.png)
Estd 4.22.2023
In today's cloud-first world, SaaS companies face critical decisions about how to structure their cloud infrastructure costs when serving their customers. Two dominant pricing approaches have emerged: the pass-through model and the markup model. The strategy you choose can significantly impact your margins, customer relationships, and long-term business sustainability.
The Fundamentals of Cloud Infrastructure Pricing
Before diving into specific pricing models, it's important to understand what we're discussing. Cloud infrastructure costs represent the underlying compute, storage, networking, and other resources that power SaaS applications. These costs are typically incurred from major providers like AWS, Azure, Google Cloud, or similar services.
As a SaaS provider, you must decide: do you simply pass these costs directly to your customers, or do you mark them up as part of your revenue model?
The Pass-Through Model Explained
In a pass-through pricing model, SaaS providers bill customers for the exact amount charged by cloud providers, without adding any markup. Think of it as a direct transfer of costs.
Key Characteristics:
- Cost Transparency: Customers see exactly what cloud resources cost
- Separated Billing: Software fees appear distinct from infrastructure costs
- Customer-Managed Usage: Customers often have more control over resource allocation
Real-World Examples:
Databricks, a data analytics platform, employs this approach. According to their 2022 pricing documentation, they separate their software licensing fees from the underlying AWS, Azure, or GCP costs, which customers pay directly or through Databricks at cost. This gives customers complete visibility into their infrastructure spending.
The Markup Model Approach
Under the markup model, SaaS providers add a percentage on top of their cloud costs before billing customers. This markup becomes part of the provider's revenue stream.
Key Characteristics:
- Bundled Pricing: Infrastructure costs are blended with software costs
- Simplified Customer Experience: Customers receive one comprehensive bill
- Provider-Managed Resources: The SaaS company typically maintains more control over resources
Real-World Examples:
Snowflake, the cloud data warehouse company, implements a markup model. According to a 2021 analysis by Andreessen Horowitz, Snowflake's gross margins of approximately 65% indicate they mark up their underlying cloud costs significantly while providing value through their optimized data platform.
Strategic Implications for SaaS Executives
The pricing model you select has far-reaching implications beyond simple accounting decisions.
Financial Considerations
Pass-Through Model:
- Lower recognized revenue
- More predictable margins
- No exposure to cloud provider price fluctuations
- Potentially smaller valuation multiples (since infrastructure revenue isn't counted)
Markup Model:
- Higher reported revenue and growth rates
- Opportunity for margin expansion through infrastructure optimization
- Risk exposure if cloud costs fluctuate unexpectedly
- Typically higher valuation multiples from investors
Customer Relationship Impact
According to a 2023 survey by Flexera, 82% of enterprises have initiatives to optimize cloud costs. This reality affects how customers perceive your pricing model.
Pass-Through Model Benefits:
- Builds trust through transparency
- Avoids customer suspicion about hidden margins
- Appeals to cost-conscious enterprises
- Aligns SaaS provider interests with customer cost optimization
Markup Model Benefits:
- Simplifies purchasing and budgeting for customers
- Reduces procurement complexity
- Provides predictable, all-inclusive pricing
- Can include value-added services and optimization
Making the Strategic Choice
Your optimal pricing strategy depends on several factors:
Market Position and Differentiation
Companies with strong differentiation or unique IP can more easily sustain a markup model. According to Gartner research from 2022, SaaS providers with high differentiation scores commanded price premiums 30% higher than those with commodity offerings.
Customer Sophistication
Enterprise customers with dedicated cloud expertise often prefer pass-through models for control and transparency. SMB customers typically favor simplicity and predictability, making markup models more attractive to them.
Operational Capabilities
The pass-through model requires excellent cost allocation capabilities and customer education. Markup models demand sophisticated cloud resource optimization to protect margins.
Emerging Hybrid Approaches
Innovative SaaS companies are increasingly adopting hybrid models that combine elements of both approaches:
- Tiered Infrastructure Pricing: Basic cloud resources at cost, premium configurations with markup
- Optimization-Share Models: Passing through base costs but sharing in the savings from optimizations
- Customer-Choice Frameworks: Offering both models and letting customers select their preferred approach
Conclusion: Aligning Pricing with Strategy
The choice between pass-through and markup pricing models reflects your fundamental business strategy and value proposition. Neither approach is inherently superior—success depends on alignment with your company's strengths, customer expectations, and long-term objectives.
The most successful SaaS companies ensure their infrastructure pricing model supports their core value proposition. If you provide unique optimization technology, a markup model may properly value that IP. If your strength is flexibility and transparency, a pass-through model might better showcase those advantages.
As cloud infrastructure continues to evolve with new pricing structures, sustainability considerations, and regional variations, revisit your approach regularly to ensure it remains competitive and aligned with both market expectations and your strategic goals.