Pricing Challenges: why raising rates may not always be the answer

raising-ratesIf I price by the hour, then I’ll always make a profit.

The logic almost makes perfect sense, doesn’t it? If you charge by the hour, and you charge for all your hours, then how could you ever lose money? And because the logic is so simple, it invites everyone to gather around and sing the same tune.

Raising rates until people walk way

If you spend time reading all the advice out there about pricing, you’ll not only read this advice given – you’ll see it taken a step further. The continued logic works like this. Start by defining your hourly rate. Then, when you notice that everyone is accepting your hourly rate without issue, raise it. Keep raising it until you notice some percent of people are walking away. At that point leave it there until everyone starts accepting your rate again. Then raise it until some portion starts rejecting you again. Keep this up and you’ve figured out what “the market” thinks you’re worth.

Let’s go to the movies

You might be reading this thinking – how can that be wrong? It sounds in line with everything you know about economics. But a simple example might help. Did you know that the motion picture industry has been growing every year? In 2000, it was a $7.5 billion dollar industry. Today it’s projected to be $10.5 billion. Revenue is going up. But here’s something you may not know – while ticket prices have been going up, attendance has been going down – from a peak in 2002 of 1.6 billion tickets sold, down to a projected 1.3 billion this year. Equally as interesting is the fact that while movie screen counts has gone up; the number of open theaters has gone down.

Lessons you don’t want to learn too late

What does this have to do with negotiating a fair and reasonable price? Two things. First, raising rates may net you increased profits, but that increase may hide the fact that your addressable market is shrinking. That’s not always good thing – if you’re not planning it, and especially if you don’t notice until it’s too late.

Second, while greater revenue is being made as rates go up, consolidation in segments also occurs. You raised rates may simply justify someone else’s rates but won’t necessarily guarantee you a customer.

If you don’t differentiate yourself from others, there’s nothing stopping your prospects from agreeing to a higher rate, without someone else.

Now it’s true, markets are often hyper-local. But just make sure that in your segment, you’re known for something. Because if not, raising your rates may just be the excuse for someone to look for someone else who specializes in what they need.

That all said, it’s a numbers and logic argument and if you don’t agree with the assumptions, you might invalidate the logic. So let’s look at this from another perspective.

Professionals use value-based pricing

The first time you do something, can we agree you’ll take longer? Good. That would mean you might net a decent price for the effort. But the fourth time you do it, you’ll do it faster. Logically, charging by the hour will net you less. Do you see the inherent lack of logic here? Clients should pay you a premium for going faster, not less.

Plus, clients don’t want to pay more when you’re learning. They want you to learn on your own time. And just because you send an invoice doesn’t mean it’s getting paid.

An hourly rate doesn’t make sense for a professional. You don’t pay your doctor or surgeon by the minute. They’re thinking about value instead.

Value is in the eye of the beholder

Here’s what we know – just like beauty, value is in the eye of the beholder. The same WordPress website may net you different amounts of revenue based on who you’re selling it to and what their objectives are.

A web site for a startup that has no money may be worth $1,000 to them. The same site, for a business doing $20,000 a month but frustrated because they can’t edit their own content might be worth five times that amount. And the same site for a larger company may not take you seriously unless you charge ten times the amount the startup would pay.

So how do you negotiate a fair price?

First, make sure you’re spending enough time with a customer to know their own business context and what makes sense to them. A lawyer who pays $20,000 a year for his accounting software won’t have an issue with a $10,000 site (and yearly maintenance). A mommy blogger just getting started may have a heart attack.

Second, ask what their budget is. Some folks may have one. But if they don’t, use the opportunity to determine how much support they’re looking for. The long-term loss on a project often comes from supporting a site rather than just developing it.

One way to do this is to share more than one price for a project. When you give them options (not too many though), you’ll quickly learn where they’re already anchored. You could, for example, offer the same site at three rates (4, 8 and $15,000) with different degrees of support. You’ll find what their budget is as well as what kind of support they’re hoping for.

Lastly, keep in contact with your peers (and competitors). Your customers are likely talking to more than just you. So don’t forget to have your own conversations. You may find that others are charging $2,500 for something you’re charging $1000. Have the discussion to see if you’re priced too low. Or you may find that conditions have driven prices lower and you’re too high.

Whatever you do – talk with other folks who understand value-based pricing and learn from the people who are further on the journey.