One of the most frequently debated topics in management consulting circles is how to price your services. Pricing your services is a struggle no matter if your company has a single employee (you) or thousands of consultants – if you do not price properly, you could lose money even if your rates are “competitive.”
As a management consultant, you are forced to think about several different factors when pricing your services. Should I price with an hourly rate? By the project? With a do-not-exceed (DNE) price? Should I base my price on the competition or on the value I am creating? How do I determine what my value proposition really is?
Fortunately for you, all of these questions have been asked and answered thousands of times by thousands of management consulting firms. There are several schools of thought on pricing services including: Cost Based Pricing, Market Based Pricing, and Value Based Pricing.
Cost Based Pricing
We’ve described these pricing strategies in easy to understand language, such as cost based pricing. Cost based pricing is actually as it sounds – pricing your service based on your costs.
This is the most frequent pricing strategy because it’s the easiest!
You can determine your pricing strategy for a single member consulting firm by estimating:
- Total working hours in a year: 2,000 billable hours
- How many of those hours will be spent working on non-billable business such as billing, customer service, accounting, etc.? For this illustration, we will estimate that 20% of the hours will be unbillable: 400 non-bill hours, 1,600 total annual billable hours.
- How many vacation and sick hours will you use this year? 3 weeks? 120 non-bill hours, 1,480 total annual billable hours.
- How much do you want to earn a year? $120,000
- How much in expenses do you anticipate for the year? Technology, office expenses, mailbox rental, billing, collections, accounting, etc? $18,000
- How much will benefits cost you? $14,000
- So, you annual revenue target should be at least $152,000. You may want to add on a profit percentage to pay for future business expansion, let’s estimate that at 20%. Add on $30,400.
- This brings your total revenue target to $182,400. Earlier, we estimated that you have 1,480 total annual billable hours, so if you divide $182,400 by 1,480, you see that your hourly charge should be $123.24 per hour, or rounding up to a nice number, $125 an hour.
There are cons to using this pricing strategy:
- It doesn’t take into account the value of your service. If your service is valued by the company at $400 an hour and you charge $125 an hour, you are leaving a considerable amount of money on the table.
- You might price yourself out of the market. Likewise, if the company values your services at $125 an hour and you charge $400 an hour, you won’t get the business.
- This pricing strategy neglects the competitive factors. Competition may have all set an effective price in a market and you might disrupt the industry pricing strategy.
Market Based Pricing
The second strategy for pricing is to set your prices relative to the market – what your competitors are charging. If you are going up against a Deloitte and Touche and your prices are higher than theirs, you must be aware that they might win the business because of their brand and perceived value. Likewise, if you’re going up against them and your price is much lower than theirs, you might be perceived as too inexpensive.
The strategy here is to base your pricing on what the market is at and how your services fit into the market. This could mean a higher or lower price than in Cost Based Pricing, but one which is reflected on the market supply and demand. Determining the right price is not always easy and requires that you find out what your competitors are doing in regards to price.
The pros of this strategy include aligning your price with the market says it should be, setting your firm within the industry structure, and easier selling process than the value based pricing. The cons include leaving money on the table and comparing yourself to your competition based on price alone.
Value Based Pricing
The final pricing methodology for services is value based pricing. Value based pricing is the least used method because it is the most difficult one to calculate. A value based pricing strategy is designed to take into account the value created by your consulting firm and taking a portion of this value. For example, if your effort is to install a new inventory management system and it is likely to save a company $400,000, your strategy is to price the service to capture part of this value created, say, $150,000. This pricing method requires you and your customer agreeing to the value created and pricing your services accordingly.
Many firms which can more accurate define the value of their services use this pricing method. For example, if you are a transportion services consultant and can demonstrate the amount of money you save a company by cutting shipping costs, you can accurately show a company a cost savings and negotiate your payment based on the demonstrated savings over a period of time.
One consultant I know uses this method with tax deduction consulting. The consultant finds tax deductions a company can use that they are unaware of and takes a 50% fee for the service. For example, if he finds an employee education tax deduction which allows the company to deduct $500,000 in training costs, he collects a $250,000 fee.
The primary pro of this pricing method is that there is potential for a large payoff from your consulting services. It is often difficult for companies to properly identify value produced from a consulting effort which often leads to firms such as transportion, telecommunications, or office services savings consultants to use this pricing methodology as they can more accurately identify cost savings.
Which Pricing Strategy is Right for Me?
Of the three pricing strategies, there isn’t a “right” answer for every consultant. You should review each strategy and see how it fits into your particular niche or industry and work with that one.
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