

Raymond Vrabel, director of technical account management at Continuum Managed Services LLC, a Boston-based provider of software for managed services providers, suggests a similar approach to pricing services, but with an emphasis on value. "Value-based pricing is a more complex way of pricing [than per-user/per-device], but you can end up with bigger margins in the end," said Vrabel.

With value-based pricing, the MSP essentially becomes the client's outsourced IT department, Vrabel explained. The MSP considers what it costs the client to deliver IT services with the amount of staff the company has on hand, and then offers to do those same services for a lower fee. For example, it may cost the client $85,000 a year to distribute desktops and to manage, maintain and monitor the company's PCs. The MSP offers to deliver those services for $65,000, Vrabel said. "Value-based pricing is a little more cutting edge than some other pricing models and probably takes a little more back-end homework to get done. But if you have the right formulas, and you can pull it off, that's a great approach," he said.

Simpson agreed. "The value-pricing model takes the highest level of sales acumen and marketing acumen to understand the needs of the prospect or client and price based upon the perceived value of the services," he said. "It takes into account not just the client's immediate pain but also latent needs and the potential drawbacks of the client not addressing them and how they can evolve into something greater."

According to experts, these more complex managed services pricing models are the wave of the future. "My best guess is that maybe 30% to 40% of MSPs are really doing anything approximating an SLA-based pricing scheme today, but I'd say it's the wave of the future, the place we're headed in the next five to 10 years," Weaver said.

When determining what to charge for SLA-based pricing, Weaver advises MSPs to consider "what are they managing, what's the risk to the MSP and the customer, then building in a 40% to 50% gross margin to whatever those services are in the aggregate. That's generally speaking where a decent average MSP should be. Less than 30% and you're not making as much as you should, so you're either priced too low or it's costing you too much to deliver the service. Margin is always a good indicator of where you should be in doing SLA pricing," Weaver said.

Simpson offers this best practice for value-based pricing: "It is simple. Include as much as possible into a flat fee to increase the value of those services, and then charge appropriately. That makes it difficult for a competitor to [displace] you."