Let’s start with some tough words for every support leader: If your support department isn’t a profit center, it’s an expense. Enterprises have always viewed expenses as something to be managed, controlled and constrained, and these constraints can have a real impact when support leaders look for the right level of resources to deliver high-quality support.
Transitioning to a paid monetization support model can be tricky, but with a little thought and some simple calculations, you can directly demonstrate your worth to your business and enjoy greater leverage and influence. Here’s how.
Understanding Costs, Margins, and Profit
Picture a kid’s lemonade stand. In this example, the product is lemonade. Lemonade cannot be separated from the core ingredients: lemons, sugar and water. The cost of these basic ingredients is called the “cost of goods sold” or COGS.
The difference between the money you bring in selling lemonade (revenue) and the direct cost of ingredients (COGS) is called gross profit.
Gross profit = revenue – cost of goods sold
Typically, businesses express gross profit as a percentage: For each dollar of sales, how much profit is made? This percentage figure is known as the gross margin.
Gross Margin (%) = (Gross Profit / Revenue) x 100
Gross margin is a crucial metric because it indicates whether a product is priced correctly. An expensive product that only makes a small profit probably isn’t worth the risk. Gross margin also makes it easier to compare a company’s performance with its peers. By cutting all other expenses (known as operating expenses or “opex”), you get the most essential part of your business – the vital and non-negotiable part.
Operating expenses and cost of goods sold
Back at the lemonade stand, the kids who run the stand decide to pay their friend to run the stand for an hour. Would this “salary” be considered the cost of goods sold? No, because that friend’s job has nothing to do with making the product — no matter who’s selling it, the product still exists.
What if the kid decides that instead of selling lemonade, they decide to have a “homework help” stand and pay their friends to tutor them? In this case, the friend’s payment is now considered the cost of goods sold. Tutoring is a “commodity” and there is no product without tutoring.
The same logic applies to software services. In SaaS, the product is a software subscription, not the software itself.
Cost of Goods Sold in Software as a Service
In general, engineers who write code for SaaS products are not considered COGS. But the engineers who keep the cloud servers running are. Account managers and customer success managers for sales and upselling are not. But for support leaders, here’s the key: Software support is definitely considered COGS.
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This is both a blessing and a curse. Since the cost of goods sold is part of the gross margin calculation, customer support costs not only affect overall profit margins but also gross margins. In contrast, if you have too many salespeople, it has no effect on the gross margin at all.
It also means that if you don’t charge for support, your gross profit and gross margin as a division will always be negative. If your company is looking to improve its overall gross margin, this is not a good place to be – if an IPO is imminent or a new funding round is imminent.
After all, there are two ways to improve gross margins: increase revenue or reduce expenses. Cutting a support team in half can easily add half a percentage point or more to profit margins.
Increase gross margins by charging support fees
Instead of reducing the number of support staff, charge customers the cost of providing support services. In many cases, simply passing the cost on to customers will increase their prices by less than 3% and allow your support organization to break even.
In a (proprietary) industry analysis of a group of SaaS businesses, the average gross margin for support organizations was much better than breakeven at 38%. But that’s still well below the typical gross margin target for a SaaS company. In other words, we’re not fighting for the stars here. Any supporting organization with a positive gross margin will be a pleasant surprise to the CFO.
Obviously, by having a positive gross margin, we can better position support in our business, but surely charging customers for support would make customers uncomfortable. It turns out that maintaining positive customer sentiment during the transition to paid support depends on how you bring new support pricing to the market.
The charge for support without disrupting customers
To successfully transition to a paid support model, you must answer two key questions:
- What am I selling?
- What do I charge?
There is no best way to package your support services. Factors such as your current channels, geographic reach, existing contractual commitments, and the specific needs of your customers within your own business all come into play. However, you’ll need to decide on a base model from the following list:
- Everyone pays for support and the service is the same.
- You offer a free tier and one or more paid tiers.
- You offer multiple tiers and they all cost a fee.
One challenge here is that option two has some risks: if you make the free tier too attractive, no one will want to pay for support. Access to a real person via chat or ticket usually shouldn’t be part of a free package, or you’ll find too many customers opting for the free option.
So what are the levels? Your specific circumstances will guide your choice, but here are some considerations:
- If you offer three support channels, put the lowest-cost channel in the lowest support tier, add the medium-cost channel in the middle tier, and put the most expensive channel in the top tier.
- If your agents are geographically distributed, 8-hour, 12-hour and 24-hour coverage is available in a three-tier model.
- Provide stronger service level agreement commitments for higher levels of support. One option is to provide a sufficiently wide distribution across tiers that support responses are measured in “days” at the low end and “minutes” at the high end.
- Consider entitlements to authorize the number of users to open support cases, assign specific agents, specific value-added services, custom dashboards, and more. The only limit is your imagination.
Remember: it’s much easier to transfer existing free support customers to paid support plans if you give them new entitlements and channels. That way they get extra money.
The next obvious question is, how much should this be?
Pricing your support offerings/services
You have two main options when it comes to pricing for the paid support tier. Both will involve figuring out the real cost of supporting customers. You can start simple: divide your total annual expenses (payroll, benefits, tools) by the number of clients.
This will give you the lowest amount you can charge per customer and still have a positive gross profit margin. Keep in mind that if you choose to have a free tier, more of the cost will be passed on to paid tier customers to make up for the negative margins on the free tier.
You now have the option to choose a flat fee or a percentage of subscription revenue (with a minimum floor) for each level. If you work with a finance team, trading desk, or pricing team, they can help determine the target gross margin for each product.
Percentage-based pricing is usually more aligned with each customer’s spending power. Once you’ve made up your profits, why not charge more for big clients? Ultimately, you’ll need to work with your sales and customer success leaders to determine how high your pricing can go.
Launch paid support
Finally, you need to push your pricing into the wild. Start by only charging new customers. Work with your sales team to inform them about pricing and any new support offerings that will help them make sales (and increase average deal sizes).
Once you’ve successfully completed the process, it’s time to address your existing client base. This is where most of the economic benefits of the business come from. The rollout plan will depend on whether to add a paid tier in addition to the existing free tier, or to migrate to a 100% paid model. The latter is much more difficult and requires a lot of care.
You may need a 6 or <> month runway with a lot of messaging and flexibility in terms of deal structures and discounts. Build effective support materials that give your renewal team plenty of opportunities to ask questions and learn “why,” and support them in what could end up being a difficult conversation.
Once pricing is deployed, make sure to track the impact on the business and iterate as needed. You may not get it right the first time, so use humility and a growth mindset to make course corrections when needed.
There is nothing more valuable than real dollars
At the end of the day, paid support is about playing an active role in revenue growth while continuing to provide the high level of service that customers expect. Generally speaking, customers are happy to pay for quality.
You’ve delivered this quality so far. Now is the time to simply align yourself with industry best practices that demonstrate that quality has real monetary value.
