What to Know about Stand-Alone Selling Price for SaaS Companies

What to Know about Standalone Selling Price for SaaS Companies

The ASC 606 / IFRS 15 revenue recognition standard can be complicated for technology companies, especially for those with Software as a Service (SaaS) offerings. The business model of SaaS companies can often trigger the need to follow a number of complex components of the ASC 606 / IFRS 15 guidance. For those companies selling multiple things (Performance Obligations in ASC 606 parlance), and particularly those that offer discounts, difficulties arise with step 4 of the ASC 606 / IFRS 15’s five-step guidance: Allocate the transaction price to the performance obligations in the contract.

It helps to understand the SSP in more detail as well as the factors that SaaS companies need to consider to determine SSP.

What is a Standalone Selling Price?

Put simply, the standalone selling price (SSP) is the amount that a company would charge for a good or service sold to a customer when sold in isolation. The computation of an SSP price for a given SKU will often involve determination of the average price that SKU receives when sold in isolation. The sold price in a specific contract may represent the SSP, but often the contractual price may be specialized (via discounts and other incentives) and not represent the SSP.

In addition, the guidance says, “the objective when allocating the transaction price is for an entity to allocate the transaction price to each performance obligation (or distinct good or service) in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer.” In other words, when an item is not sold at its SSP value, one must perform a proportional allocation of the TCV (Total Contract Value) according to the proportion of each line item’s SSP value related to the sum of the SSP values on the contract. In addition to figuring out the SSP, a company must also look to the contract with the customer to determine when the good or service is transferred and when the revenue can be recognition.

In SaaS, the business model and customer contracts might exclusively be sold as bundled licenses and service packages, making SSP difficult to determine via the primary means. In addition, SaaS pricing models can vary depending on the number of users or actual consumption of the service. The SaaS product could have evolving features that make a consistent SSP difficult to maintain. Finally, market competition could mean the SaaS product has a price that changes based on other companies’ products or special offers to gain market share.

How can a SaaS company estimate SSP in these scenarios?

When a SSP is not determinable through primary means, there are three ways in which a company can determine it.

1. Adjusted Market Assessment

Adjusted market assessment involves an evaluation of the market prices for similar products with adjustments made for major differences in feature or market circumstance. The steps involved in an adjusted market assessment include the following:

  1. Market Analysis: Identify similar products and services using data from competitors, market research, analyst and equity firms, etc. in the analysis
  2. Comparability Assessment: Compare the identified products/services to the components of the company undertaking the adjusted market assessment, with attention paid to functionality, features, target market, and customer value proposition
  3. Differences Appraisal: Identify any differences between the comparable products/services and the components being priced. These differences could include features, functionality, quality, customer support, and other relevant factors
  4. Adjustments: Make adjustments to the market prices of the comparable products/services to account for the identified differences, such as adding or subtracting value based on the relative strengths and weaknesses of the components being priced compared to the market alternatives
  5. Final Price Assessment: After making adjustments, arrive at an estimated SSP for the components based on the adjusted market assessment.

An example of an adjusted market assessment for SSP for a SaaS company

A SaaS company wants to launch task management software but does not have a history to determine a SSP. The company uses an adjusted market assessment that first finds the average monthly price of task management software is $20 per month per user. However, the company also determines that its product has more advanced features and allows a collaboration component in addition to task management. Given the additional features, the company determines that the software’s value is $25 per user per month. The SaaS company is launching in a competitive market, so it factors the competition into its analysis and settles on an estimated SSP of $22 per user per month.

2. Expected Cost Plus a Margin

Another approach a SaaS company can use to determine SSP is expected cost plus a margin, which calculates the SSP by adding a markup to the expected cost of producing or delivering the product or service. This markup represents the desired profit margin or return on investment.

For a SaaS company, the expected cost may include various factors such as:

  • Development and Maintenance Costs for the software platform
  • Infrastructure Costs related to hosting the software on servers, cloud services, or other infrastructure
  • Operational Costs for customer support, marketing, sales, and other operational expenses
  • Overhead Costs associated with running the business, such as office space, utilities, and administrative expenses

The margin added to the expected cost represents the desired profit margin or return on investment for the company. This margin can vary depending on factors such as market conditions, competitive landscape, and company objectives.

The simplified formula for calculating SSP using the expected cost plus a margin approach is:

 SSP = Expected Cost + (Expected Cost × Margin Percentage)

For example, if the expected cost of providing a SaaS solution is $100,000 per year, and the company aims for a 30% profit margin, the calculation would be:

SSP = $100,000 + ($100,000 x 0.30) = $130,000

So, the standalone selling price (SSP) for the SaaS solution would be $130,000 per year.

This approach provides a straightforward method for pricing products or services based on their expected costs and desired profit margins, but market expectations and competitive pricing must also factor in.

3. Residual Approach

The residual approach is one that is only permitted to be used in certain circumstances, if one of the following criteria is met:

  • The entity sells the same good/service to different customers for a broad range of prices (i.e., highly variable)
  • The entity has not yet established a price for a good or service, and it has not previously been sold on a standalone basis

Additionally, if the outcome of using the residual approach leads to the allocation of little or no consideration to a performance obligation, this method may not be appropriate.

Let’s assume that a SaaS company meets the criteria and wants to use a residual approach. The company would take the following steps:

  1. Identify Observable SSPs: Identify any components within the bundled offering for which the SSP is known or can be reliably estimated. Examples include standalone pricing for individual features, modules, or services
  2. Allocate Known SSPs: Match the known SSPs to the corresponding components within the bundle. This step involves subtracting the known SSPs from the total price of the bundle
  3. Determine Residual Value: The residual value represents the portion of the total bundle price that is not accounted for by the known SSPs
  4. Allocate Residual Value: Assign the residual value among the remaining components based on their relative importance or value within the bundle. This allocation can be based on factors such as functionality, customer demand, or cost of development
  5. Calculate SSP for Unobservable Components: Once the residual value is allocated among the unobservable components, the SSP for these components can be determined by adding their allocated portion of the residual value to any additional known costs or estimates
  6. Validation and Adjustment: Validate the calculated SSPs to ensure they align with market expectations, competitive pricing, and the overall value proposition of the bundled offering

Example of a SaaS company using a residual approach for SSP

A SaaS company offers a bundled project management software package that includes task management, document collaboration, and time tracking. The company wants to determine the SSP for each component using the residual approach and uses the following steps:

1. Identify Observable SSPs
    • Task Management: The company has conducted market research and determined that a standalone task management tool typically sells for $20 per user per month.
    • Document Collaboration: Market analysis suggests that standalone document collaboration software sells for $15 per user per month.
2. Allocate Known SSPs
    • Task Management: $20 per user per month
    • Document Collaboration: $15 per user per month
3. Determine Residual Value
    • Total bundled price: $40 per user per month
      • Known SSPs:
        • Task Management: $20
        • Document Collaboration: $15
    • Residual value: $40 – $20 (Task Management) – $15 (Document Collaboration) = $5 per user per month
4. Allocate Residual Value
    • Time Tracking: Time tracking is an essential but unobservable component within the bundle, contributing significantly to the overall value. Therefore, it receives a higher portion of the residual value compared to other components.
      • Allocate $3 of the residual value to Time Tracking, leaving $2 for other unobservable components.
5. Calculate SSP for Unobservable Components
    • Time Tracking: $20 (known SSP for Task Management) + $3 (allocated portion of the residual value) = $23 per user per month
    • Other unobservable components: The remaining $2 of the residual value can be allocated among other unobservable components based on their relative importance or value.
6. Validation and Adjustment
    • Validate the calculated SSPs against market expectations, competitive pricing, and the overall value proposition of the bundled offering.
    • Adjust SSPs, if necessary, based on feedback, market changes, or additional data.

Automate SSP and Revenue Recognition with SOFTRAX RMS

The SOFTRAX Revenue Management System (RMS) offers a powerful approach to revenue management. It is the world’s only system that combines best-in-class automation for one-time, milestone, subscription, and consumption billing; contract renewal management; and complex revenue recognition in a single solution to streamline the revenue management process.

SOFTRAX RMS supports policy-based processing in all areas and includes both a workflow middleware layer and an analytics engine. With SOFTRAX RMS, SaaS companies gain transparency across billing, contract renewal, and revenue recognition, as well as the components to help with SSP and other determinations.

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