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Pricing By a Formula

pricing by a formula

Recently, I’ve had a few people ask me about using a formula to price and what I thought about it. The short answer is that it depends on the basis of the formula.

Some pricing formulas are completely inadequate, to be kind about it, because the components of the formula have nothing to do with a client’s outcomes.

Hourly pricing is one example. The formula for hourly pricing, of course, is the hourly rate of the service provider times the number of hours worked.

The problem with an hourly pricing formula is that it’s based on inputs alone. There’s no attempt whatsoever in that formula to approximate the value of client outcomes and base a price on that estimate.

There are other pricing formulas, however, that attempt to gauge realized client value. A pricing formula might be based on a proportion of the increase in revenue a client realizes after the work of a service provider is completed. Another example could be a percentage of realized cost savings. Another might be a fee tied to the positive change in a client’s customer satisfaction surveys.

You might also have a formula that includes some non-financial metrics. The logic, from your perspective as the service provider, is that you are pricing based on client outcomes you’ve generated in past engagements. You might know, from past experience, that the client-derived value from your project for a construction company, for example, will be different than that of a medical practice, even if both have the same revenue. Because of that experience, you price the same project performed for a construction firm differently than that of a medical practice.

In all of these cases, the pricing formula is a crude attempt to approximate client-realized value and price based on that value. A crude attempt is better than no attempt at all.

Here’s what such pricing formulas omit consideration of: additional value derived by the client because of the positive change in the success metric. For example, a formula based on a revenue increase omits any accounting for what that increase in revenue makes possible. That additional revenue creates additional cash flow, and that, in turn allows the company to hire additional employees to grow, for example. What’s the value of that additional growth? It allows the company further options for expansion, or debt paydown, or a larger bonus pool for employees at the end of the year.

Any of those outcomes create further value for the business.

It's difficult, if not impossible, to gauge all that additional spillover value with a formula, and then, in turn, price to that value.

If you're reluctant to dive fully into having value dialogues with clients and price relative to the client-perceived value which comes out of those conversations, then formula pricing can be an alternative.

Just make sure that your formula has some basis in client outcomes.


About me:  I’m John Ray, a business consultant and coach, author, and podcaster. I'm enthusiastic about how changes in pricing strategy can significantly change profitability for a business and enhance life choices for business owners. I work with business owners on how they can change their pricing not just to make more money, but attract and serve their best-fit clients and bring more joy to their business. Click here to learn more or contact me.

My forthcoming book, The Generosity Mindset: A Journey to Business Success by Raising Your Confidence, Value, and Prices, covers topics like value and adopting a mindset of value, pricing your services more effectively, proposals, and essential elements of growing your business. Follow this link to learn more.


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