Are you charging enough? (Try value-based pricing)
“How much should I charge?” is a common question that arises in my business support group, the Free Agent Collective.
And that’s no surprise—the rate you choose to charge is an integral part of how you run your business.
I’ve talked in previous articles about how to determine your hourly rate to make sure you are getting paid enough. But today I’m going to talk about a totally different approach: value-based pricing.
What’s value-based pricing?
Value-based pricing is a method of determining the price you charge based on the value it brings to the customer. Basically, it means charging what people are willing to pay, not how much it costs you to create/deliver the product or service.
Here’s an example of how it works.
Lena is a website designer. She used to charge hourly at the rate of $50/hr. It takes her approximately 100 hours to complete a site. That means $50 x 100 hrs = $5,000.
However, one of her past customers told her that the new website she made for him brought him an additional $30,000 of revenue over the past year. And she confirmed with other customers similar examples of her websites driving measurably more business for them.
So Lena realized that the value her services brought to customers was considerably higher than $5,000. In fact, over the span of 10 years, that one client could be expected to possibly earn 10 x $30,000 = $300,000 more because of her.
So she changed her approach, and now she charges a flat rate of $8,000. She estimates that companies would be willing to pay $8,000 to earn $300,000. (That’s a return on investment of 275% in one year, 2,750% in ten years!)
However, a higher price tag means it will be more difficult to close sales. So if you use value-based pricing, you have to also know how to do value-based selling.
Value-based selling
Let’s take a look at how Lena used to describe her services when she was trying to close a sale.
Here are the points she would make:
Low hourly fee (lower than competition)
Quick turn around
10 years’ experience
10 templates to choose from
Ongoing support through a low monthly support plan
But now that her prices are higher, she has to describe her services in a way that justifies that higher price tag.
The way to do that is to focus not on the details of the service (e.g. low hourly fee, quick turn around…) but on the value that her services bring to the customer.
So the points she might make now are:
Increase ROI by X%
Increase website traffic and click-through rate
Turn your website into a money-making machine
Never worry about your website again
Focusing on the benefits of a service, rather than its details/features, is actually a tried-and-true marketing method, even for hourly based services. But it is especially crucial for value-based services.
You just can’t command higher fees unless you use this method. You have to prove value, and the way to do that is to focus on the benefits.
Here’s another example.
Jim runs a residential snow-plowing service. He charges a flat, value-based fee of $600 per winter. It doesn’t matter how often it snows (or doesn’t), his fee stays the same.
When he sells his services, he doesn’t focus on “how many hours of snow plowing” the customer gets. Instead, he focuses on the benefits/value his services bring.
The peace of mind they get knowing they don’t have to worry about shovelling their driveway for the whole winter, no matter how much it snows.
They wouldn’t have to worry about straining and possibly injuring themselves shovelling
They would save themselves an average of 50 hours of work each winter (if they did the shovelling themselves).
They never have to worry about being late for work. (Most of his services are done between the hours of 4:00 and 7:00 a.m.)
Sometimes it not that easy figuring out what value you bring. Here’s a more complicated example.
Bert is an accountant. He wants to start selling all-inclusive, year-long accounting packages to small businesses. He usually charges $100 per hour, and a typical client takes about 10 hours, for a total of $1,000. But now he wants to charge using a value-based model.
Here’s how he might think about the value he brings.
How much would the customer be willing to pay to make all their accounting paperwork worries go away?
How many headaches would he prevent?
How much peace of mind could he bring them, because all of their paperwork would be done properly, and any issues with the CRA would be dealt with by Bert?
How much money could they save by having their tax minimized by someone who keeps up to date on all the new tax laws?
How many hours of work would he save his customers, because they no longer have to do all their own bookkeeping?
Let’s take a closer look at that last one, because it’s an important, but often hidden benefit. That’s because every hour you save a client means another hour they can go out and earn more money.
Let’s say a typical customer that might hire Bert spends 5 hours a week doing accounting paperwork. Multiply that by 52 weeks, and you get 260 hours. That’s 260 hours spent in the office that the client could instead use to go out and make more money. Let’s say that he earns $40 per hour. That means he could potentially earn an additional: $40 x 260 = $10,400, if he hired Bert to do his paperwork for him.
So if Bert decides to charge $5,000 per year for his all-in service package, not only is the customer benefiting from all the peace of mind he will get, he also has the potential to earn another $10,400, a more than 100% return on his investment.
So it almost becomes a no-brainer: hire me and you can earn all your money back plus $5,400 next year. Who wouldn’t want that?
The pros and cons of value-based pricing
This pricing method does, of course, have its pros and cons. Let’s look at some of those.
Pros
You can earn more money (prices that are value-based are typically higher than those that are hourly based);
It gives you negotiating room (if a potential client doesn’t want to pay your price, you can offer a discount and still know that you are making enough money on the project);
This model can work well for niche products/services that not too many others are selling (this doesn’t necessarily mean you have to sell a product/service that no-one else does; it might also work for products that stand out because they are noticeably better than the rest).
By offering a fixed price to your client, they know exactly how much it is going to cost them up front. That means no surprises like “Oh it took 10 hours longer than I expected, you so you owe me another $400”.
Cons
Because the cost is higher, it’s a harder sell (you have to learn how to sell value);
Your expenses may be higher (your service has to have high perceived value for this model to work, and in order to deliver that, you probably have to put in more hours than your competitors, or buy higher quality products, and that all means you have higher expenses);
If you have a lot of competitors, this strategy might not work, because some of them are bound to undercut your prices;
You have a smaller client base—you aren’t selling to the same type of group as before, but rather to a group of people who are willing to pay your higher price tag.
You have to work to make your product/service different/better than the rest. It needs to be somewhat specialized—no one will pay more for a product or service that is the same as what all of your competitors produce.
It takes time to think about your pricing model and to plan for different scenarios. You may need to come up with different prices for each of your products/services, or for different situations. For example, our accountant might have one value-based price for individuals, another for small businesses, and still another for medium sized businesses. Or he may base his price on the number of employees.
Despite the cons, many businesses embrace the value-based model. I frequently encourage many of my clients—and now you too!—to consider this approach to pricing. As you can see, it has several advantages, and can make a significant difference to your bottom line, especially if you offer services as opposed to products.
Cheers,
Tim
Helping you engineer the business of you
p.s. Want to accelerate your self-employment success? Join our community, the Free Agent Collective.
Information in this article is for general information and is not intended as professional advice.