What is value-based pricing?

Paul Doerwald
July 22, 2020

Value-based pricing is exactly the same as project-based pricing — when a vendor (freelancer, agency, or consultant) and their client agree on a fixed price for a fixed scope of work — except that the fixed price is based on the perceived value the client derives from the work, not on the time-effort the work will take.

To help understand value-based pricing, consider this old anecdote:

After 30 years of service as the bottling line manager, Frank finally retires. Six months later the line goes down. The line workers can’t fix it. The new line manager can’t fix it.

Desperate, the owner calls Frank back in. Frank walks to the machine, picks up a hammer, taps a peg 3 times, and the line springs to back to life!

“Please, send me an invoice! You’ve been so helpful!” the owner says to Frank.

A few days later, the owner receives an invoice for $2,000 with two line items:

Tapping on the motivator: $50
Knowing where to tap: $1950

Frank knew that with the line down, no jam was being bottled, and production staff was sitting idle, costing his former employer tremendously. Although the fix only took 5 minutes of Frank’s time, he knew the value of his work was much higher, justifying the $1950 charge.

The dream 💭🌤🤑🌈 of price-by-value

To succeed with value-based pricing, you must have a deep understanding of the value your client will get from the proposed project.

Be an expert in the client’s space. If you’re an expert on your client’s business and market, and you’re confident your work will directly increase revenue or decrease cost, you have leeway to charge more, potentially much more.

Ask them what their budget is. Clients will often tell you how much they want to spend on the project. That gives you a very good window into what they believe the value of the project is. Pro tip: if they’ve given you a budget, they want your estimate to come in at that number, and they’re going to compare you with competitors based on features, not on price.

Does the project affect the bottom line? Ask yourself “if I do this work, how will it affect my client’s bottom line?”. Projects that increase profit (either by reducing costs or increasing revenue) are good candidates for price-by-value. The challenge you’ll face, unless you’re an expert in the client’s market, is knowing how much profit will be affected.

Does the project cost <= 10% of year-1 ROI? If your product/project costs less than 10% of the first year’s return-on-investment (e.g., your product costs $5000 but the client will earn $50,000 more because of it), then the product/project is generally considered a “no brainer” — i.e. an easy choice because the benefit vastly outweighs the cost. Therefore, if your project only has a time cost of $2000, and you can charge $5000, go for it! (That said, in my experience it helps to be an established vendor with a track record to make this case!)

Is there a substantial non-monetary benefit to the project? Some projects make life easier or happier for employees but don’t affect bottom line. Some are necessary side projects tangential to the client’s main business. In these cases, you’ll have a very hard time charging-by-value. On the other hand, if your work will help your client retain highly trained staff, the project may be worth much more than its time cost.

The challenge of pricing by value

Greed. You might overestimate the value to the client, and lose out on the bid.

You can’t deliver for the price. The value of a project to a client may be $5000, but it will cost you $10,000 to deliver. The client may still be convinced to go for the project, but you’ll probably want to charge $10,000 😄.

Clients aren’t stupid. The client knows that the project will take a certain amount of time. They may not know how much, but they know there’s a time factor. Clients can tell when the price they’re paying has no connection to the time spent. Clients don’t like feeling ripped off.

Personal anecdote: I was connected with a major brand at the last minute to do a website for their PR campaign. Since it was an urgent, drop-everything, last-minute, burn-the-midnight-oil request, I had the leeway to charge more. Unwisely, I took the liberty of charging way more. Hours turned into days (for the Star Trek fans 😆 🖖) as I sent off one ridiculous invoice after another. The invoices were all paid — I did, after all, get a last-minute project done faster than their internal team could have — but I heard through my contact that the client was unimpressed. I never worked for them again.

Thinking that billing by value means you don’t need to track time. Just like project-based pricing, you’re still spending time on a project, and that time has a cost. The only difference with bill-by-value is that you’ve separated the cost of the project (your time) from the price of the project (the amount your charge your client). All other agency metrics still apply as before.

The reality of bill-by-value

I’ve met a lot of freelancers and small (!!) agencies that say “we bill by value”. They rarely do. Pricing by value usually requires discipline and an intimate knowledge of your client’s business and market.

In practice, these freelancers and agencies are choosing a price more-or-less at random that feels right in order to avoid the burdens of a) estimating how long a project will actually take and b) tracking the time on that project.

This approach often works — or appears to work. The vendor does work, they make good money, and they don’t have a time tracking hassle. The irony is that without time tracking data, they don’t know whether their value-based pricing is ridiculously profitable, or if it is actually a steal for their clients.

Conclusion

Food for thought: I’ve never met a senior manager at a medium or large agency that bills by value.

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