The Role of Information Asymmetry in SaaS Negotiations

This post will review a research study addressing the procurement challenges of the information asymmetry between buyers and suppliers in digital transformation.  

In this scenario, traditional procurement approaches that rely on well-known information about suppliers become inadequate because crucial details are not accessible.

Information asymmetry

An unequal distribution of information often complicates the traditional buyer-supplier relationship, hindering well-informed decision-making. This challenge intensifies as we enter the digital age, particularly regarding digital procurement objects and software suppliers. 

In business and finance, information asymmetry can lead to adverse selection and moral hazard problems. 

Adverse selection occurs when buyers need help distinguishing between high-quality and low-quality products or services, leading to a market dominated by lower-quality offerings. 

On the other hand, moral hazard arises when one party can take risks because it does not have to bear the full consequences, as the other party carries some risks.

Information Asymmetry in SaaS Negotiations

In the following sketch, we summarized the research study we referred to earlier in this post. 

Information asymmetry in IT Procurement


The mystery of SaaS production cost 

Information asymmetry in SaaS negotiation primarily concerns the buyer's need to know the seller's production cost. 

As explained in our dedicated post, that cost is only sometimes based on the basic R&D and sales expenses. 

Many SaaS companies belong to hedge funds, which value their investments using a 20-70% discount rate. Thus, their margins will be much higher than the average market to compensate for the risk of SaaS investments and related moral hazards.  

Without that knowledge, a buyer cannot assess the vendor's margin to understand the "fair price." 

The post suggests some Game Theory instruments to overcome that challenge. 

However, it offers another more straightforward and intuitive approach to assessing price fairness. It relies on the reference solution's known price and adjusts it using the Technology Attractiveness Index from the graph on the right side of the sketch. 

This suggests a three-time price difference between the Pacemaker Technology (e.g., AI) and the Base Technology (3/1 technology attractiveness ratio).  

Still, the key finding of the post is the focus on the classical information asymmetry problem, which all educated buyers must be aware of.   

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More information on this and other exciting topics can be found in "The Technology Procurement Handbook." It represents 23 years of experience, billions of dollars worth of successful sourcing projects, and 1000s of hours spent on research, analysis, and content creation for the most demanding professional readers.
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