TSIA Point of View: Should Cost Pricing

This week we received an inquiry from one of our members:

We are seeing a new approach to negotiation of pricing for some of our services – what is being called “Clean Sheet” or “Should Cost” analysis. In a nutshell, the customer does their own in-house assessment of what they believe a service (such as training) costs a supplier to deliver. The customer also does their own assessment of supplier overhead and margin, and presents a “should cost” price to the supplier. The supplier can either accept the proposed price, or refuse – in the latter case the supplier is then expected to reveal their cost structure to the customer for negotiation.

 This approach has been applied in other industries, such as the commodity auto parts supply business, for some time, but this year is the first time we are seeing it being applied to technology services. This could turn service pricing on its head if it became a widely adopted model among consumers of technology services.

 Is TSIA seeing this trend emerge more broadly in the technology services industry?

I strongly agree with the observation that “should cost” pricing could turn service pricing on its head. Also, I believe that any technology service that is commoditizing and can be sourced from multiple providers is susceptible to this pricing approach from customers. For example: you want to provide Microsoft Office training, or you have a managed service to maintain a customer’s server environment. Clearly, outsourcing vendors that are providing generic IT services have been faced with “should cost” by customers that want to secure the best deal possible.

However, I am not hearing from our members that customers are using a “should cost” model for technology services they view are unique. I think this is true because “should cost” pricing requires the buyer to understand the creation process of the provider, as discussed in an article on this topic from GBM Consulting:

Initiating should cost analysis requires that the company have a good understanding of the manufacturing processes used to produce the item that they are buying.  Because should cost analysis is typically applied to specialized and unique parts, this is a reasonable assumption.  When a company designs a part or assembly for a car or airplane they typically specify much of the manufacturing process or at the very least they specify the characteristics of the part that define the process.  Based on those specifications, engineers can determine the manufacturing process steps what a reasonable amount of accuracy

For example, if a customer wanted to use “should cost” pricing to determine how much they should pay for technical training on your product, these are the relevant questions to ask:

  • Are your customer’s experts at creating technical trainings materials?
  • Do they know how long it takes for your specific product?
  • Do they have accurate market data on how much experienced technical trainer’s cost?
  • Does your customer know how much time is required to develop competent technical trainers?

All of these variables factor in to the final price for your education services. All of these variables make “should cost” pricing more challenging to apply.

 

The TSIA POV (point of view) on “should cost” pricing:

TSIA does believe that many technology market segments are commoditizing. Especially at the product level. With this in mind, it is even more imperative that technology companies are able to defend the unique value  they are delivering through service interactions. And remember, value typically equals margin. For this reason, TSIA has the following POV regarding “should cost” pricing for service offerings:

  • Technology companies should resist “should cost” pricing for any unique services.
  • Intense effort should be applied to educate both your own sales force and the customer on why a “should cost” model is not applicable to specific services.
  • Once a “should cost” pricing model is applied to a service offering, that offering will be relegated to a “cost plus” pricing model.
  • Cost plus pricing models that are totally transparent to the customer will yield very thin margins.
  • Once a “should cost” pricing model is applied to a service offering, TSIA recommends a company divests itself of that commodity service.
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