A Beginner’s Guide to Value-Based Pricing
I started out freelancing like everyone else: with an hourly rate.
Over the years, I slowly increased that rate from about $30/hr to $75/hr because I was becoming more skilled and experienced as time went on.
Then I quit my job and raised my rates again to $100/hr and later to $125/hr.
That’s when I started to meet some resistance.
Most clients just weren’t willing to pay more than $150/hr for custom web design and development. With freelancers in high demand, it’d be easy for them to find someone cheaper – and I couldn’t blame them for trying.
That’s when I started hearing about alternative pricing strategies such as:
- Daily Rates
- Weekly Rates
- Monthly Retainers
- Fixed-Fee Projects
- Value-Based Pricing
That led me to a tidal wave of questions.
Which pricing strategy should I be using? What’s wrong with hourly billing? Do I need to price every project the same way? What are the pros and cons of each?
Then one day I took Brennan Dunn’s free email course, Charge What You’re Worth, and learned that he charges $20,000 per week for software development.
$20,000 per week?? That’s over $500 an hour! How could anyone be worth that? How could any client be dumb enough to pay that kind of rate? Is that even ethical?
Which pricing strategy should I use?
The more I learned about pricing strategies, the more confused I was.
I had friends charging hourly and daily rates while some consultants like Brennan charge by the week. Then I met other successful freelancers charging a fixed-fee for each project.
Still, others like Jonathan Stark and Ryan Waggoner were firmly against billing for time and determined pricing based on value.
So what’s the deal?
No matter how much research I did, I never firmly grasped all the rules associated with value-based pricing. I had so many questions:
- Is there a right and wrong way to bill clients?
- What exactly is value-based pricing?
- How can I accurately determine the value of a project?
- How can I charge for an outcome I can’t guarantee?
- Is value-pricing right for every project?
- Is it wrong to bill hourly?
- How do I transition from hourly billing to value-pricing?
- How do I give an accurate timeline without estimating… time?
- How do I present such high prices to clients?
- How do I compete with others charging so much less than me?
- Won’t clients just reject me for being the most expensive option?
- How do I prevent clients from calculating my “effective” rate?
- Can I price for value as a subcontractor?
- Is it unethical to charge 10x “market rate”?
After nearly 4 years of full-time freelancing and dozens of attempts at using each pricing method, I’ve finally answered these questions for myself and want to share the answers with you today.
What is value-based pricing?
A value-based project is simply a fixed-fee project where the price is determined by the value of the outcome to the clients business – not the estimated time it will take to complete.
But it’s slightly more complex than that.
A true value-based price is typically 15-25% of the clients first year of realized revenue. In other words, if the client expects to profit $100,000 in the first 12 months after the project is completed, it would be reasonable for them to pay $15-25k for the project.
The first year of realized revenue for the clients business is the value, and the price or cost of the project is the % of that amount you decide to charge them.
What exactly is value?
Value comes in all shapes and sizes. It’s not always about what the business stands to make, but sometimes how much they stand to lose if things go wrong (hire an inexperienced person, execute against the wrong goals, etc.)
How much do they stand to make if the project is successful? How much do they stand to lose if the project fails?
The client MUST be willing to discuss their financial business goals and objectives with you and answer some tough questions. They must know how big of a problem they have and be ready to invest in an appropriate solution, not just a hire freelancer to execute tasks.
In my experience, it’s nearly impossible to shift a clients thinking from, “I need a freelancer to get this work done for as little money as possible” to, “I have a big business problem that only a seasoned consultant can fix for me and I’m willing to pay for it.”
How do you determine value?
Determining the value of the outcome for the clients business requires you to discuss how big of a financial problem their trying to solve.
That means you need to be confident enough (and smart enough) to ask strategic questions to high-level executives at the company about sensitive financial information.
Talking to an HR rep who reached out on behalf of their superiors isn’t going to cut it. You have to talk to the key stakeholders directly to get the information you’ll need to set a true value-based price.
For example, I once spoke with a business who offered custom surveys and reports to Fortune 500 companies. One year, they started losing business to a main competitor because their reporting tool “didn’t look quite as good”.
They had lost over half a million to their competitor in less than a year. This was the perfect opportunity to charge for value. It’s not verbatim, but the basic sales pitch was framed like this:
“You’ve already lost over $500,000 this year to your competitors. Pay me $50,000 and I’ll design a new reporting tool that looks better than your competition so you can stop losing valuable business.”
In this instance, it wasn’t about how much money the business was going to make, but how much they needed to stop losing.
Value-Pricing in Practice
Let’s say you’re a graphic designer charging $150/hr and you get hired to redesign the Nike logo. You estimate it will take you 120 hours to design a new logo for them (including several directions, iterations, application examples, package up deliverables, etc)
The final price is $18,000. That might seem like a good paycheck, but does it seem appropriate for a company worth over $34 billion?
Nike has their logo plastered all over billions of dollars in merchandise. It’s absolutely iconic across the globe. It will cost millions of dollars just to get the new logo rolled out worldwide.
In this example, paying $100k for a logo that is going to cost them millions just to launch makes sense. The time it takes to create doesn’t matter to anyone. They’ve got one chance at success (high-risk) and it will be expensive to implement (high-value).
When time isn’t a factor in your price, you eliminate your income ceiling.
You can charge $10,000 for a logo that took you 5 hours to complete. Why? Because your price is based on what the work is worth to the clients business, not the time it took you to create it.
So at it’s core, value-pricing is simply a method of framing or “anchoring” a fixed-fee price against the clients financial upside.
How Does Value-Pricing Benefit the Client?
Now, you might still be asking yourself, “why a client would ever be willing to pay such extraordinary rates?”
The truth is, not many clients are going to pay a $2,500/hour rate. But they would pay $10,000 price for a solution that can make their business $100k+ next year.
Here are a few practical reasons clients would be open to value-pricing:
- They know the exact price of the project upfront. They don’t have to make a large purchasing decision based on an hourly estimate.
- They know they are paying a relatively small % of what they will make from their investment (ROI).
- They know they are investing an appropriate amount of money into a solution. How confident would a client be investing $5,000 to solve a $1,000,000/year problem?
- They know you’re entirely focused on helping their business from a financial perspective, not on tracking hours, taking orders, or executing tasks in exchange for a paycheck.
A Value-Pricing Hybrid Approach
I love what Ran Segall (Youtuber “Flux”) has to say about value-based pricing. His approach is identical to mine, which is pretty cool since I’ve been making up my own approach for years.
We’re a little less traditional. Essentially what Ran and I do is try to make sure we’re always getting the most out of the client, providing more value than what we’re charging, and keeping our minimum required price in mind for the project.
More Questions, Answered.
Now that I’ve introduced you to some of the basics of value-based pricing, I want to address some of the questions I had a difficult time answering for myself.
Is there a right and wrong way to bill clients?
While there aren’t necessarily right and wrong ways to bill clients, there are effective and ineffective ways to price your projects.
For example, you wouldn’t try to charge for value if the client just needs some business cards designed. In contrast, you’re also unlikely to win a high-ticket project for a large company by charging hourly.
As a freelancer, it’s your job to ask questions that help you determine what the client needs and what pricing method makes the most sense for that project.
How can I charge for an outcome I can’t guarantee?
You might be wondering, “how can I be sure that the clients business will make as much as I’m predicting they’ll make?”
You can’t. There are too many factors outside of your control. That’s why you have to work with the client to determine what ROI they think is realistic.
Is value-pricing right for every project?
Absolutely not. Value-pricing works best when you’re talking to key stakeholders in the company about a high-risk, high-value project.
Is it wrong to bill hourly?
Absolutely not. Don’t be fooled into thinking hourly billing is somehow intrinsically wrong. There is nothing wrong with hourly billing when it’s appropriate for the project.
What do you do when a client asks for your hourly rate?
Jonathan Stark suggest saying, “I don’t have one”, allowing a pause, and waiting for the client ask how you charge for your services. Then, you can respond with something like this: “I’ll work with you to determine an exact price for this project so you’ll know exactly how much it will cost upfront. Is that something you’re interested in?”.
The client will almost always say yes. If they don’t, they might not be a good fit to work with you on that project.
How do I give an accurate timeline without estimating… time?
You can still estimate based on time/hours internally to help determine a timeline for the project. High-value projects typically aren’t done in a week or two, so you can say give an estimated range such as 6-10 weeks or 3-4 months. In my experience, clients are fine with this because high-value projects can’t be rushed.
How do I present such high prices to clients?
Presenting huge prices to clients can be nerve-wracking, especially if you’re new at it. One way to ease your way into presenting higher pricing is to offer multiple options.
If you think the project is going to cost $25k, try also offering a meaningful solution at $15k and $40k. The higher price will make the primary option look more attractive and the lower price will soften the blow and give the client another reason to hire you over your competition.
How do I compete with others charging so much less than me?
You don’t! Freelancers charging significantly less than you aren’t the people you’re competing with. If you’re talking to the right clients about the right types of projects, you won’t have to worry about competing with cheap “commodity” freelancers.
Won’t clients just reject me for being the most expensive option?
Maybe, but this is where you have to step into a sales role, confidently outline the value and approach, and communicate your ability to help the client and their business.
How do I prevent clients from calculating my “effective” rate?
You can’t prevent clients from trying to reverse-engineer an effective hourly rate from your value-based, fixed-fee project. However, clients who make a point of doing this likely aren’t in the right mindset to discuss value, or you haven’t yet had the right business conversations with them.
Can I price for value as a subcontractor?
No. You can’t price for value as a subcontractor because you aren’t working directly with the client and therefore not absorbing the risk. The company you’re subcontracting for has taken the risk for you and handled the difficult financial conversations already. You should charge an hourly rate or set a fixed price for the project.
Is it unethical to charge 10x “market rate”?
I don’t consider it unethical to charge any price as long as the business stands to profit from my solution. High prices only seem unethical when compared to other freelancers, but not when compared to what the business stands to profit in the years to come.
Can you have business discussions without charging for value?
Absolutely! Regardless of the project size, type, or scope, it’s in your best interest to learn about how important the project is to the clients business. This will help anchor your pricing and show the client that whatever you’re charging is well worth the investment.
Overall, value-pricing isn’t easy. It requires you to have difficult and strategic financial conversations with your clients. It requires you to speak articulately on the phone (this won’t work well if you hide behind an email address).
It also requires that the client has a high-risk, high-value project AND be in the right mindset to invest in an appropriate solution.
However, value-pricing can remove your income “ceiling” and allow you to charge much more for your work if you can use it on the right clients and projects.
Last updated on April 24th, 2020