Value Pricing: Why you should use it in your business
Many professions are paid “per hour”. When you think of this, you probably imagine a timeclock that someone punches in and out of, and that person gets paid based on the hours they worked in the pay period. This is how it works a lot of the time.
There are other professions though, where the salaried employees are paid their salary for a set amount of hours per week, while the firm they work for bills to the customers in timed intervals (let’s say 15 minutes). Law firms bill in this way, as do many accounting firms.
More and more commonly, there are professional service providers who have chosen the entrepreneurship route and are working for themselves, instead of “the man”. (Hello, it’s me!) When many service providers start working for themselves, one of the first things they do is set their hourly rates. This article is meant to provide you with a new way of looking at things, so that you can maximize your earning potential.
When I started my CPA firm, I wasn’t entirely sure what I was even going to DO for my clients, let alone how I was going to go about billing them. I joined Ryan Lazanis’ Future Firm Accelerate program and learned from him many lesson about building an accounting firm. This is where I was introduced to value pricing, and I quickly sought out and consumed Ron Baker’s book - Implementing Value Pricing.
Reading this book was life changing for me and I think the lessons within it are valuable for any service-based business. I will do my best to sum up the key takeaways I got from this book, but if this topic gets you as excited as it does me, definitely buy the book for yourself. (It’s a write off for your business!)
Race to zero?
There is no denying that technology is changing the way we do business. In a lot of cases, this means that some tasks are not taking as long as they once did.
Does this mean that those tasks are no longer as valuable to your clients? No.
In fact, it could be argued that the tasks might be more valuable to your clients because they can be done in “real time”!
If you are billing per hour, the result of technological advancements ultimately means billing your clients less… which is sort of counter intuitive, and brings up a troubling reality:
Hourly billing does not lead to seeking efficiencies
What is your motivation as a business owner to streamline your processes and get things done more efficiently, if that means you will start billing your clients less time and therefore make less money? It’s not the direction most business owners want to go, since the usual goal is to have your revenues on an upwards trajectory rather than a race to the bottom.
Value pricing attempts to price out jobs based on the value they provide your clients, regardless of how long those jobs take you to perform. Ask yourself the question: What problem am I solving for this customer, and how much s the solution to their problem worth?
Once working on the engagement, you can focus on getting the tasks done in the most efficient way possible, rather than ensuring the largest amount of billable time. This will foster ingenuity in your operations without a corresponding dip in revenues due to less billable hours.
The sky is the limit with value based pricing
Another downfall of the billable hour: you create a revenue ceiling for your business.
If you have 3 employees each with 40 hours per week of billable hours, you know that the weekly revenue you can bill will equal:
(Employee 1 hourly rate + Employee 2 hourly rate + Employee 3 hourly rate) x 40.
Of course there will be some people who are unconcerned with this limit and we will not get into that on this blog post. The fact remains:
There is no exponential growth when you are limited by billable hours!
Is one customer subsidizing the next?
The first time you do something, it usually takes the longest. This is especially true when you are creating a product for a customer. Once you have created the product, it will take less time to create a similar product for your next customer. Some of the project components will be able to be reused over and over again. When you’re billing by the hour, this isn’t fair to either you or your customer(s)!
Let me explain. Your first customer is going to get hit with the largest bill, and will be paying you for every hour spent creating the original product. Your second customer will be charged significantly less for their product, since a lot of the leg work was done for the first customer and didn’t need to be repeated.
Does the second customer receive a product with the same value as the first customer?
Yes they do.
Is this fair to your first customer?
Not really. They essentially “subsidized” the product for your future clients, as the initial brainwork was done on their dime.
Is this fair to you, as the service provider?
Not really. You are providing the same value to both clients, but will get paid significantly less for the second, and subsequent, engagements.
This is where value pricing comes in - you price the product based on the value it provides to your customer. What problem does it solve for them? All customers purchasing the product will receive the same value, and will pay the same amount for that value. On your end, some engagements may take longer to execute than others, but as long as you ensure your value price more than covers the cost of “your time”, you are in the clear and can actually see higher profit margins as a whole.
Risk of overages
Many firms are afraid to leave the tried and true billable hour in favour of value pricing because they are afraid of cost overages when executing the work. It is true, that when you offer a deliverable for a set price, you are on the hook for any overages that may happen. This fact will actually give your clients comfort, as they usually don’t like “being on the clock” (Especially if you’re doing work in an area they have not much familiarity with).
With value pricing, you give your customer price certainty, and we cannot underestimate how important this is to most business owners. How do you adopt value pricing of engagements without risking losing money due to overages? By very carefully, and specifically, outlining what is included in the engagement.
You must be very very specific, and outline what is - and arguably more importantly - is not - included in the engagement cost.
You should be very upfront about the specific things included in the engagement as well as upfront about the fact that anything that needs to get done which falls outside the scope of the agreement will be quoted separately and charged on a change order.
Change orders are very important!!
This is so important it needs its own heading. The biggest risk to the profitability of your value-priced engagement is scope creep.
Scope creep happens when the engagement has not been properly defined and unexpected “extras” pop up. Some types of projects are more prone to scope creep than others, but the key is to properly define the engagement and explicitly state that any work which may arise that is outside of the scope of the initial agreement, will be charged separately on a change order.
How do I implement value pricing?
Implementing value pricing will look different for different people and businesses. If you already have a business offering services for an hourly rate, you have a bit of a leg up on someone who is just starting a business from scratch.
If you are converting an existing hourly-rate business, you should do an analysis of your billings for various deliverables. You want to ensure to price in enough “wiggle room” so that any overages are covered, and your customer will happily pay this extra premium to have cost certainty rather than face a running clock and invoices that vary month to month.
If you are starting from scratch, you won’t have “hourly rate” engagements to compare to, so you’ll have to do a bit more market research on the going rates for certain services. I’m certainly not saying that existing firm owners shouldn’t also do market research, but it will be especially important if you don’t have a baseline for your billings. This market research can be done by networking with other service providers and seeing how they price their services. I know some might be hesitant to do this because it has been ingrained in us that other businesses are “the competition” and we must not work collaboratively, but I think that couldn’t be further from the truth.
… People don’t like “take it or leave it” pricing!
This is a lesson I’ve also learned through Ron Baker’s book and Ryan Lazanis’ program - people want options!
Value pricing means there is a set price for services, but since people also like choice and options, how does this work?
The ideal proposal will have 3 options, all offering different levels of service.
Let’s say we’re going to label these packages Platinum (high-tier), Gold (mid-tier) and Silver (low-tier). Your platinum package will be the most expensive, and may give your customer a bit of “sticker shock”. Your platinum package will include ALL of the bells and whistles. Some customers might see the value in this most expensive option and choose it, but many will look to the gold and silver tiers for a more “reasonable” investment option.
Your Gold tier will be the option that most customers will choose. It will be priced comparatively lower than platinum, but will provide the customer with a solid service without all of the extra bells and whistles they will find in the platinum package.
Of course this leaves the Silver package option which is the lowest price and has the most limited level of service.
What these various package options will look like for different types of service providers will vary greatly, but providing your customers with options gives them choice and that is always a good thing!
Give it a try!
Sometimes you just have to dive into something new. Hopefully this blog post has given you an explanation on what value pricing is, and why value pricing is superior to hourly billing in so many ways.
Interested in implementing value pricing in your business? Click Here to download my guide!
Still have questions or need support? Click here to reach out!
I LOVE banishing the “finance scaries” by teaching entrepreneurs in an easy-to-understand way. If you’re reading this, you might benefit from my FREE Financial Health Check, which will assess how you’re doing with the financial management of your business, and provide you with customized resources that will hopefully resonate with you.