(8 minute read)
Time, Cost, or Value...
If you had to choose one, which one would you prefer your new agency to focus on?
This question may be puzzling, but the standard pricing models pitched by every agency determines their focus.
Most agencies, and freelancers, work on either an hourly or fixed-price basis. This means, first and foremost, their focused on delivering a product either within a set amount of time, or for a certain cost. Decisions throughout the project become solely based on how to fit the project into a certain number of hours, or into the quoted cost.
Goals and objectives become secondary priorities in these models. What would happen if agencies were laser-focused on achieving your objectives rather than hours or fixed prices?
In this eBook, we’re going to reveal the real risks behind hourly rates, fixed-priced projects, and value billing.
Let’s go ahead and burst the paradigm bubble of “fixed pricing.” There is no such thing.
The thinking behind a fixed price project is that, while the project’s value and ROI are unknown, at least the cost has been predetermined. This creates a pre-defined risk.
Companies like fixed-price projects because they can easily attach an assumed value to the work being done (it comes with a price tag). Such projects are easier to get approved by CFO’s and it helps people involved with the project set expectations on the value they should receive.
But there are also downsides to fixed pricing.
Downside #1: Waste
Fixed-price project specifications create waste and rely solely upon guesswork to assume the right solution at the right price. When agencies guess, they always pad their estimates to account for unknown setbacks.
You pay more for a fixed price, every time.
Downside #2: Rigid Scope
The scope is held rigid, protecting the agency from being asked to build anything they didn’t quote. When weaknesses in the plan inevitably pop up, change orders and revisions are made to increase the budget.
This happens a majority of the time, breaking the “fixed cost” benefit that was initially so attractive.
Downside #3: Creativity Cap
Rigid project specifications ultimately limit creativity and remove incentive to use rapid iteration cycles to test ideas and improve the project spec whenever possible. Rather than focusing on the objective behind the project, fixed-price projects limit creativity and instead focus 100% on delivering what’s listed in the project specification while not going over-budget.
From an agency perspective, fixed price projects are best managed by focusing on cost over value, satisfying specification over building the right solution. Innovation is frowned upon during the project by both parties. Neither the agency, nor the customer wants to mess with change orders, so everyone focuses on completing the project rather than achieving the objective behind the project.
Fixed pricing is the #1 way to lower quality.
If you’ve ever been billed by an agency or freelancer on an hourly rate arrangement, you probably have at least a few scars to show for it. Hourly rate agreements are invitations for mis-managed projects. After all, hourly rates offer no guarantee of total cost, quality, or delivery date.
Agreeing to hourly pricing also normally encourages a lack of project specification.
Hourly engagements trade the focus on project cost for a focus on the billable hour. Quality may increase, but the budget could explode. The risk becomes unpredictable pricing, miscommunicated ideas, and general lack of focus on completion.
There are a couple positives to hourly billing. First, hourly rate projects are technically easier to create and approve since no strict specification is required to get started. Second, because there are no change orders or fixed budgets to contend with, they are more fluid and easily adapt to change.
In our observation, hourly rate projects tend to take longer to complete and involve a lot more problems for the customer than fixed price projects.
With a fixed-price project, agencies are incentivized to deliver something that works within a reasonable timeframe. If they fail, they expect not to get paid. Hourly rate projects leave the customer vulnerable to quality issues, scope issues, “developer flight,” and sometimes, complete project failure.
For both fixed-price and hourly billing, there’s one glaring problem: As soon as the project is complete, the relationship is over. Support is often lacking or completely non-existent. Tweaks, improvements, or “quick fixes” can involve high prices, long delays, or even worse, having to find a new provider altogether.
The current trend from most if not all pricing experts is leading agencies to utilize what they call, “value billing.”
Value Billing is a bit of a twist on fixed-price billing. Rather than create a fixed-price estimate based on the work required to complete a project, they base price on what they think the work is worth to the client.
Here’s an example:
Company A requests Agency B create a newsletter signup form on their website. Agency B knows it will take 3-4 hours to complete. However, they also believe this new form will help Company A add 100,000 new subscribers this year. Rather than bill for 3-4 hours of work, the agency sets a price based on the value of the 100,000 new subscribers. They're essentially paid on the value they provide your company.
Value Pricing Breakdown:
Most agencies using the Value Billing methodology calculate the price as 10% of the lifetime value, LTV, of the new subscribers or the improved cost of customer acquisition, CoCA; whichever is higher.
The positive of value billing is that only higher-quality agencies who know their stuff tend to use this billing method. You can easily vet their track record of delivering results by speaking with their references. These agencies tend to build great solutions because they know they won’t get paid if their solutions fail to work.
There's other ways value billing makes sense as well; for instance, logo creation. Should the logos for Pepsi and a small, local beer brewing company cost the same? Probably not.
Expert designers charge these companies according to the value provided for each, not according directly to the time spent on each project.
Value billing tends to focus the agency on delivering value much better than hourly rates or fixed-price projects do. Agencies justify their pricing by the value they provide, which is a plus.
However, there are downsides to value billing. The first one is huge!
Agencies who choose value billing over fixed-price, or hourly arrangements, tend to charge their clients significantly higher prices. Value billing agencies capture more of the “value” they produce, costing their clients quite a bit more compared to the other pricing methods.
I’ve personally never seen a value billing arrangement that didn’t end up costing the client exponentially higher per project than fixed-price, hourly billing, or even competent in-house arrangements. Essentially, value billing is like paying someone as if they’re a business partner, even when they’re not.
Finally, most agencies who employ value billing require detailed contracts. Companies are often locked-in for two years without much flexibility to change providers, even when they feel they need to go in another direction.
This is the Price War raging in thousands of companies right now. It’s rather clear the pros and cons to each pricing arrangement. Companies are fighting to determine what they want to sacrifice for the sake of a project; time, cost, or value.
We consider each one of these pricing arrangements fundamentally flawed. If we had to pick, we would personally opt for fixed-price projects with reputable and trusted agencies with a track record of producing great results. This way, at least, the risk is defined and you have their past work history to suggest your project will also work well.
Every war is won before it's ever fought.Sun Tzu - The Art of War
After a decade in the business, we’ve grown to resent hourly, fixed price, and value billing. We think these pricing models limit the success of our projects. We went back to the drawing board to devise a new price model that ends the price wars and bases pricing on the same principles that guide our work. We call it, Velocity Pricing.
When you engage Lean Labs, it’s exactly like it sounds. We get ENGAGED.
We marry our talented team with the mission of filling your gaps and achieving your company’s objectives. We vow to always deliver value, value backed by a promise that you’ll only pay us when you’re satisfied with our work.
Objective: First we define and discuss your highest priority objective.
Lean Projects: We split each objective into small, prioritized projects, making each project as small and lean as possible. Small projects launch way faster.
Velocity and NTE: You then set a monthly “velocity” - a monthly spend that you are comfortable with; which can be between $2,000 and $20,000/mo. This determines whether the project is completed over 1, 2, 3, or more months. We also set a NTE (not to exceed) cost for each project.
Build>>Measure>>Learn: Next we start building, focused entirely on meeting your objective. Once complete, we measure results, analytics and user feedback together to identify whether the objective was hit or missed, and how to improve. We improve as necessary to hit the objective. You pay when you’re satisfied. That means “no yay” - no pay!
If we fail to deliver excellent value, we don’t get paid. It’s that simple.
Agencies must overcome their flaws in pricing before pricing flaws overcome their agency.Kevin Barber, Founder & Head Entrepreneur - Lean Labs