Pricing and profitability require a finely tuned balancing act: price too low and you miss your profit goals; price too high and you’re at risk of customer resistance and being undercut by the competition.
Companies take a couple of different tactics. They scope out the competition and try to position themselves near the top. They hope that clients don’t try to drive the price down. They use marketing tactics to improve the perception of value. Or they add value in increments hoping to hit a sweet spot where the value is appreciated by buyers, but expenses don’t derail the profit. One other option is to reduce the profit goals. Then you must ask, why are you in this business in the first place?
This goes back and forth in services companies. The reason you have these conversations, and this balancing act is because you’re selling your knowledge and expertise through units of time and deliverables. It’s extremely difficult to convince buyers that there’s an intrinsic value to an hour of your time.
All of this is to say that your choice of the hourly billing pricing model is the primary factor in how much profit you can make. Services companies subtract from revenue the typical expenses such as overhead, compensation, marketing and sales activities, customer service, resolving complaints. Your hourly rate must cover all those things plus provide a profit. So, you get to there, unless you are in an extremely high bracket based on reputation, you’re always struggling to hit your profit goal.
Profit is necessary to accumulate cash, which is necessary for growth, however you define growth. It may be expanding into a new area either physically or IP-wise or both. It might be acquiring another company. Companies want to be good corporate citizens and use profit for that. And of course, to reward the owners, which is why they do this in the first place.
How do you close this gap?
I come down on the side of changing your pricing model from hourly billing to value based pricing. It changes the whole conversation. Instead of asking yourselves “what are we giving to the client” you ask, “What is the client getting or taking away; how are they benefitting?” The more they benefit they more they are willing to pay and the greater your profit.
People will pay for value as long as get it and are happy.
This is the power inherent in services companies: you can use your knowledge and expertise to continuously create new value. Not incrementally add value. Create brand new value that gives your buyers what they want. You are limited only by your imagination and willingness to invent and reinvent.
The greater the value delivered to clients, the greater your compensation.
Don’t let habit, standard industry practices, fear or uncertainty prevent you from closing the gap between pricing and profitability. Make your pricing create the profit you deserve.