Value-Based Pricing.

I took the approach that if you can define the scope, which is possible with nearly every marketing agency service, then you can standardize the service and a.s.sign a set price. Although some services, such as website projects and marketing plans, are more complex than others, the vast majority of agency services can be standardized by clearly defining the scope of what is to be done.

Sample Standardized Service.

Standardized services, such as the following case-study example, commonly include description, features, benefits, and set price: Provide prospects and customers with powerful examples of how your products or services deliver value and results. Case studies are ideal website content for your visitors, make great marketing and sales tools, and can be used as editorial submissions.

What Makes a Good Case Study?

Satisfied, recent customer.

Unique or high-profile application (company, product, event, etc.).

Clearly defined challenge and solution.

Impressive, quantifiable results.

Innovative or customized solution.

Hi-res photos available.

Customer resources willing and able to be interviewed.

Limited legal concerns with trade secrets/proprietary information disclosure.

Story highlights key product/service benefits (speed, efficiency, productivity, profitability).

What's Included?

Following a standard outline of challenge, solution, and results, PR 20/20's professional marketing copywriters will craft a case study for publishing on your corporate website, blog, or media room.

Approximately 700 words.

Optimized with priority keywords and written with buyer personas' key needs in mind.

Additional fees apply for graphic design and strategic planning if you plan to use case studies in print or PDF form as sales support.

Average turnaround: 1520 business days.

Price = $1,000.

The guiding principle was that set prices had to be value based, meaning they were to be determined based on perceived and actual value rather than the number of billable hours something takes to complete. So if a trifold brochure was priced at $2,500, then it did not matter if it took 15 or 35 hours to produce, the client would pay $2,500. The burden was on the agency to build systems and processes, and put the right talent in place, to profitably deliver at the set price.

In the traditional billable-hour model, the basic formula to determine cost is hourly rate billable hours. It is simple, but as we have seen it is also inefficient and favors the agency's needs over the client's. On the other hand, the value-based pricing model takes seven primary variables into account: 1. Estimated hours.

2. Hourly revenue target (HRT).

3. Costs.

4. Perceived value.

5. Builder vs. driver.

6. Loss leader.

7. Service level.

In most cases, you will be able to determine prices by simply calculating estimated hours HRT, but you want to take the other variables into account before finalizing the price.

Estimated Hours.

At peak efficiency, how many hours will it take the agency to complete a project? Keep in mind peak efficiency is the key here, and one of the main differences from the traditional model. For services to be value-based, clients should not pay for agency inefficiencies. They should be charged for the estimated time in which the agency is capable of completing the service. The actual time invested will vary project to project, but if your estimates are accurate, and your team works efficiently, it should average out over time.

The best way to determine estimated hours is by referencing historical timesheets. Let's say you want to standardize blog post copywriting. Pull reports from the last 10 blog posts your agency has completed, and look at the average hours needed. If you do not have timesheets to reference, a.n.a.lyze the scope of the service, and forecast time to complete based on your experience and educated best guess.

I can tell you from more than six years experimenting with this model, value-based pricing is about testing and revising. You will get some pricing very wrong, and you will get burned a time or two, but as long as you have the right tracking and reporting systems in place, you can quickly adjust and move on.

It is important to note that the value-based model does not eliminate the need for timesheets. Accurate time tracking actually becomes more essential in order to monitor efficiency and productivity, evaluate employee performance, produce activity reports, and evolve pricing. We will talk more about time-tracking systems and software in Chapter 4.

Hourly Revenue Target (HRT).

How much revenue does the agency need to generate per hour of client work to achieve profit goals? For solo pract.i.tioners, the HRT will probably be similar to your hourly rate, but, for agencies with multiple employees, you will need to consider additional variables such as expenses, growth goals, payroll, and target profit margins.

In essence, the HRT is similar to a flat rate in the traditional billable-hour model, but now it is only one of seven factors taken into consideration when determining service prices. My best advice is to talk with your accountant or financial advisors to determine your agency's HRT, but following is a very simplified way to look at calculating it using the industry standard benchmark of revenue per employee.

We will a.s.sume an agency has five full-time professionals with varying client-service hour capacities. For example, the CEO may be forecasted for 50 hours per month, whereas the a.s.sistant account executive is targeted for 140 hours per month. The agency's annual revenue per employee goal is $120,000, which translates into $600,000.

So, if the agency delivers 5,880 client-service hours, it would need to earn $102 per hour in order to achieve its annual revenue goal of $600,000 ($600,000/5,880 = $102 per hour).

Again, this is not the only option to calculate HRT, but it provides a basic structure to determine a starting point.

Costs.

Are there any costs a.s.sociated with the production and delivery that will be built into the price? This may include fees from partner agencies for services such as graphic design, video production and editing, or licensing fees. I suggest considering these costs when determining your HRT.

For example, you may decide that, on average, it takes your agency eight hours to write a 1,000-word sales sheet, and your HRT is $105. Your price would be $840, but that does not take graphic design fees into account. So you contact your preferred designer and negotiate a fixed cost of $500 on design. Now you have a price of $1,340, which you can leave as is, or round up to $1,400 to account for markup or to give yourself a little flexibility on your time estimate.

Is a 1,000-word, professionally designed sales sheet worth $1,400? That question leads us to our next factor, perceived value.

Perceived Value.

What is the fair market value? What are clients willing to pay for the service? In many cases, this is the most important factor to consider. By drawing on your own experience and researching what other agencies are charging, you can often settle on pricing that fits market demands.

Revisiting the example sales sheet, you may determine that $1,400 is too low. You have been charging clients $1,800 to $2,200 for the same job for the last two years and have had nothing but rave reviews. So put the price at $2,000 and move on to the next one. You have now created a value-based price that meets client needs, and gives you the chance to earn more than your HRT of $105. Use your time-tracking system to ensure that future jobs are actually getting completed on time and on budget, and adjust the set price as needed.

In some cases, clients will put tremendous value on project work that has no measurable impact on the bottom line. This may be because they simply do not have the resources or knowledge internally to deliver the services your agency is capable of providing, or because of basic supply and demand rules. If your agency has capabilities that are scarce and in high demand, then you are in a strong pricing position, and I suggest you take advantage of the fundamental economics working in your favor.

Builder vs. Driver.

Is the service designed to set the foundation for future success (builders) or to produce short-term results (drivers)? This directly affects the perceived value and what clients are willing to pay.

For example, if a client comes to your agency for support to create and grow the company's social media presence, it is going to take time before your services have any real impact. You have a lot of building to do, and, therefore, the client may not consider the services as valuable. On the other hand, say a client comes to you with a sales database of 25,000 prospects, and your agency plans and conducts a webinar that generates 1,000 qualified leads. That is driving real business results that organizations highly value.

We will talk more about builders and drivers in Chapter 8.

Loss Leader.

Is the service designed to entice first-time clients with attractive pricing? Is it proven to create cross-sell and up-sell opportunities?

In retail, loss leaders are products sold at lower prices in order to drive sales of more profitable items. For example, we originally used PR and marketing plans as loss leaders, a.s.suming they would convert into ongoing campaigns. We would charge a few thousand dollars and invest 100 hours or more of our top talent's time building incredibly comprehensive and valuable plans. Project-based clients would thank us, use the plan to justify hiring more staff, and then take everything in-house.

We have learned that plans as loss leaders are a bad idea, so I do not suggest replicating that approach. I highly recommend requiring clients to commit to contracts of six months or more before providing detailed strategic plans.

This goes for the business development process as well. Do not give away the whys and how-tos just to win accounts. If prospects or clients want plans for free, they will never truly value your agency's services and knowledge. This is a primary reason that requests for proposals (RFPs) are often so detrimental to agencies, and such a flawed system. Agencies invest significant time and energy developing creative and strategic concepts for prospects, and the organization only compensates the firm that wins the bid. RFPs are an archaic process that devalues agency experience and expertise.

Service Level.

Will basic-, intermediate-, or advanced-level talent produce and deliver the service? Even if you are no longer charging hourly rates, there is an hourly cost a.s.sociated with every employee, so do the math.

A senior account executive making $75,000 per year in total compensation-salary, benefits, and bonuses-costs the agency approximately $32 per hour, while an a.s.sistant account executive earning $30,000 costs approximately $13 per hour. These hourly rates are based on 260 business days per year at nine hours per day, or a total of 2,340 hours.

Work that primarily requires basic-level service should cost less in the value-based model, and high-level services should cost more.

Consider the service-level factor in the example of an e-mail newsletter and a crisis-communications plan. a.s.suming both are completed in 10 hours, which is more valuable? I would argue that the crisis communications strategy, which requires advanced capabilities to devise, should be priced at two-to-three times the e-mail newsletter, which can be completed efficiently by an a.s.sistant account executive.

Remember, we are pricing on perceived value, and a strategic plan to mitigate risk and protect your client's brand is gold. When demand exists for advanced expertise, you have the opportunity to create and capture tremendous value. Always make your profits where they are justified.

Revenue-Efficiency Rate.

Although estimated hours to complete a service are heavily weighted in the value-based pricing formula, prices are no longer based on how many hours it takes the agency to deliver services. Efficiency becomes the primary driver of success. So rather than relying on straight billable-hour reports to determine agency performance, we came to focus on revenue-efficiency rates (RER).

Simply stated, the RER measures how efficiently your agency turns one hour of service into X dollars in revenue, with X being the HRT.

The RER formula is relatively straightforward, once you know your target HRT. Let's say that your agency strives to generate $100 in revenue for every client service hour. The goal is to deliver the service as close to 100 percent efficiency as possible in order to achieve your desired profits. As we discussed in the previous section, you want to take costs into account as well. Here is how to calculate the RER of a completed project: RER = [(Price Costs)/Hours]/HRT.

Sample 1: Website Project.

This is excellent. The agency's gross profit (or revenue after subtracting vendor fees) on the project was $12,000, and it invested 120 hours to complete the project. That means that it generated $100 for every hour of service for a 100 percent efficiency rating. a.s.suming that the services were provided by an account executive earning $45,000 per year, or approximately $19 per hour ($45,000/2,340 hours), the agency has plenty of room in there to cover operating costs, employee compensation, and a nice profit margin.

Now let's look at an example of how this can go wrong.

Sample 2: Marketing Plan.

Marketing plans can be time intensive, and they often drain significant agency resources to execute. In this scenario, the HRT is $100, and, like the website project, it takes the team 120 hours to complete the project. At set price of $5,000, the revenue-efficiency rate is only 42 percent. In other words, the agency only generates $42 per service hour. To make matters worse, the marketing plan requires heavy senior-staff involvement, which costs the agency more to deliver the service.

The agency can absorb the inefficiencies as long as it is being delivered as part of a larger contract and campaign, otherwise it can be a major problem. But what is the alternative? Charge the client for all 120 hours at whatever the hourly rate is?

If we a.s.sume a billing rate of $150 per hour, then it would be $18,000 for a marketing plan that will be outdated by the time it is presented. Are there clients willing to pay that much for a plan? Even if there are, will you be comfortable with the value they will get from it, knowing how quickly plans change?

I would argue that with a 12-month contract in place, this is potentially a loss leader worth taking. Your goal is to build long-term client relationships, and this gives your team the chance to immerse itself in the industry and put a solid foundation for success in place. However, do not make a habit of taking on low-efficiency projects like this.

When Do Billable Hours Make Sense?

Even knowing all the challenges with billable hours, when variable scope is involved, they may be the only viable solution. This applies to services such as consulting time and media relations, which can be very difficult to forecast, given their dependence on variables such as ever-changing client needs and demand from third-party audiences.

For example, a PR firm may forecast 20 hours to make targeted pitches to 10 high-priority journalists, and coordinate any follow-up communications and interviews. If it takes 15 hours to research, craft, and distribute the 10 pitches, 5 hours are left for any additional work. However, when all 10 journalists respond and request supporting materials and onsite interviews, the agency realizes it dramatically underestimated hours.

My solution would be to define the known scope-research, craft, and distribute 10 highly targeted pitches-and commit to a value-based set fee for that first phase, regardless of how long it actually takes to complete. Then, have a contingency allotment of service hours available based on media demand. Although still integrating billable hours, this approach is preferred for a few reasons: Clients know exactly what it will cost to develop and send the pitches, and they agree to the value of that work, knowing it does not come with any guarantee of results. In other words, they see the value in the outputs provided by your firm, which they would prefer not to handle in-house.

The up-front set fee forces your professionals to be focused and work as efficiently as possible, knowing that if it takes longer than forecasted, the agency, not the client, is losing time and money.

The hourly-rate contingency will only be activated if the client will gain additional value from your services, because it only comes into play when the media responds and expresses interest.

Focus on Recurring Revenue.

There is an enormous, albeit unstable, market for project-based services. The success of solutions such as Logoworks, crowdSPRING, and the HubSpot Services Marketplace has demonstrated a rising wave of interest in affordable marketing support. As a result, agencies and professionals that figure out models to profitably meet growing demand for project work stand to prosper.

However, project-based work is less predictable, making it incredibly difficult to forecast workflow, expenses, staffing, and income. In other words, if you are planning to stay a solo pract.i.tioner or if you are building a distributed network of contractors, project-based opportunities may be exactly what you need. However, for those of you focused on building an agency, success depends on your ability to create recurring revenue from a diverse and stable client portfolio.

The goal should be to sign up the majority of your client base to long-term contracts, preferably 12 months or more, and to have 80 percent or more of your annual revenue coming from those contracts. This ensures a predictable and steady cash flow, a.s.suming clients pay their bills on time, and it gives you the confidence to invest in growth and take the calculated risks needed to innovate and excel.

While building your contract base, your largest client should not account for more than 20 percent of your annual revenue. This rule is flexible if it is a long-time loyal client that has grown organically over time, but never for newer, high-risk accounts. You take on too much exposure, to borrow an insurance industry term, when you rely so heavily on one account.

No matter how good you are, there are too many variables out of your control that can lead to an account loss. We have had solid contract accounts disappear overnight due to bankruptcy, mergers and acquisitions, internal shakeups, and poor management decisions. On the other hand, we have also had to drop clients for a variety of reasons. You have to protect yourself and your employees. When accounts leave, you are stuck with the overhead, and you either need to quickly replace the business or make difficult decisions to cut back expenses, which may include staff reductions. You can mitigate your risk and give yourself the freedom to walk away from deadbeat accounts by having a well-balanced portfolio.

Chapter Highlights.

The traditional billable-hour system is tied exclusively to outputs, not outcomes, and a.s.sumes that all agency activities-account management, client communications, writing, planning, consulting, creative-are of equal value.

The amount professionals are paid does not have a direct correlation to the quality or value of the services they provide, especially when you consider the impact of change velocity, selective consumption, and success factors.

Distractions lead to higher costs and lower quality.

Transparency in pricing builds trust, removes friction from the client-agency relationship, and makes it simpler to sell services to the ma.s.s market.