In this post I’m going to share with you the number one mistake I see agencies make when pricing their services that is absolutely killing their business…and how to do your pricing right!
Pricing is critical in any business, but it’s particularly important when you are selling agency services to small businesses.
Because the wrong prices will kill your sales velocity and leave you without any margins to reinvest in your company.
The challenge is that small businesses can’t spend a lot on agency services, so you have to be very smart about how you structure your pricing. So let’s go ahead and walk through the numbers and let’s talk a little bit about pricing strategy and just thinking about how you would even approach this.
Value-based Pricing vs Cost-based Pricing
There are two primary primary approaches to pricing: value-based pricing and cost-based pricing.
Value based pricing is what’s being discussed when you see those arguments happening in the Facebook groups – like the Clickfunnels group – and there’s somebody in there asking how much they should charge for a funnel…and there’s always some smart guy or gal in there saying, you know,
“You should price it based on the value, the impact that you’re making it the business…”
That could be great advice if you are selling to a large company with big budgets, but it’s a disaster if you are selling to small businesses!
When dealing with small businesses you may be able to sell services once a year or maybe every five years if you are pricing that way. Small businesses can’t afford to pay your agency for that kind of price.
You have to price your services in a way to sell successfully and not once in a blue moon every time you deal with clients.
Number one Mistake: Not doing the Cost-based Pricing
The reality is that you need to price your services through cost-based method. Cost-based is wherein you compute the cost of delivering those services then build your price on top of those costs to cover the expenses, and finally, to make that sure have money at the end of the day to run your business.
That is the way that services get to be priced particularly in small business.
One good example is when I was talking to a good friend of mine. He has an agency and he has been doing social media management services for $150-$200 a month.
You can’t ever get ahead with your business if you are pricing your services that way.
Here is a little dose of reality. Think about how much B2B software businesses are charging other businesses to have access to their software per month.
B2B software businesses are essentially automated. They have no service delivery cost they only have development cost, and sales and marketing cost. They don’t have service delivery fees. Their business is much more scalable than a business doing manual labor, and they are charging $200 to thousand dollars a month.
They charge at that rate for a software while you are offering services through menial labor and give much of your time to your client at a low price points.
The thing that sucks the most about this kind of situation is that you are working so hard for these clients and it doesn’t matter even if you are the best client service personnel. You will never ever get ahead and you will always wonder why. The answer is simple, it is because you got nothing left to invest in your company.
How to price your services
Let us say you want to make a hundred thousand dollars a year. There are 52 weeks in a year take away 8 weeks for vacation, holidays, family time, sick time, and other personal stuff you have to do. That leaves you with 44 weeks to work.
Now let us say you are a machine, and you are able to bill 70% of a 40-hour work week. That leaves you with 28 hours a week.
Multiply that 44 weeks you are able to work in a year and 28 hours a week you are able to work in a week, then divide the product by 100k to get the price per hour.
To understand better, let us illustrate below:
52 weeks – 8 weeks = 44 weeks
40 hours x .7 = 28 hours
$100k (44 x 28) = $81/hour
So you need $81 an hour to make a $100k a year.
You would think that, “No way I am going anywhere near $81 now”. Now, what I am about to tell you is this is not enough.
Think as a business owner
Now, here is the second biggest mistake. The second biggest mistake is that they stop at that computation. The problem is you are thinking like an individual, not like a business owner.
You are building a business so you have to think like a business owner. Business owners invest in sales and marketing, offices, accountants, lawyer, and all other expenses vital to running a business.
So, if you are a business owner, that is not the case. These are what you need to make a $100,000 dollar a year. You have so much to pay for.
Thus, we have a new set of numbers. This new set of numbers is a proven formula that is well known in service accounting and service industry.
Get the minimum acceptable pricing you multiply Cost by 2.5. The resulting product is the 60% gross margin.
For example-start thinking like business owners now-if I bill myself 70% of my time, let us say 42 weeks a year. Say, I have employees billing their time, and I am not going to pay them a 100 grand a year but a 50 grand a year. That 50-grand is fully loaded with your employees doing the client works.
So, we have $81 to get to a hundred grand a year, let us divide it to two to get a 50 grand a year. Let us use $40 for easy calculation. So, $40 x 2.5 equals $100/hour.
To understand better, see the illustration below:
Cost x 2.5 = 60% Gross Margin
$40 x 2.5 = $100/hour
Now, where does everything go? You may ask yourself, “Why do I have to charge so much?”, and “My clients are never going to pay that.”
Here is where it goes:
$40 goes to the employees
$15-30 goes to sales and marketing
$15-20 goes to overhead cost
$10-30 profit margin
The $40 that goes to the employees includes the tools, service delivery, software tools, and there is a 10-15% in there on top of their basic salary.
The $15-30 goes to sales and marketing. You have to invest in sales and marketing to grow your business. This is one of the huge mistakes that business owners make when they are starting. They don’t account for sales and marketing because it is them doing sales and marketing in the beginning. They assume that it is always there, that they don’t have to account for the expenses to be made for sales and marketing.
As soon as you hire sales and marketing team you would realize that there is a real cost for doing that. But I tell you that this is the case if your business is already up and running, you got clients, and you are operating fairly efficiently for a while.
The other 15-20% go into overhead cost. Overhead cost is usually composed of the expenses used in the office like a printer, paper, and etc.
That leaves you with 10-30% for profit. Unfortunately, in reality, most business operates around 10% profit margin because numbers are going to get sloppy, and sometimes, get out of control. Sales and marketing may take more than 15%, so is overhead cost.
How to make sure you have something left in the end
You have to multiply the cost three times to get $120 an hour. Go back and do the math. If you are billing yourself, that $40 employee would have to be a $120 an hour employee now.
The $81/hour multiplied by three would be $240- $250 an hour now. That is what you need to make a $100k a year.
You can see that the math is different when you are thinking like a business compared to as an individual. When you are thinking like a business you got to build up the margin to cover the cost.
How does that work out in the service equation?
Once you understand the numbers, you can combine or add up the number of hours it takes to service a client to come up with a realistic number.
Let us say $100/hour, which means you only have one hour spent a week. How many clients do you know that can provide an hour of service a week? Not many at all.
Which is why if you are doing any sort of professional service, the minimum rate per month-and this is if you have anything signed up in a monthly contract-is $15,000 a month.
Divide the $15,000 by $100/hour and you would get 15 hours in a month. That is just over 4 hours a week. That is not a lot of time, and if you are going to provide a decent quality service then you have to be up in the range of $15,000 – $25,000 a month.
I know what you are going to say, “My clients won’t pay that”, “My small business clients won’t pay that”, “They don’t have that kind of money.”
WRONG. There are lots of clients that will pay that kind of rate.
There are two things to do to be able to charge that rate. One, is you have to know how to sell, or two, you can provide services at $400/month. If you know how to create a scalable service that has lots of automation so you don’t have lots of labor to do then do it and charge $400/month.
You can do that as long as you deliberate about doing one or the other. Either have a very automated service, keep the price points down low and be super efficient or make sure that you are charging enough that you can invest in building your business.
[watch the video to continue…]
PS – See how my video has a little animated play button on it? That’s a pretty cool attention grabber. I created that using a simple tool called Playboost – click here to learn more about it.