Business

Everything you’ve read on pricing is wrong


How to price freelance web development services (this applies to any knowledge based services business really).

When I started doing web development work ten years ago, I did my cursory google searches and found a few articles highlighting how to figure out what to charge. Opinions varied from hourly to fixed rate billing to blended fees to how to come up with each one. ALL of the price suggestions had one common factor, they were rooted in cost. This is where the root of the problem lies. According to Professor Vohra, whose book I recommend grabbing if you’ve got a chance, cost based pricing means you’re leaving a ton of money on the table. We need to shift your mindset to value based pricing.

Let’s start with the methodology you’re likely to be taught from all the basic tutorials on pricing. They say start with a target revenue in mind. Let’s say $50,000 USD is what you want to make per year. There are realistically a maximum of 2,000 billable hours per year (50 weeks * 40 hours per week), as you want to allocate at least 2 weeks of time off. So remember your new cost is $50,000 (your desired income), so to work backwards from there that means you have to bill $25/hr to achieve that, assuming 100% fill rate of your time. Realistically you’re not going to be able to fill over 80% of your time as billable (that’s what everyone says at least). So that means you’re now down to 1600 billable hours per year. Now your rate is up to $31.25/hr just to keep your $50k gross income target.

So far this math is super easy, it gets you to a target, and assumes so few variables its incredible. Sadly life isn’t that simple, because you’re going to have to spend money to get to $50k, and you’re also going to have to pay taxes and other expenses on that 50k (another entire can of worms).

So many of these examples assume you throw a shingle out there on the side of your home-office and the clients will roll in. They also assume a constant flow of customers, these customers are free to acquire, and new projects keep rolling in. In reality, none of these models work well, and definitely shouldn’t be used as defacto guides for establishing your pricing. After you factor your tax burden, office expense (even if its home office), equipment, marketing, and any other expenses, that $50k you theoretically grossed is withered down super fast. Of that magical $31.25 (I say magical, because your first year out, you’re unlikely to bill even half your time), you’re probably going to be left with less than half after expenses and such. So imagine you’ve taken home $15/hr for a year’s work, this leaves you in the low-20s earnings wise, without factoring in living expenses.

Now that you’ve understood the fallacy of these simplified cost based models, let me hammer it in a bit further. Suppose your new client comes in, you’ve spent a bunch of money on marketing to get them, and they hire you to build out an e-commerce site for a few grand. If you’re doing it based on cost, you’ll bill them for a couple weeks time, maybe a month, and then never hear from them after; so you made $5k on the high side based on your rate. You just delivered to THEM more VALUE than you received in monetary VALUE compensation. Now there is an inequality in the value exchange going on. You exchanged years of your training and education for a temporary exchange of value that will likely drive more value long term to them than to you. So when you go to price your project, you need to think about how much VALUE are you giving them, and what will they derive from it. Treat something like an e-commerce site the same way a company would invest in building a physical store. What value are they going to derive from building that location vs your ecommerce store?

Do you really think it costs $20k MORE to build a BMW 5 series car vs a BMW 3 series? No, the price difference in cost is likely a couple grand in extra metal and plastic. The 5 series presents a different VALUE proposition to the customer though.

Now you’re thinking, but Brian, I just read 800 of your amazing words, and you didn’t give me an easy answer!?! What gives? Well in the end it IS useful to understand your baseline costs, but once you establish that, you should disconnect that figure from your pricing. If you base your price solely on cost, and create your value propositions purely on time/costs, then you’re forever destined to compete on cost.

So here is my advice: figure out your value proposition, learn what your competition is charging, study how they are positioning themselves, and then make yourself unique. How do you price a unicorn anyway? It’s definitely not priced the same way as a horse but with an extra cost for the horn right?

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  • BenB

    Brian, you make a good point about pricing services, but can you take it a step further and break down a specific example of value based pricing for a service. For example, with the ecommerce site, can you do a subscription pricing model by offering to build and maintain the site? Or go through an example from Professor Vohra’s book?

  • Ben I think in that case a bundling strategy is best. This is murky though, because sometimes bundling can be considered illegal. But in the case of an ecommerce site, you could go with a monthly recurring service fee + smaller up front charge in order to eliminate some of the initial sticker shock.

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