This is part 2 of a 3 part series. Click here to read part 1.
Know your operating costs (or, know your margins).
As we consider the various factors surrounding MSP pricing models, we are obligated to look at operating costs. I assume that you have a good handle on your true operating costs. That said, most IT service providers still live with a cost-plus markup pricing model. In that world, profit margins are built into price. The presumption in this world is that a price that delivers reasonable realization against standard rates will be profitable. In our new profit margin world, realization is only one factor in determining profitability.
What you really need to know is your profit margin on a given piece of work. And to get to this number, you need to know your costs—the cost of the hours involved in providing that service. For a routine service, this sounds simple, but can become complicated for a larger, more complex offering since principal (or owner) pay is profit. You must decide how to treat principal/owner compensation on a cost-per-hour basis. Some firms just exclude that portion. Others treat it as a “comp divided by hours” function. Whatever your approach, it should be used consistently so that analysis of potential margins on work is understood.
Obviously, the goal in setting prices should be to drive positive margins. But knowing your margins, even when they are negative, has value. Then you can make informed decisions about which matters to take on, including where to invest negative margin dollars. Too many times the amount of the investment is unknown, which means any expectation for a return is non-existent.