Over the last four years, my service business has become a product business. During the transition, I’ve had a chance to reflect on the uses and pitfalls of each model. Hindsight is a wonderful thing—I can now see that many of the difficulties we experienced as a service business could have been avoided with a different pricing model. Yet what was ultimately one of our biggest mistakes gave us experiences we could draw on when deciding on a pricing model for our product, a model that has been very successful for us.
When I started my company in 2001, I was essentially operating as a freelance developer. I was still relatively inexperienced, with a few years of Perl and Classic ASP development under my belt. I had a natural aptitude for troubleshooting problems, but this meant that many of my projects were fairly short term. I would bill for a few hours here and there fixing a problem or writing some additional code for an existing system. Therefore, I figured out an hourly rate based on what I needed to earn to survive, and charged per hour worked.
The hourly rate method of pricing worked well for an individual developer on short-term projects, but in retrospect we should have moved away from that model once we were developing large and complex projects. Six years ago, Drew McLellan joined the company. By then, I was developing fairly large projects, often using other contractors, and Drew brought another 12 years of experience to the company. Our value at this point was not that we could write lines of code. Our value was in the huge amount of experience we brought to projects. However, we were still charging like PHP freelancers, trying to work out the number of hours any project might take.
As we gave the client an estimate based on an hourly rate at the start of the project, any change to the spec or designs meant a recalculation of that estimate. Costs were constantly being discussed; I’m sure it felt to our clients that every interaction with us came with a price tag. Of course, when you are outsourcing services, that is ultimately the case. However, constantly needing to discuss and sign off changes meant the focus became the price and not the work. Our model worked best in the early days of the web, when designers would sign off designs and throw them over the fence to be built in a “pixel perfect” fashion by developers. It fell apart once a more collaborative and iterative way of designing and developing sites was attempted.
Pricing your services
For a new service company or freelancer the issue of what to charge is probably top of the list of worries. There is a huge amount of material out there to help you. For example, Cole Henley has recently begun to publish the results of his 2013 freelance rates survey; Jason Blumer has presented his opinion on value-based pricing here on A List Apart; Andy Clarke has written about moving to weekly billing. However, rather than just figuring out an hourly or project rate, I’d like to encourage people consider the type of service they want to provide, and tie the pricing model to that. Whichever model you choose, it needs to be profitable. You need to know that you are going to earn enough to pay any fixed costs and be able to live. However, that can be attained through very different ways of charging your clients. To illustrate, let’s take a look at two freelancers, both just setting up a new business.
Our first freelancer wants her offering to appeal to small businesses, perhaps those who don’t have a website at all. In order to appeal to these small owner-run companies, she wants to offer a low-cost service. To do this, she decides to put in place a number of constraints—for example, the sites will be essentially customized templates and the client will pick from a menu of features that can be implemented quickly. This approach enables a rapid turnaround time. It will need to be to keep costs down yet allow our freelancer to make enough money.
Our second freelancer has just left a job in a large agency. She has 10 years of experience on large-scale projects in a niche area and a good track record of delivering. The type of service she is keen to provide is very bespoke. She wants to work with a single client at a time, iteratively developing their identity and bringing in specialist skills as required to build their website and applications.
Both of these businesses are viable and valuable to the clients that they serve, but their pricing models are likely to be very different. Our first freelancer knows her potential clients do not have a lot of money to spend and want to know what things cost up front. A fixed price for a site built within constraints will work well for these clients. By tailoring her service to suit, she can do that and still make money. It would be a disaster, though, if she tried to offer a bespoke service like our second freelancer within the first pricing model described. With clients requesting extensive changes or asking for functionality outside her skillset, she would soon find herself working for less than minimum wage.
The type of project our second freelancer is skilled in is by nature that of far larger businesses with larger budgets for this type of work. Due to the iterative nature of the work and decisions made throughout the process, the project might take longer than expected, which makes any kind of fixed-cost quote impractical. She considers an hourly or daily rate, but given her desire to immerse herself in the requirements of only one client at a time, she decides that charging in one-week blocks makes more sense. It is much easier to estimate the length of a project in weeks, and the client doesn’t feel nickel-and-dimed when the scope changes. My own experience shows that it is hard for a client to feel like a partner in creating something with you if every interaction has a price tag attached.
There is nothing wrong with offering a fixed price, inexpensive service with strong constraints. I know many companies that have been successful with that type of service. But you are heading into difficult territory if you try to offer the same service as a company that bills weekly and uses an iterative approach. Equally, if you are happiest working long term with clients, in an iterative manner, the necessary constraints of fixed-price work would not enable you to do your best work.
Pricing a product
In our work as a service company, I believe our pricing strategy negatively affected the service we offered. On the flip side, the pricing for our product has been very successful. It has enabled us to look after our customers well, make a profit, and continue to develop and improve the product.
The most obvious place where pricing will change the decisions you can make is in support. Our support for the product we develop has been incredibly important to our overall success. However, it comes at a cost. In order to offer the free and unlimited support that benefits our customers and motivates them to speak highly of us, we need to dedicate a lot of time to it. This impacts our profit. As we grow, we will need to hire more people to do support if we want to offer the same quality of service. Charging less for our product might double our sales, but it would also double our support and the number of people needed to offer the same quality of support.
For the same reason, we chose not to offer a free version of the product. If we did so, we would need to support all of those free users. We wouldn’t be happy with offering a free version with no support, as any free users hitting a problem would take their issues to Twitter, giving a skewed version of what our product and support was like. But support takes time, which has a cost. Ultimately our paid license holders would be paying more in order that we could support everyone who is kicking the tires. We don’t think that’s fair.
When deciding on a pricing strategy, we also considered the type of customers we were aiming our product at. Our target market is web designers and small agencies. The majority of these will be more like the first freelancer I described in the section on service pricing. Typically, they develop a large number of sites per year, and once a site is finished it is handed over. If more work needs doing in the future, that will be billed as a separate job. In light of this, we gave our CMS product a single, fixed, and one-off cost. There are no recurring costs, and no additional charges for add-ons to the core product. This means that companies can quote for a job and know up front exactly what the CMS license will cost. Four years on and the model still works for us; it suits the majority of customers and is transparent to everyone.
Base pricing decisions on the service you want to offer, and who you want to offer it to
Whether products or services, much hangs on a pricing decision that frequently comes down to a gut feeling or a quick look at what other people are charging. You should always start with an understanding of what your costs are, in order to come up with a basic amount you need to earn as a freelancer or bring in from sales of your product.
Once you know the bottom line in terms of profitability, I would encourage you to think about what you want to offer and who your ideal clients or customers are. You can then start to shape your pricing model in a way that will appeal to that customer. You can ensure that the way you price your product or service supports the way you want to work with people, rather than it becoming a source of friction in your relationships. And finally, be confident in your pricing once you have made a decision, but don’t be afraid to take a look at the situation again as the industry and the people you work with change.