Are you struggling with pricing your services? Are you having cashflow issues? Do you feel like you’re working too hard for what you earn? Is there no margin for scale and growth? Value-based pricing will change your business. Here’s what you need to know…
Note: This is a really detailed article (roughly 4000 words). If you don’t have time to read it all, click here to download the value-based pricing cheat sheet (PDF) with all the most important points and action steps.
What is Value-Based Pricing?
Value-Based Pricing is a pricing strategy which sets prices primarily, but not exclusively, according to the perceived or estimated value of a product or service to the customer rather than according to the cost of the product or historical prices.
So yeah, that’s the definition. But what can you really do with that alone?
In order to understand value-based pricing, we first have to talk about some conventional pricing methods. This will help you understand how most pricing works and then make the value-pricing pricing differences crystal clear.
Cost-Plus Pricing & Conventional Pricing Methods
Most service businesses use a pricing model called “cost-plus” pricing.
Cost-plus pricing is a way of arriving at a price by adding together the direct material costs, direct labor costs, and overhead costs for a product and then marking it up to create a profit margin.
There’s a similar method that I often see recommended where you start with the goal salary you want, add in your costs, and then divide by the number of clients you want to work with. That calculation leads you to the goal figure. We’ll call this “salary-based pricing.”
Let’s use a photographer as an example. They decide they want to make a salary of $100,000 per year. Their costs are $70,000 per year. That means they need revenues of $170,000 per year.
To hit that with a little cushion, they need about $15,000 in revenue per month. If they only want to work with 10 clients a month, their average client needs to bring them $1500 in revenue.
Knowing this, they can design their packages and pricing around hitting that average sale price. Simple.
These two methods are how most new business owners set their prices. The problem is, they’re both awful pricing methods.
Why Cost-Plus Pricing Isn’t Great for Most Online Businesses & Freelancers
Let’s use the example of a web developer – a classic online business / freelancer model.
She has two clients who both want an e-commerce site and both sites will be of fairly equal complexity.
Both clients are currently selling their product offline and want to move into the online space.
- Client A is a bootstrapped startup with offline sales of $10,000 per month.
- Client B is a well-established brand with offline sales of $250,000 per month.
With cost-plus pricing, you’re probably going to bill both of these clients by the hour (the cost of your business expenses plus your time).
- Client A gets a proposal for 50 hours at $100/hr.
- Client B gets a proposal for 50 hours at $100/hr.
You’ve told both clients that you can build this e-commerce site for $5000.
With salary-based pricing, you’ll still probably bill by the hour and you’ll take every job that nets you more than the average client value you’re targeting.
Since you can only complete two e-commerce sites per month, you would need an average client value of $7000 to hit your six-figure salary goal.
In this salary-based e-commerce scenario, you say “Yes” to both clients because they’re both “close enough” and you’re tight on cash and “need the work” (who’s heard this story before – raise your hand!).
The result is that both of these pricing models have brought in $10,000 of revenue in a single month across two very different clients.
But look at what happened here. If Client A generates $50,000 in online revenue in the first year, they’ve made a 10x return on their spend with you (and that only grows year after year). If Client B generates $100,000 in online revenue in the first year, they make a 20x ROI on your work.
You busted your ass to pump these two projects out. You’re taking on all this risk of owning your own business. You have fixed costs and a family to feed. And you have to do it all again next month while what you created is netting your clients a 10x, 15x, 20x, etc. ROI year after year.
Not to mention, doing work for Client B is riskier to you as a business owner. If you screw something up with Client B it’s a far more costly mistake than if you screw something up with Client A.
Keep that in mind as we continue…
How to Earn What You’re Really Worth with Value-Based Pricing
Thinking about hourly value is the wrong mindset to be in from the jump.
Drill this into your head: your worth is determined by the value that you bring to your client.
In the e-commerce scenario above, the value that you provide to Client A is very different than the value you can provide to Client B.
Client A has a lot more risk. They’re new and they don’t have a lot of revenue. Their product is unproven.
An e-commerce site helps them, for sure, but it’s not a game changer and it’s going to take time and a lot more money to make it work well for them.
Client B has a lot less risk. They’re established and have a lot of revenue. Their products are proven, they’re just not taking advantage of the digital landscape.
An e-commerce site could add six figures to their bottom line in just a few short months, especially with all the buzz they can generate from their existing client base.
Surely you can see that an e-commerce sits is worth more to Client B than it is to Client A.
Client A is going to get a slow ROI with greater risk. Client B is going to get an immediate ROI with much less risk.
As a developer, your work brings more value to Client B than it does to Client A.
Think of it from an investment perspective…
How much money would you be willing to invest in a business that has a proposed return of six figures after five years, but that has a 50% chance of going out of business by then?
How much money would you be willing to invest in a business that has a proposed return of six figures after one year and only a 10% chance of going out of business by then?
I’m guessing that you’d be willing to put up a lot more money in scenario two, yes?
That’s how smart companies are looking at the services you provide, so that’s how you need to be thinking about pricing them.
If I’m going to build an e-commerce site that’s going to net a six-figure profit for my client, you best believe that I’m going to recognize that value to them and price accordingly.
If they’re smart, they’ll be willing to pay $25,000, $35,000, or even $50,000 for the project.
Why wouldn’t they? Even at a cost of $50,000, they’ll have doubled their investment after only one year (and the ROI only continues to increase each year thereafter).
Do you know of any other investment with that kind of return?
What About Competition When Using Value-Based Pricing?
I’m not ignoring the fact that we all have competition. But having competition doesn’t mean you have to race to the bottom.
The first thing you have to consider are your intangibles. You do have intangibles, don’t you?
- You have more experience.
- You’re more trustworthy (in your client’s eyes).
- You’re faster.
- You’re more responsive.
- You fill a gap/need that others don’t.
- Your knowledge/skills directly contribute to an increase in ROI (maybe your competition designs pretty websites but you design pretty websites that CONVERT at double the rate of your competitors’ sites).
- You’re more creative.
- You’re more likable.
The more intangibles you have, the more you can charge.
If you don’t have intangibles, debating me about pricing is a waste of time because you’re screwed anyway.
The next thing you have to consider is the tangible value you’re adding. For B2B, this is usually what you’re adding to the bottom line through an increase in revenue or a decrease in expenses.
The more tangible value you add, the more you can charge.
The next thing you have to consider is how value-based pricing directly contributes to your ability to serve clients at a higher level…
- Who is going to be more responsive to clients? The developer who is working with a single client paying them $50,000 or a developer who has 6 ongoing projects all paying them $7k?
- Which developer is more likely to have one or more team members to assist in getting the project done on time or ahead of schedule?
- Which developer is less likely to be frazzled and stressed and missing deadlines?
- Which developer is more able to invest in ongoing education and knowledge development?
- Which developer is more likely to still be around in 5 years?
These are real benefits that your clients will get by paying you more aside from the fact that you’re delivering tons of value for them.
If I submit a proposal for $40,000, there’s nothing stopping that company from hiring a developer that submits a proposal for $20,000.
You might think that I’d never land any clients when they can just go somewhere else.
And you’d be wrong.
They’ll pay the extra because of my intangibles. They’ll pay the extra because it’s time-consuming and frustrating to go find/interview/vet other developers. And most importantly, they’ll pay the extra because it’s still worth it to them based on the ROI they’re going to get.
If you can sell the value, your competitors don’t stand a chance.
Value-based Pricing is the Key to Scale
You have to land almost six $7000 clients to match the same revenue from one $40,000 client.
That’s six projects you have to learn about, strategize for, execute on, and collect payments from. That’s a lot of time and energy.
And there’s little margin in the $7000 client that can be used for recruiting help.
You haven’t built a business with cost-based pricing, you’ve built a job.
That brings me to another point: value-priced owners are the employers of cost-priced workers.
You don’t even have to do the work to develop the e-commerce site if you don’t want to! That $40,000 contract gives you the freedom to hire two great developers at $50/hr or even $100/hr to do the work.
If they cost you $10,000 or even $20,000, you’ve doubled your money.
At that point, your real value comes in finding new deals and providing a high-touch experience for your clients. You remove yourself from the role of coder and transition straight into the role of CEO.
You don’t have to do this, of course. You can go in a different direction if you want. Instead of hiring a team and taking on more high-paying work and building a giant agency, you can make those high-value clients translate into more time independence for you.
Working with one client at a time instead of six gives you a lot of free time and flexibility. It keeps your stress low. It leads to a higher happiness quotient.
You’re also more likely to get higher quality clients. Clients that have the money to invest are typically not as uptight, demanding, and annoying as the nickel-and-dimers.
None of this freedom and scale and opportunity is available to you with the cost-based model.
How to Switch to Value-Based Pricing
Switching your business from cost-based pricing or salary-based pricing to value-based pricing is fairly easy. The two most difficult steps are:
- Finding the conﬁdence to do it.
- Communicating that conﬁdence to current and future clients.
To be clear, value-based pricing does not work if you are unable to conﬁdently communicate all the value you provide to your client.
Step #1: Outline your intangibles.
What do you bring to the table that your competitors don’t? These are what I call, “intangibles.” They separate you from the competition and they’re a big part of what your client will be paying for.
- You have more experience.
- You’re more trustworthy (in your client’s eyes).
- You’re faster.
- You’re more responsive with communication.
- You ﬁll a gap/need that others don’t.
- Speciﬁc skills that directly contribute to more value for your client (maybe your competition designs pretty websites but you design pretty websites that CONVERT at double the rate of your competitors’ sites).
Obviously, some intangibles are more important and more valuable than others.
Step #2: Stop quoting clients based on cost or hours.
If you currently have hourly pricing on your website or in your proposals, delete those mentions. Never speak of hours or costs, ever, unless there are signiﬁcant costs associated with taking on a client (such as a photographer who has to rent specialized equipment or sets in order to create a speciﬁc shot).
Your pricing, for the most part, will no longer have anything to do with either of these factors ever again. Once a client knows you price your services that way, you’re ﬁnished.
Step #3: Understand your client’s pain and put that pain in context before you offer a quote.
There’s a reason your client is coming to you. They have a pain that they’re trying to solve. That pain, plus the speciﬁc circumstances surrounding your client and their pain, are what create the value of your services.
If you don’t understand the pain or aren’t able to grasp the context, you’re going to struggle with determining a price.
Here are some questions you can directly ask your client (in whatever way you’d like that ﬁts your discussion)…
- What will [my service] do for you or your business over the next 6-12 months?
- More speciﬁcally, how will that help you? What will you be able to do that you weren’t able to do before? (Always go deeper on the ﬁrst question. They’ll usually answer with something generic).
- How long have you been looking to take action on this? (If it’s very recent, you might be one of the ﬁrst people they’re talking to which means they’re more likely to shop around after getting your quote. They’re going to require more education around the value you provide).
- If we don’t do this, what will happen? (Get them to communicate the negatives or missed opportunities they’ll experience if they don’t take action).
- Are you willing to make a signiﬁcant investment in this and how soon are you prepared to take action? (This will help you determine if you’re working with a serious client who is truly feeling their pain point).
Here are some questions you can ask yourself as you listen to your client…
- What will my intangibles do for this client, speciﬁcally? (You need to know the answer to this so you can communicate it clearly rather than just talking about your intangibles in generic terms).
- What is the total value my client will gain from investing in my services? (If your client is *truly* making an “investment” with you, then you need to treat your pricing like an investment product. What kind of ROI will your client be getting? Is that a good ROI or is it an ROI that’s exponentially greater than they can get anywhere else? If it’s exponentially greater, why are you okay with leaving so much money on the table?)
- How pressing is the need? What is the timeline? (This is urgency. The more pressing the need, the greater the value).
- How soon am I able to execute on this? How fast can I get them a return?(The sooner you can execute and the faster you can get your client a return, the more valuable you are. If your client has to wait for you to get started or has to wait a signiﬁcant amount of time to see a return, your value is reduced. In behavioral economics, this is referred to as “hyperbolic discounting.” The longer it takes to realize a return, the less value the client will place on that return).
- How many closing signals has the client given me? (If a client has given you signals that they are ready to work with you or ready to buy, that’s a good sign. It should also be a signal to stop selling and ask for the sale right then and there).
Step #4: Sell (Differently)
Now that you’ve worked to deeply understand your clients pain point and how your service and your intangibles align with that pain point and the value they provide, it’s time to sell.
Selling isn’t closing, by the way. Selling is communicating.
Your job now is to communicate everything to the prospect.
- Say their pain point back to them.
- Mention again what they’ll lose if they don’t take action.
- Communicate your intangible value speciﬁc to the context of their situation.
- Communicate the tangible, real-world value your client will get from working with you.
- Talk about the timelines (but don’t say anything about hours or costs).
Additionally, you should inspire your client with conﬁdence and keep their focus on how much better their life is going to be after working with you.
The key thing to understand about selling using value-based pricing is that you can’t be impersonal or use traditional methods. If your argument is that you’re worth more, you need to start acting like it…
- Always meet in person to do the deal if possible.
- Never sell via email. At minimum, speak with the prospect on the phone.
- Stop sending proposals. Proposals are DEATH to higher ticket deals. Instead, close the deal in person or on the phone with the promise that you’ll send a detailed scope agreement with everything you’ve talked about – but they have to agree to the deal before you’ll send anything.
- The money is in the follow ups. If you suck at following up you’re going to have a hard time closing higher ticket deals.
Step #5: Propose & Close
After you’re done selling, it’s time to propose and close.
Arriving at a price is more of an art than a science and boils down to a host of different factors.
Keep in mind two things when you’re ﬁrst starting out with value-based pricing:
- Most people underprice themselves signiﬁcantly in the beginning.
- Your proposal is open to negotiation. It’s not a take-it-or-leave-it offer.
Once you have your price, communicate it conﬁdently to your client. There should be no question marks in your structure or tone.
For example, “I think it’s going to come out to around $15,000” or “How does $15,000 sound?” That’s weak sauce.
Try, “We’re going to knock this project out of the park for you. It’ll be $15,000 and we’ll have it done by X date. Here are the payment terms…”
If you’ve communicated the value properly and you have a serious prospect on your hands, you’ll close right then and there.
That will happen a good percentage of the time, but you’ll also run into a high percentage of objections.
If your prospect objects…
Step #6: Overcome objections, negotiate, and re-close.
Value-based pricing is mostly subjective. A good salesperson is able to get both parties (themselves and their prospect) to arrive at the same objective conclusion (that the price is worth it).
If you’re unable to do this, it’s okay. It’s important acknowledge the subjectivity of value-based pricing.
If your client has objections, the ﬁrst thing you should do is work to overcome those objections. This usually means re-iterating your intangibles, re-iterating the tangible value, and reminding them of what will happen if they don’t take action.
If you’re struggling to overcome objections, you can also negotiate on the price (but I recommend cutting features whenever you reduce the price. Don’t just reduce the price willy nilly. Your other option is to throw in bonuses, upgrades, or additional services instead of reducing the price – sweeten the pot instead).
If you’ve done things correctly up to this point, you’ve quoted a price that’s signiﬁcantly higher than anything you would have ever quoted before. That gives you plenty of wiggle room.
It’s a matter of deciding how much you’re willing to negotiate. An important part of value-based pricing is the willingness to let prospects walk out on you.
Remember, with value-based pricing you only need a small fraction of the clients you used to work with in order to make the same amount of money. You can afford to let certain prospects get away.
Once you’ve worked to overcome objections and feel like negotiations have gone well, re-close your prospect.
Some Additional Random Thoughts
The value-based pricing model works both ways. If you’re pressed for cash and clients (e.g. desperate), that’s a context that plays against you and will allow your clients to get better deals.
The market is fair. This entire process is voluntary. Nobody is being taken advantage of. Both parties are free to walk away at any minute. That’s the beauty of it all.
Many people will object and say, “that person can’t be worth that much more than someone else.” Well, here’s the thing: there might be legitimate reasons why one person is worth so much more than another person in this context. BUT, there doesn’t have to be! The simplest answer to the question, “Why is that person worth so much more?” is “Because they asked.” It doesn’t have to be any more complicated than that. All value is subjective. What your client is willing to pay is always the right answer. Your job is to inﬂuence the amount they’re willing to pay and then knock their project out of the park for them.
You won’t get this pricing model right in the beginning. One of the ﬁrst lessons you’ll likely learn is that you continue to leave money on the table in your early dealings.
The more clients you land at higher prices, the more your conﬁdence will grow and the more you’ll start to really see how much you’re worth.
After a few successful closings, you’ll really start to feel the need to demand higher prices. Going back to the old model will look and feel like the worst idea ever and you’ll kick yourself for how long you struggled within its prison walls.
Recap: Why is Value-Based Pricing Better?
Value-based pricing might be difficult to grasp at first but there are 7 key areas where it’s clearly the better model, especially for freelancers and authority-based businesses selling digital products and services.
- It better leverages supply and demand.
- It aligns the value of your skill and knowledge with the value you bring to the client – it’s a fairer pricing model.
- It greatly increases your proﬁt margin.
- It allows you to make more money while working with fewer clients.
- It provides you with much higher margins that can be used to increase freedom or scale.
- It opens the door to working on your business instead of in your business, elevating you to CEO.
- It empowers you to provide a higher quality service.
If you have questions about value-based pricing, leave them in the comments below and I’ll be happy to address them.
Wait! Don’t leave without grabbing the FREE Value-Based Pricing Cheat Sheet (PDF). You won’t get the benefits of value-based pricing if you don’t execute on the strategy – the cheat sheet will guide you.