Creating the right pricing model for you agency is the most important thing you can do.
The pricing model you choose not only determines the profitability of your agency, but it also influences your staff’s retention rate and happiness, client satisfaction, how you market and sell your firm, and your financial stability.
But many agencies approach creating their pricing model like it is a business practice that should be established and then ignored. Once they’ve “figured” it out, it’s time to move on to a new business, add creativity, or whatever other activity they’d rather focus on.
Instead, your pricing model or strategy should be constantly evolving. Agencies should be consistently testing and optimizing their pricing models to create a bigger impact on profits. Long gone are the days of set commission fees and 30% profit margins.
Choosing the Best Pricing Model for your Agency
Today, there are a variety of different pricing models, each of which has its own pros and cons. Although we at Tech Finity believe that Agencies should use Value Pricing instead of hourly or project pricing. To understand why we believe this let's look at these three pricing models:
1) Hourly-Rate Pricing Model
The hourly-rate pricing model is when an agency or freelancer exchanges time for a set price.
Typically, an agency determines an agency-wide hourly rate (also known as a blended rate), or it charges by the hourly rates of specific employees whose rates differ based on seniority/talent.
Many in the industry have spoken against the hourly-rate model as it emphasizes the costs to the agency, rather than results or value to the client.
The hourly rate also disincentivizes agency efficiency. Under this model, the agency’s wants are in opposition to the client’s. The longer the agency takes to complete the work, the more it gets paid. Tracking the time of employees comes secondary to scoping and management of projects. It also makes it difficult for agencies to predict profits and cash flow.
This model can cause issues for the client, especially if project costs exceed the estimate. And if trust in the relationship is damaged, clients can begin to question how much work the agency is actually doing, what they are paying for, what the costs to the agency are, and if high-level talent is actually working on their projects.
2) Fixed-Fee or Project-Based Pricing Model
Fixed-fee pricing model is when an agency estimates the cost of a project by calculating the number of hours required by the project and the hourly rate per employee or agency, and then tacking on a buffer fee or margin. This fixed amount is billed to the client in increments (25% or 50% upfront and the final amount due at the completion of the project).
This model also includes retainer-based work as typically, the agency scopes the number of hours or projects to be completed within a monthly fee -- the billing model is adjusted.
The fixed-fee model works better for clients who have a budget to adhere to and want to know exactly how much a project will cost and when they will need to submit payment.
The problem is that projects change and evolve as the agency and the client begin working on them. The agency’s estimate can become inaccurate very quickly, which requires the firm to submit additional bills to the client or reduce its own profits on the project. A project-based pricing model requires the agency’s team to be masters at scoping and project management as these things will determine if the agency makes a profit on the project.
This model can also be limiting to the relationship. The agency doesn’t want to suggest new and novel ideas -- things that would improve the final outcome and results for the client -- midway through a project as it might cause the firm to lose out on profits or confuse the client. Additional requests from the client can be seen as the client trying to get work for free. In addition, clients can feel like the agency only cares about completing the project, not the quality of the outcome.
3) Value-Based Pricing Model
Pricing your services on the value (or results) of the work aligns the agency’s and the client’s goals -- both parties become incentivized by the end result due to the shared risks and rewards. Clients no longer need to be concerned with the agency’s costs, and the agency can focus on the end product and its effectiveness rather than the productivity of its team members and the pre-agreed upon limits to the project.
This pricing model is the most advanced, but it has also shown to be highly effective at increasing an agency’s profits.
First, the agency has to determine what is specifically valuable to the client, such as leads, traffic, conversion rates, etc. Most importantly, it has to be able to track and measure the performance and results.
To sell this pricing model, agencies need a track record of producing high-value outcomes so they can build trust during the sales process as some clients will be hesitant about this more customized pricing model. However, most prospects come to the realization fairly quickly that they want to buy results, not hours or even projects.
Small improvements to your pricing models can have a significant impact on your agency’s financial health. In fact, a study done by pricing experts at McKinsey and Company and published in Harvard Business Review found that a 1% price improvement results in an 11.1% increase in profits. This can make a big difference for small and growing firms looking to invest in new team members and additional resources for their agencies.
It’s time to become a pricing model expert and take control of how you price your services – before your clients do.