Send an RFQ for an injection moulded part and you ask for a cost breakdown. Automotive, pharma, aerospace, renewables, everywhere, it’s simply how the category works, and no supplier has ever found the question rude.
Send an RFQ for software and we ask for a discount.
I’ve spent time on both sides of this, manufacturing first and then years of buying indirect spend, and the gap still bothers me.
What a breakdown actually looks like
In a manufacturing RFQ you make the supplier open the book. Material cost. Then manufacturing, split into the machine and equipment, which machine, the cycle time on it, the tooling you need for that specific part. Labour. Packaging. Scrap, and yes they’re allowed their 1% or so. Then material overhead, bc someone works in that warehouse. Then the manufacturing overhead for everyone in the plant not touching your part. Then R&D, sales, administration. And on top of all of it, profit, which in the manufacturing world sits somewhere around 5 to 10%.
Get 3 or 5 of those back and you start seeing patterns. This supplier’s material line is off. That one’s cycle time is 40% longer than the rest for the same process.
And then the conversation is about facts.
I’ll say the part I actually believe here: I don’t chase a supplier’s profit. They need to make profit, come on. What I want to talk about is cost. Why is your machining inefficient. Why are you not buying that aluminium at market rate. The should-cost model exists to give you an anchor for that conversation, not to squeeze the last point out of someone’s margin.
The software version is harder, not impossible
The honest objection is intangibility. There’s no sheet metal, there’s a UI. So when you ask a SaaS seller for a cost breakdown, the answer you get back, and I’ve had this conversation, is a genuine question: which cost do you mean? Hosting? The marketing spend that got us in the room? Customer success? The developers? And the product’s been built over 10 years, so what are we amortising, and over what.
fair enough. It’s a real problem.
But 20 or 30 years ago there was no way to get any of that information at all, and today the giants in the space are publicly listed. The cost drivers are not a mystery. R&D. Infrastructure, cloud, compute, wherever it’s hosted. Sales and marketing, which includes the Michelin star dinners and the sponsorship of every single event going. Finance, admin, office space.
Add all of it up, then look at the gross margin sitting in the annual report. 80, 85, 90%.
I’m not finger pointing, it’s a business model, and it’s something you can literally just read. Very few people are doing it.
The thing that blocks the transfer
Value-based pricing. That’s the whole answer, and the well placed sellers use it beautifully: this isn’t about what it costs me to produce, it’s about the value I’m giving you.
Which is why the manufacturing approach doesn’t transfer 1 to 1, and I want to be straight that I haven’t solved this. I think it should be transported to the SaaS world, I think there are ways to do it today, and I might actually experiment on it properly this year. Ask me again in 6 months..
When value based pricing turns into an excuse
There is a point where it stops being a justification, and it’s simpler than people make it.
It’s when the value is gone, bc the thing got commoditised. It was worth something 3 years ago because nothing else did it. Now it’s the status quo, everybody has one, and the ROI calculation from the original business case, the 4 FTEs it was supposed to save us, is just not accurate anymore. So what are you bringing now, on top, that justifies the same number?
And there’s a tell. When we push on this and the vendor responds by changing the pricing model, from seats to consumption, from consumption to some new unit that happens to grow faster than our headcount, then it was never about value in the first place. You don’t change your pricing model if your price is anchored to the value you deliver.
Said the way a CFO hears it: we are renewing multi-year recurring spend at a price we have never once tested against the vendor’s own cost base, and the vendor’s own filings tell us their gross margin is north of 80%. That’s not a negotiation position, it’s a gap in what we know.
Where I’d start
Not with a full should-cost model. That’s a project and most of us don’t have the resource for it.
Start by reading the annual report of your 3 largest software vendors before the renewal call. Gross margin, R&D as a percentage of revenue, sales and marketing as a percentage of revenue. It takes an afternoon.
Then when they tell you the price reflects the value, you at least know what else it reflects.
This one came out of a conversation with Sam Jenks on Kodiak Hub’s podcast The Way We Source, ep. 66. We went further on it there than I’ve managed here, including the bit where Sam, who sells software for a living, gets asked for a cost breakdown live on air and has to work out what I’m even asking for. 49 minutes, worth it for that exchange alone.
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