From the time of the Industrial Revolution, people used cost-based pricing to decide what they YesYesshould charge for their products and services. This mindset can also be seen in the bookkeepers and accountants who always demand to know the cost of everything but often ignore the value being delivered. For the past 100 years, we are going with the same mindset of cost-based pricing as it captured us.
Knowing your cost is important to understanding your profitability. But, the problem occurs when you start to base your pricing based on cost. Cost-based pricing can set up an unfriendly relationship with your clients from the beginning.
What Is Cost-Based Pricing?
It is a method of determining your selling price. Compared to other methods it is quite a simple method. You calculate what it costs to produce your product or to provide a service, you set your desired profit, add profit to the calculated cost and yep! There is your selling price. If you want to formulate, the formula will be;
Calculated cost of Product + Profit you want = Selling Price
It is fair, straightforward and easy to calculate. FASB (Financial Accounting Standards Board) oversees “official” accounting rules (such as GAAP) so that everyone does the same calculations in the same way. It makes it very easy to regulate the business and also to compare one business with others.
Cost-based pricing has evolved in three different modules over the past years and they are:
- Opaque Pricing
- Line-based pricing
- Fixed Package Pricing
We will see them one by one in detail.
1. Opaque Pricing:
The opaque pricing strategy is popular in the travel industry. Opaque pricing allows companies to sell products or services at hidden, lower prices. This type of pricing is targeted at price-conscious customers, as opposed to reputation or amenities. If we use an opaque pricing method, clients will not understand how we derived the price we are charging for our product or service. This pricing system is rapidly disappearing because nowadays customers demand more transparency. Out of this model came “the Line-based Pricing.”
2. Line-based Pricing:
Line-based pricing came out of opaque pricing. We can say that line base pricing depends upon time and amount. It is also known as billable hours. We just need to calculate the amount we spend per time. It is transparent compared to opaque pricing. Line-based pricing lets the client see what they are getting and at what total price.
3. Fixed Package Pricing:
Fixed package pricing is based on an estimate of the amount of work that needs to be done. Here time is not an important factor but we can set some period. With this pricing method, the service provider and client have some scope related to risk.
Social media packages, pay-per-click packages, SEO packages are some examples of fixed package pricing.
Why the client will not fit perfectly into anyone package:
- Every customer has unique problems and challenges.
- Customer’s business decisions and capabilities are not in our control.
- The difference between their investment and the goals they want to achieve is very large.
- The commitments made by them to you may change with situations, time and their will.
- Their resources keep changing.
Fixed package pricing is almost either too low or too high.
Too low aka Floor pricing can cause damage to you, your agency and your staff. If your pricing is too low then you may demoralize your staff, not get desirable profit and lower the quality of your work. Too high aka ceiling pricing also causes damage. You may not get new clients at such high pricing or you will be on the verge of losing old clients. In both ways damage or may I say the loss is fixed.
You need to describe your work and why you are charging this much for your work. You need to justify the value of your work. Then only your clients will find a way to talk away.
Why you should not use any of the above pricing:
Setting your prices based on cost is a big trap. If you use either of the above pricing systems, it won’t be satisfactory to your customer and they are going to question your;
- Expertise (Why do I need videos? Or Email marketing?)
- Efficiency ADD QUESTIONS
All of the above points could affect your relationship with your client. Your client will always want to buy at a reasonable price. He will always bargain. He will desire the most at the lowest price.
At the same time, You also want to get paid the most for at least your work.
What is the Solution? Value-based Pricing
It sets prices primarily but not exclusively. Value-based pricing is a method which sets the price according to the estimated value of a product or service to the customer rather than according to the cost of a product. This system is more relatable to customers. If you use this system, your conversations will be about the client’s goals, challenges, his desires, capacities, what he tried to do earlier, what he wants to do now, what are his main problems, what solutions he has, what pain his company is suffering etc. This helps you to build a positive and trustable relationship with your client. Value-based pricing requires a lot of research.
Once you know all these things about your client, then you can set your own goals for that particular client. You will be determined about what you want to provide and focused in a specific direction. By using value-based pricing you can provide more profit to your client as well as you can gain more profit to yourself.
Advantages of Value-based pricing
- It provides a real willingness to customer to share their data
- It helps you develop a higher quality of service or product
- It allows you to provide phenomenal customer service
For your agency to make a greater profit, fame etc you need to grow from cost-based pricing to value-based pricing. If you do this, it means you and your staff are experts and have an increasing number of clients with desired profits. After this you will stand out of your competition and also clients can reach to you more easily.