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The Role of Information Asymmetry in SaaS Negotiations

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 relying on well-known information about suppliers become inadequate due to the lack of accessibility to crucial details.

Information asymmetry

The traditional buyer-supplier relationship is often complicated by an unequal distribution of information, hindering well-informed decision-making. This challenge intensifies as we delve deeper into the digital age, particularly concerning 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. 

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 use a 20-70% discount rate to value their investments. So, their margins will be much higher than the average market to compensate for the risk of SaaS investments and related moral hazards.  

A buyer cannot understand the "fair price" by assessing the vendor's margin without that knowledge. 

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

However, it offers another more straightforward and more intuitive approach to assessing price fairness by relying on the known price of the reference solution and adjusting it by the Technology Attractiveness Index from the graph on the right side of the sketch. 

I.e., it suggests the 3-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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This post first appeared on The Good Spending, please read the originial post: here

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The Role of Information Asymmetry in SaaS Negotiations