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  Different Kinds of Pricing

Key Concept:

There are more ways of billing than just hourly, and hourly is the worst method of all.

The Different Ways to Price Your Clients

Some people think that hourly billing is the only way to bill clients. It isn't. You can bill clients using methods like: hourly, daily, weekly, monthly, fixed, value, and hybrids. Each method has its own benefits, so let's explore each in turn, and find out what you should use.


Hourly

What it is

Hourly is the most common way that people bill clients. And It's simple to understand: You work for an hour and you charge by the hour. Then you simply multiply the hours worked by your rate per hour. Though this method is easy to use, it is destructive to the productivity of a project. Charging hourly means that as you get more skilled that you actually earn less. This means that you have less of an interest in working hard for a client, and it puts you at odds with your client. Also, it means that the client has more of an interest to micromanage you, because they don't want you to overcharge.

The Good

  • It's very common, and so it's the expected way to charge.
  • Simple to setup.
  • It's easier to make the mental leap from hourly employee to hourly freelancer

The Bad

  • You'll be viewed as a commodity
  • If you work faster you lose.
  • If you work slower you lose (perhaps even the client).
  • You have no incentive to become better in what you do.
  • It puts you at odds with the client, and you immediately have a conflicted purpose: you'll naturally want to work slower, and the client will naturally micromanage you because they don't want to be overcharged.


Daily

What it is

Daily rate is a great step up from charging hourly. You aren't a code machine anymore, and you don't have to list out every. little. step. that. you. did. For instance, you can simply list that on that day you: Sent status updates, and finished page optimization for the careers section. This is so much better than saying you, reworked the header title, optimized meta tags, tweaked color of call to action button... you get the idea.

Also, if you are more productive than expected you can finish early for the day, still get paid in full. Not only is this ethical, it gives you some motivation to work hard, and to get a 'days' worth of work done sooner. For instance, Ryan Waggoner does 6 pomodoro sessions that are 45 minutes long, and then he's done for the day. He gets a shocking amount of work done, the client is happy, and he gets rewarded for working more efficiently.

The Good

  • Daily billing sets you apart from other commodity freelancers
  • It helps you to appear like a consultant, which then helps you to have a higher rate.
  • You don't have to write down every, little, thing, that, you, did. Just a summary will do.
  • If you work fast, you can take off early and feel good about it.
  • You earn more than hourly, because you always bill in full-day periods.

The Bad

  • You can't switch from client to client in different hours. This actually a good thing, but it can be difficult when there is a critical issue for another client that you have to fix.
  • Some clients don't understand daily billing, and you'll have to teach them why it's in their best interest (no loss of time from task switching, more work gets done, better quality work).
  • Late night deploys can be tricky. What if you've worked the day already, and then you need to work 2-3 more hours to do a deploy with database changes?


Weekly

What it is

Weekly is 10 times better than daily billing, and 100 times better than hourly. It allows you to charge for a large chunk of time. It absorbs holidays, and makes it easy to schedule out your month. Yet it's good for your clients as well. When you bill weekly, your focus is mainly on building the product, and the value you create.

The Good

  • You can make much more money than hourly.
  • You don't have to track all the minuta, and all the small steps. This means you only have to report on moderate tasks and major milestones.
  • You can absorb scope changes without too much worry.
  • It helps you to charge more along the value of a project, and not on the time it will take (hint, clients really only care about the value a project brings, and as long as it's within budget they don't care how long or how little it took you.)
  • It's harder for them to compare you against people who bill hourly. A weekly rate, is really just a fixed fee for a block of time.

The Bad

  • This doesn't work for small projects.
  • Clients don't like it when you try to charge weekly when there are holidays involved.
  • Some people still think that they can take your weekly rate, divide it by (5*8), and use that 'hourly rate' to compare you to other consultants.


Monthly

What it is

Monthly is usually the largest amount of time that you can bill a client for. This is typically used for retainers, or other fixed-price and recurring services. For instance, if you do web optimization you might include a few split tests, a CEO-ready report, and a minor optimization services as requested. If you made a web app it could be regular database backups, as a set of reasonable modifications per month. If you do coaching, then you can guarantee them a fixed number of coaching sessions per month.

The Good

  • You get (mostly dependable) recurring revenue
  • Often the work can be automated, or it only takes you a few hours to complete the task.
  • You don't have to draft new contracts month after month.

The Bad

  • Scheduling conflicts can be a pain, especially if you bill weekly and you are working for a different client that week. This means either you need to have "slack time" built into your weekly rate, or it means you are working evenings.
  • Some clients might view this as a lack of trust, as they could always just ask you for your services on demand.
  • Clients might expect immediate feedback from you since they are paying for your services, and it gets hard to balance large projects.


Fixed Pricing

What it Is

Fixed pricing is where you simply charge a flat fee for a project. You might use a number of hours to calculate how long a project will take you (and if you do, always 2X the time you think it will take. Trust me. It always takes longer than you think), and then use that to quote to determine your fixed price Then you don't use that hourly rate, but you bill your client based off of your fixed rate.

This method is handy for consulting, and especially with productized consulting (selling your services as bundled product for a set cost). The client knows exactly what they will spend, and you have a very valid reason to work hard.

Also, this method can also be used to charge based off of the value of the project. If you know that you'll make them $500,000, then as long as you anchor your cost to the revenue of the project, you can send proposals for 10% of the revenue.

The Good

  • Clients love this method as it means less risk for them.
  • And less risk for them means an easier sell for you.
  • If you work fast then your effective rate skyrockets.
  • This method naturally pushes you to get better at estimating and better at your craft.

The Bad

  • If you estimate poorly you'll lose money.
  • You need to spend more time assessing the project to make sure you can get the right estimate.
  • Asking lots of questions gets tedious.
  • Some clients will want to take advantage of the fixed price, and they will keep asking for revisions.


Value Pricing

What it is

Value pricing is like fixed pricing, but it deserves its own spot. While fixed pricing is usually just that; a set price based off of how much you think someone should pay for a project. In contrast, value pricing depends on how much someone thinks it is worth. For instance, say you are asked for a bid on a task, and with your experience you think it will take you around 10 hours to do, so you propose a fixed rate of $1,000. But, what if you dug deeper, and found out that this project would make the company $50,000 in revenue every year, and it will save them headaches, and make their work more enjoyable. Do you still charge them $1,000 for it? Well you don't have to. Now that you know how much they will make, you can ethically charge them $5,000 or more, and the client would be happy to pay it. This is why value-based-pricing is so powerful.

The Good

  • You can make a whole lot more money
  • You learn more about the client, and you learn how to understand their true business needs.
  • You get to charge a percentage of how much they think the project is worth.

The bad

  • You'll never sell this to some people. Some people are still stuck in the 'hourly only' mentality, and won't accept value pricing (regardless how much much more money they will make).
  • It takes more digging and researching.
  • It's a revolutionary way of pricing, and you'll have to get over some of your preconceived notions about billing.


Hybrid Pricing

What it is

Hybrid pricing is mixing two of the above methods. I've used this method a fair deal in my proposals, though I've never had to use the clause. For example, I'll often quote three fixed prices for a project, but then I'll have in my terms that any additional work that is reasonably out-out-of-scope will be billed out at an hourly rate of $XXX.00 per hour. This protects me in case my client wants to add some last minute features and I can just do the work, and it helps my clients because they don't have to sign a new contract each time they have a major feature set.

The Good

  • If they want more work that is out of scope then you can bill for that.
  • You don't have to draft up a new contract.
  • It's a catch all and can give you some piece of mind.

The Bad

  • You are mixing rates, and are grouping fixed costs with hourly costs. That can get confusing to some.
  • Some clients that don't read the contract well might be surprised with the extra charge on the invoice.
  • There are those people who will want to ask for multiple revisions, and this method can scare them off.


In Close

You'll need to decide what method is the best for you. Personally I'd recommend that you to stay away from hourly. I know it's hard, but if you choose another method like daily, weekly, or fixed, then you'll make more money, and you can avoid the commodity trap.

Also, your chosen specialty can also determine how you bill. For instance, many programming projects take a whole month to complete, and weekly billing might be best for that. If the project is a redesign of a website, and it's fairly well scoped then charge a fixed rate. If you are writing an article for a publication, then a fixed rate might be best.

So, it really depends on what method you choose. But above all, don't charge hourly. And if a client demands an hourly rate, then simply say that you work in day increments, and I'll bill you hourly in daily chunks of time.

So, now that you have picked a niche, and you know how to find clients, now it's time for you to decide what method you will use for your billing. You don't need to know an amount just yet, but you should decide what method you are going to use.


Assignment

  • Decide what your minimum rate is for your services.
    • For me, if it's a website redesign then my minimum is $2,000. For anything less than that it's hard for me to even begin to consider it. For programming, $500 a day is my absolute minimum. At 20 working days in a month this comes out to minimum $10,000 a month. you can just walk away.)
    • You can have different rates for different kinds of projects, but make sure you define the minimum rate that you'll work for.

Further Reading

Stop charging hourly by Ryan Waggoner


How to morally handle hourly billing - Jonathan Stark

Here's a great thought about hourly billing. It's by a man who does mobile consulting, and if you want to learn more about him, here's a link to his site. In the meantime, here's his great article.


WHAT WOULD YOU DO?

Imagine that you've estimated a 40 hour job at $200/hr for a total of $8000. The client happily approves it and you rejoice.

After some initial research, you discover that there is a tool available for $1000 that will allow you to deliver the project in 5 hours, rather than the 40 hours that you've estimated. What do you do?

A) You buy the tool for $1000, you deliver the work in 5 hours, and bill the client for 5 hours. Result: You work 5 hours, pocket $0, own the tool, and the client loves you.

B) Have the client buy the tool for $1000, you deliver the work in 5 hours, and bill the client for 5 hours. Result: You work 5 hours, pocket $1000, the client owns the tool, and the client loves you.

C) You buy the tool for $1000, you finish the work in 5 hours but wait to deliver it at 30 hours, and bill the client $6000. Result: You work 5 hours, pocket $5000, own the tool, and the client is very happy that you finished faster and cheaper than promised.

D) You don't buy the tool, you deliver the work in 40 hours, and bill the client $8000. Result: You work 40 hours, pocket $8000, don't own the tool, and the client is satisfied.

I think that all of these options suck, and I don't advocate any of them. What's interesting to me is the moral dilemma between C and D. C is clearly dishonest, but it's undeniably better than D for both you and the client. The client saves $2k, receives their work 10 hours earlier than expected, and you make $1000 per hour!

I can imagine a variety of other options, and I'm sure you can, too. Unfortunately, none of them would address the underlying issue: that billing by the hour for software projects makes no sense. Software projects should be billed based on the client's perceived value of the outcome. Period. How many hours it takes you to deliver it is irrelevant; in fact, the fewer the better!

Hourly Billing Punishes Increased Productivity

When I first switched to value pricing for software projects, I was struck by my sudden inclination to research and purchase tools. These days, I don't think twice about dropping $500-$1000 for something that will make my work go faster or better.

Herein lies an insidious truth about hourly billing: If you are billing by the hour, you have a subconscious incentive to NOT become more efficient. Because of this, your skills will stagnate and your clients will suffer.