“Every single decision you make in business has an opportunity cost and how you choose to invest your time as well as your staff’s time can be critical to success.”
Assessing the time spent running your business as well as the time used while generating whatever product or service you provide, are the most critical factors which allow you to effectively price small business services.
For most business owners who generate revenue through producing, building, or creating an end product or experience, as well as those in service-based markets, Time-Based pricing is probably the most common model you are familiar with. Anytime effort or energy is spent in exchange for delivery of a product or service, the time spent on those efforts has value and will factor into the price you charge your customers. In addition and more importantly, the time spent focused on one task, means your ability to focus on another is in short supply, hence the term opportunity cost.
As business owners we must constantly weigh the cost of one decision versus another.
If I choose to spend 3 hours on a presentation for a large prospect who is ready to buy, what would be the cost of not getting to other projects or tasks sooner?
Alternatively, if I focus on the other tasks and choose to forgo the presentation, what is the cost of not pursuing business opportunities with this prospect?
If I decide to dedicate one hour per night to reading and learning instead of catching up with customers, what would be the cost to my business? Or if I don’t, the cost to my continual pursuit of knowledge and insight?
Are these simple costs to calculate? Nope!
Are they guaranteed / approximate costs and can I be sure there will be a negative trade off? Not necessarily.
Does something always have to suffer for something else to gain? To that I say yes.
Scary as that might sound, we are talking about time here. It’s something we cannot make more of and it is precious. How we choose to spend the time we do have will always mean we cannot spend it doing something else.
Therefore, the things you are most passionate about will be the cause of suffering elsewhere in your life and your business. Let’s keep in mind “suffering” is a loose term, not to imply we are hurting others, ourselves, or causing harm to all that we encounter simply to gain something in return. Look at the nighttime reading example I mentioned earlier. If I choose to spend that time bettering myself (which also betters the business) the business does suffer short-term because I’ll be one hour further behind in my work than I could have been. That is a compromise I’m willing to make as education is a far greater asset and more valuable to me, than anything I could accomplish at my desk in an hour’s time. Plus the long-term gain of the acquired knowledge could greatly benefit the business.
If we get hypothetical for a moment, much of opportunity cost, when talking about a behavioral decision is speculative.
I really cannot say with much certainty what the cost of spending the time on the proposal versus my other workload might be:
- I have no absolute way of knowing that the prospect would sign on with us (I’ve learned no matter how promising, until check is in hand, it is never a sure thing)
- Are my other tasks emergent issues I must handle this very moment? Or are these items I can get back to at a later point in time?
Pricing based on time is really a critical factor more so for a small business than a large one. A retailer or manufacturer for example, does not directly base pricing on the cost of labor or efforts of it’s employees. That will certainly influence cost but often in these markets products are mass-produced so the time spent designing and building may be only a fraction of their actual costs over the life of a product.
If you are unclear how time-based pricing would work, you simply establish an hourly rate for your services that seems appropriate for the work being done and keep track of the hours spent producing the end product or service. Therefore if you charge $50 per hour and it takes you 10 hours of actual production time, the customer would be billed $500.
Seems simple enough right? Here are 3 pros and 3 cons to the time-based pricing model.
Pro #1: Estimating Costs & Setting Expectations
There is truly no simpler way to estimating costs than looking at the time needed to perform the job. If you get paid up front, than it will take a little bit of time to figure out exactly how long a particular task will take. However, if you are paid upon completion its simple enough to discuss the project with your customer and give them a reasonable time estimate the job will fall under. For example, if you tell the customer the job will take 7-10 hours and they know your rate is $50 per hour, it is easy for them to assume they will be paying $350 to $500 to complete the project.
Note: Stick to your time estimate, unless the customer changes the scope of the project or adds additional tasks to their original request. If you estimate 7-10 hours but it takes you 11 and nothing changed, you should eat that last hour of time. Or you can charge the customer but it’s unlikely they’ll work with you again. Customers do not like or appreciate surprises or miscalculations on your end that they are expected to pay for. Chalk that up to a learning experience and be more efficient next time.
Pro #2: Transparency
Pricing based on time keeps you honest.
Not only does it give the customer a reasonable expectation on how long it will take to complete the project, they also understand what it might cost if they decide to simplify the project or make it more complex. Therefore it’s easier for your customer (especially repeat customers) to have a reasonable expectation on time and cost before ever requesting the work to be done at all. In my business making sure customers have reasonable expectations on cost, time, and what they will get in return for their investment is very important.
A quick example, if I were to charge per hour for website design and gave the customer a price of 5 hours for a 5 page website, they can make the assumption a six page website would simply add an hour to time and cost. Easy, and no real opportunity to question the pricing when it is laid out so clearly.
Pro #3: Create an Hourly Rate Based on Your Revenue Needs
At any time it’s very easy to calculate what you should be making (at minimum) as your actual professional rate. There are many formulas to do this. The simplest would be to divide your monthly expenses by the hours you plan to work. If you are full-time than you would divide monthly expenses by 160 (40 hours per week). That would be your break-even rate. Then take that number and multiply by 3 to get your actual professional rate. Multiplying by three is recommended since you should apply 1/3 of profit to taxes, 1/3 as income, and the other 1/3 into a savings/expense fund to cover any ups and downs in the industry.
You could adjust your rate easily by project or periodically using this model and always insure you are taking in what you need to cover all of your expenses and then some.
Let’s Base This Scenario on Reality…
It is pretty rare for new self-employed individuals to be billing a solid 40 hours per week. Not even attorney’s who are notorious for billing, rarely accomplish this feat.
While you might work 40 hours per week (probably much more), not all of those hours could be billed to the customer at your professional production rate. Outside of working on a project, as a business owner you are now dividing your time across many different job duties and responsibilities, many of which do not even apply to one specific project or customer, such as handling self-promotion, accounting, on-going training and education, prospecting, staff meetings, and much more.
That time is not passed along to customers or if it is, should not be billed at the full rate you would charge for tasks that require your expertise and training. So keep this in mind otherwise even multiplying your break-even-rate by 3 might not be enough to break even.
If you find yourself wearing multiple hats, I recommend establishing a professional rate and an administrative rate. Therefore if you know 20-30 hours of your week are spent on production work and 10 are spent in business management and administrative duties, you should base your break even rate on that assumption. It will most likely mean your professional rate may increase to compensate for the administrative hours being spent. Those hours are afterall an opportunity cost as you cannot spend them producing new deliverables for clients or accruing your higher paying professional rate if you are busy with admin tasks.
Con #1: Trading Dollars for Hours
I’ve already hammered this point home enough, but for posterity’s sake, here it is, one more time:
“As a business owner you will quickly learn that time is your most valuable commodity.”
There are only so many hours in the day and you must learn to monetize as many of them as possible. When your work requires you to be present and revenue is tied directly to the time spent working on a project or task, those become hours you cannot spend doing something else. You really cannot be in two places at once and therefore the only ways to earn more would be to increase your rate or work more hours. Another option to avoid this dilemma would be to hire more employees to further increase the number of billable hours you can charge since you and an employee could both be accruing billable time simultaneously. While that might seem like a solution it is only a temporary fix because once again you are limited to the number of hours you and now, your employees are contributing.
Also, when trading dollars for hours there is always going to be a price ceiling.
Here is a good real world scenario:
Pretend for a moment that I own a CrossFit Gym. It’s a business model I’m familiar with as I spend 4-5 days a week in my local CrossFit box. So if I’m playing the owner, there are only so many athletes which can be in the gym at any given time (average class size is 10-15 athletes), classes run an hour, and the gym can only be open a set number of hours per day. Due to the limit on the number of athletes who can access the gym at one one particular time as well as the number of hours it makes sense to be open, profit is limited by these two factors.
Unless I increase the cost of membership, invest in a larger facility that accommodates more athletes, or increase the hours the gym stays open (which in and of itself doesn’t guarantee more profit) I am limited in growth potential.
There are ways to generate more revenue internally such as merchandise, add-on membership services, specialty classes, events, etc but overall you must be careful tapping into your existing client-base to continually fuel growth. In addition, increasing class sizes can create additional problems if that means additional staff has to be brought on to handle the larger class size.
So what are my real options here? …Expand? …Start a franchise? …Hire more coaches to accommodate more athletes?
All good options but all come with a cost of course.
Time is limiting and puts a great deal of constraints on your ability to generate more revenue and growth over time. Find ways to add value that do not require you to spend hours in the day, just to generate revenue. If you don’t do this you will most likely be stressed constantly thinking that time not spent working is time not spent bringing in revenue.
Time is money, but it doesn’t have to be.
Con #2: Remaining Fair and Balanced
When your time is worth a fixed dollar amount you have far less flexibility when it comes to pricing your products and services. This is especially the case for public perception of the company. For example, if you charge Customer XYZ $50 per hour, you cannot ethically charge Customer ABC $75 per hour to do the same exact thing. Your rate can fluctuate of course but it should be universal.
In this scenario, people are also buying your time, and not the end product so the true value of whatever it is you are doing is under appreciated. They see the end product as the result of however long it took to produce which is a poor perception of the value gained upon receiving it. A website for example. If it takes 60 hours to build at $100 an hour, that costs the customer $6000. But a great website has the potential to generate a massive influx of new business. So while time has a price tied to it, the value gained by the investment into those hours far exceed the initial cost a customer pays.This can be very frustrating especially for business owners who provide a product or service which enhances or improves another business in some way.
Shouldn’t a website that generates 2-3 or even 10x the leads and revenue than the old website generated, cost more?
Other pricing models allow you to set prices according to a specific customer’s needs or even their disposition. If you know they are difficult to work with or tend to drag things out longer than needed, these extra efforts should equate to higher costs. Especially if it’s not your fault! Some clients are just a handful to deal with, but you shouldn’t have to bear that burden without recouping additional revenue to compensate for the added time and effort spent with them.
Not basing pricing on time also allows pricing to fluctuate based on demand as well as a great variance of other factors. In my website example above, we do far more than simply build a website and there are typically 6-10 services happening all at once. By not fixating on an hourly rate we can set pricing for all components as a group or as individual stand alone products and services. This gives us much more flexibility and opens up massive opportunity for faster growth.
Con #3: Too Many Eyes Behind the Curtain
“Transparency is both a benefit and a curse.”
If you are pricing based on time and delivering an end product such as a website, a print piece, a cake, a birdhouse, etc. penny-pinching customers will evaluate your hourly estimate and try to cut corners. If they see you are charging 10 hours for design they will start to question why and try to cut the time down by eliminating parts of the project, even if you tell them 10 hours is necessary.
It is in our nature (most of us) to haggle and I cannot say I blame anyone for trying to save money. Especially when paying for professional services, which can get costly very quick. Customers often forget that they are not only paying for the time to produce the end product or service, but also for the expertise that goes with it.If I spend ten hours developing a website versus if a novice customer attempts to do the same, which ten hours would produce a better result? Obviously not the customer’s.
The final point to suggest here in terms of transparency is, like it or not, it’s really none of your business what my hourly rate is. Some might find that off putting but what I select as my base rate to determine pricing baselines is not something anyone is entitled to know. I’m not required to divulge this information based on the type of business I operate. How I choose to price our services is based on many factors such as the job description, availability, complexity, on-going needs beyond the project itself, and what value this solution holds for the customer’s business. There is no clear cut definition or standard when pricing creative services and I do not feel there should be as every project is extremely subjective in nature.
Suggestions for Time-Based Pricing
Unless you run a day-laborer type of business such as a plumber, electrician, mechanic, etc. where the work you do is based on someone showing up to complete a particular task, avoid pricing by time whenever possible. If you are serious about growth and increasing revenue without hiring a large staff, pricing based on time could very well be a limiting factor.
Haggling and having to defend the hours needed further devalues what it is your providing. When a customer feels entitled to do this, they are telling you (but not in so many words) that they do not see the value in what you provide at the cost you are estimating. In fact, they think your service is worth a different price and will often tell you what they are willing to spend. Don’t fall into this trap. You are the expert, hence the need for your assistance in the first place, which should mean justifying every second you spend on a job should not be necessary. And do not let someone else tell you what your time is worth.
Learn how to say “No” and to walk away.
- If you bill $100 an hour but they want to pay $50 why in the world would you even entertain this notion?
- What else will they ask you to compromise on?
- And what does this say about your hourly rate if you are willing to change it so dramatically?
That would tell me, you yourself do not believe you are worth the $100 rate and simply use it as a negotiating chip (Once again referring back to Pricing Concept #1: Removing Limiting Beliefs About Money and Personal Worth).
Running a business that has relied heavily on the labor involved to produce the end product, such as building websites and delivering marketing services, I have gone through many pricing models, one of which was pricing based on time. I’m no stranger to it and understand the attraction. However, I quickly realized that the issue of customers nitpicking and haggling over every single component was too cumbersome and counterproductive to their needs. Customers should not be the ones telling us what they need and don’t need. They came to us, asked for a marketing assessment and based on what we uncovered we made suggestions, all of which should be implemented.
Often, in my business, customers do not even understand the service or the true value of it, but would still try to debate the need for it. Oh wait! they are the experts… I forgot. That’s why they came to us in the first place…
PS: …that was a joke.
Customers would also see every component as one more “Added cost” they didn’t want to pay. This was the start of the removal of time based pricing whenever possible for me. I first began to remove itemized costs from our marketing proposals and simply provided one set cost for all tasks associated with the project.If a customer did or didn’t want to do one particular component typically the cost would not change much if at all. We would simply reallocate those hours towards more of something they did want.
Moving beyond that, we now focus solely on value based pricing (i.e. what this project is worth to customer and the value it brings to their business). By no longer itemizing costs or estimating time, it removes the “ala carte” approach where the customer can pick and choose. Instead, we pick and choose for them. We are the experts, that’s why they hired us in the first place. Letting them control everything hurts the end product and doesn’t make you seem like you have a professional, packaged end product in place. So minimize time base pricing if you can and try to minimize options you give your customers. Too many options lead to analysis paralysis and can be overwhelming which often leads to them walking away and not buy anything.
Wrap Up
This article is part of a 7 part series I’ve put together to help you effectively price small business services:
- Getting Rid of Limiting Beliefs About Money
- Creating a True Cost Analysis of Your Business
- Avoiding the Pricing Push (overpricing)
- Avoiding the Pull to Cheapen Your Worth (underpricing)
- Pros and Cons of Time-Based Pricing
- Pros and Cons of Value-Based Pricing
- Monitoring & Grow While Maintaining Pricing
Want to learn more about how to improve your overall marketing approach? Contact us anytime for a no obligation marketing assessment.
