A recent client offered a variety of services where actual usage was all over the place but it was the availability of those services that mattered to customers. Examples for this client and others include 24/7 "out of hours" coverage, call centers to handle inbound events that may occur zero times one week and dozens the next, advice on demand for regulatory matters, etc. The consistent theme is the availability to provide the service for needs that arise on a timetable you have no control over.
My client based its pricing for most of these services on an estimate of how much usage would apply, and then based its invoicing on actual usage. Yet their profitability and forecasting were struggling mightily because these services were performed by salaried employees whose compensation was not (and should not be) based on their own actual "usage".
What We Achieved
Pricing
We reviewed each of these services from the following perspectives:
Market benchmarks, if any
Accuracy of usage estimates
Internal cost modeling
Market Benchmarks- we reviewed my comps and intel from their sales and operations teams, and I reached out on a generalized basis to a few industry counterparts. In all but one case, comps were all over the place and rarely useful in terms of raw pricing. We did, however, learn useful information around common methodologies.
Estimates of Usage- we took a fresh look at how usage was estimated and modeled, comparing to both historical actuals and, more importantly, go-forward expectations given recent changes in staffing and technology. In some cases, current usage estimate held up perfectly fine. In other words, significant changes were made.
Internal Cost Modeling- the modeling to date was based on actual utilization over the trailing 12 months and was missing certain fixed costs associated with carrying these services. We revised it to model both variable and fixed costs into the gross profit estimates based on targeted go-forward revenue coverage.
The end result was a service-by-service decision of how to price each based on a review of the market benchmarks, where available, compared to usage estimates for the particular opportunity and the projected gross profit contribution of the opportunity. |
Billing
The change in billing method was far simpler to approach and far more impactful on future profitability. The client simply changed its billing methodology for availability-based services from usage to flat duration-based fees (per month, quarter, annum), even for services priced primarily on usage estimates. The terms had the flat fees based on generous "up to" levels of usage, with the provider having the ability to adjust the flat fees should usage far exceed expectations.
This change in methodology allows the provider to generate flat, fixed, predictable cash flows against its fixed costs for people, technology, and vendors associated with providing the services. Less obvious but just as important- their clients also benefit from having flat, fixed, predictable costs from the service provider. Prices only change if usage dramatically exceeds expectations, and those expectations are laid out in the contract.
Bottom Line
For services where availability matters as much or moreso than usage, incorporate market benchmarks and broader business modeling into your pricing structure. Bill these services as flat fees with generous usage caps that are clear and transparent to customers. You will capture more value in your pricing and generate recurring and more profitable cash flows, and your customers will enjoy a simpler approach to doing business with you.
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Contact me or book a meeting to discuss how these principles can be applied to improve the performance of your organization.
