What are the pricing models?

What are the pricing models?

Price is one of the key variables in the marketing mix. There are four general pricing approaches that companies use to set an appropriate price for their products and services: cost-based pricing, value-based pricing, value pricing and competition-based pricing (Kotler and Armstrong, 2009). The cost of production sets the lower limit while the upper limit is set by consumer perception about the product/service (McCarthy et al., 2001). Companies must also consider competitor prices to find the most suitable price between these two extremes (Cravens and Piercy, 2008).

A pricing model can be as simple as a demand curve. To get a demand curve, you plot the price against the increasing demand - that is you assume that if someone will pay $50, they would also pay $40 and $30 and so on. The use of cumulative measure gives a demand' curve' (often it's a straightish line). This can then be converted into a revenue curve by multiplying the demand by the price. Commonly the revenue curve has a maximum point where a higher price causes a drop in willingness-to-pay, so reducing revenue. This then suggests the revenue maximisation point. However, in most cases, revenue is not profit, and it may be worth including fixed and variable costs to estimate a profit curve - at low prices or very high prices; this may be negative. This starts to define potential optimum points, but the pricing strategy may be more sophisticated - for instance 'skimming' - setting high prices for early buyers (cf Apple) or 'penetration' type pricing - setting value prices to win market share. In most cases the pricing specialist will want to look at more than one curve; for instance for significant market segments or to investigate the potential for promotional or discounts to target different groups, or in the most sophisticated models, to look at dynamic pricing where early buyers might pay a lower price and late buyers a higher price in order to optimise yield.

How to do the pricing?

Pricing your creative and design services effectively is a complicated business. After you have calculated your shop rate, you have a baseline number for all of your pricing calculations. Using this number, you can determine what it takes to complete a project. To do so, you'll use one of seven different pricing methods.

Whether you're a freelancer or large agency, there is no single 'right way' to price your services. Instead, look for the 'ideal way' to price. Most companies will use two or three different methods.

Use your past experience and estimation exercises to determine how much time and effort is required for each project. Look at two or three models to find the right one for each situation. And since your shop rate already covers your minimum profit, you have much greater freedom to say no to bad pricing situations.

Frequently Asked Questions

Information services is defined as the system of keeping records, forms, statistics and data at a business. An example of information services is the storing of client's credit card billing statements at a credit card company. See Information Systems.

5 Components of Information Systems
  • Computer hardware. This is the physical technology that works with information. ...
  • Computer software. The hardware needs to know what to do, and that is the role of software. ...
  • Telecommunications. ...
  • Databases and data warehouses. ...
  • Human resources and procedures.

These include libraries, computing services, archive services, and information support services.

What are the pricing strategies?

A pricing strategy is a model or method used to establish the best price for a product or service. It helps you choose prices to maximise profits and shareholder value while considering consumer and market demand.

If only pricing were as simple as its definition. However, there's a lot that goes into the process.

Pricing strategies take into account many of your business factors, like revenue goals, marketing objectives, target audience, brand positioning, and product attributes. They're also influenced by external factors like consumer demand, competitor pricing, and overall market and economic trends.

It's not uncommon for entrepreneurs and business owners to skim overpricing. They often look at the cost of their products (COGS), consider their competitor's rates, and tweak their own selling price by a few dollars. While your COGS and competitors are important (as you'll see in the various strategies below), they shouldn't be at the centre of your pricing strategy.

Before we talk about pricing strategies, let's review an important pricing concept that will apply regardless of what strategies you use.

What is the importance of pricing your products?

Pricing your products or services accurately is one of the greatest challenges you are going to face as a business owner or manager. The importance of pricing is obvious, as it has a direct correlation to the amount of money you bring into your company. If you price your products and services too high, you are going to risk driving customers into the arms of your competitors. On the other hand, prices that are too low will leave you with small margins, even if you are able to make plenty of sales. In the end, only companies who can find the 'sweet spot' for pricing will be able to thrive well into the future.

For that reason, it is a good idea to use advanced pricing models to settle on a price point that makes sense for your market and your products. It doesn't really matter what you would like to sell your products for – it only matters what customers are willing to pay.

How to determine the best pricing model for your business?

Determining the most appropriate pricing model for your business is tricky and takes considerable research, planning and testing before full implementation across all of your products and services. Of particular concern to many business owners is the impact of price model changes on the customer and their standing among the competition.

Finding that number is a complicated task in many cases, which is why we have compiled the list of pricing models below. Review these options and use the ones that are going to help you find the perfect number to attach to everything you sell.

Hourly pricing

Hourly pricing is one of the two most simple models. The key things you need for successful hourly pricing is discipline, documentation and communication. It requires greater scrutiny of the process, which often doesn't foster client trust. Hourly pricing only works when you have good data. You must meticulously track your time and expenses, and consistently check in with your client. 

This approach is ideal for freelancers who aren't directly working with the client – for example, a freelancer for an ad agency. It's also suitable for any work involving sophisticated technology such as app development, where things often go wrong. However, it isn't a long-term solution for most creatives unless you choose to remain freelance. You will only become more profitable by raising your rates, which has a ceiling.

To summarise, hourly pricing is a good option if:

  • You're regularly working with the same client, on similar work
  • The project's deliverables are unclear
  • Project scope changed several times when meeting with the client
  • You're doing complex technical work

Hourly pricing, also known as rate-based pricing, is commonly used by consultants, freelancers, contractors, and other individuals or labourers who provide business services. Hourly pricing is essentially trading time for money. Some clients are hesitant to honour this pricing strategy as it can reward labour instead of efficiency.

Project-based pricing

The second of these simple models are project-based pricing, which can be used in tandem with the hourly model.

Project-based or 'flat-fee' pricing is the most common model. Someone asks you how much a website costs, you tell them $4,000, and you charge them $4,000 regardless of the time or cost involved. However, with this method, we often underestimate the effort required and end up with excessive changes or unexpected problems. This means a loss in profit or an awkward request for a budget increase.

Project-based pricing can be profitable, and it's a step toward value-based pricing and higher profit levels. If you do similar work for similar clients routinely (e.g. WordPress websites for restaurants), you can cut costs and increase profit with this approach. It can also work well if you're good at time estimates, but most of us aren't.

You want to use this approach if: 

  • The client asks about money a lot up-front
  • It's clear you can get the project done faster than the client's estimate.
  • What you're pricing: Pricing packages don't have to be for deliverables, they can also be used for things like workshops.

A project-based pricing strategy is the opposite of hourly pricing — this approach charges a flat fee per project instead of a direct exchange of money for time. It is also used by consultants, freelancers, contractors, and other individuals or labourers who provide business services.

Project-based pricing may be estimated based on the value of the project deliverables. Those who choose this pricing strategy may also create a flat fee from the estimated time of the project.

Retainer pricing

A retainer is the closest thing to a regular paycheck; it's a pre-set and pre-billed fee for a time period or volume of work. This can be based on time – for example, the client agrees to buy 100 hours per month at $100 per hour, for a total of $10,000. Alternatively, it can be based on value. In this case, the client might specify the features or deliverables they need, and pay $10,000 per month for this work, regardless of exactly how long it takes.

There are two types of time-based retainers: rolling and use-it-or-lose-it. In a rolling retainer, clients rollover any unused hours to the next month. In a use-it-or-lose-it retainer, any unused time is lost, and the balance resets the next month. Don't offer rolling retainers; you'll end up doing meaningless work just so your client can burn through the hours.

You will find a maximum hourly rate a client is willing to pay. Value-based retainers enable you to scale your skills instead of your time, which means you can increase your profit. If you can reduce the time it takes to produce a chunk of code, you are no longer penalised for the increased efficiency. You are paid the same amount regardless of how long the job takes.

Perceived value

Often you'll be called upon to detail how your work is 'worth more' to the client than the work of others. There are ways to quantify value, but the mentality has to change from what the client values to the client valuing you and your expertise. This means you have to demonstrate expertise, competence, and the ability to understand their problems quickly.

Value-based pricing

Value-based pricing calls for a less traditional client relationship. At Nine Labs we call it growth-driven design and our clients love it. 

The crux of value-based pricing is ensuring the client is satisfied; they paid for what they received. Two clients may pay a different price for the same work. But they aren't paying you for your time; they're paying you for solutions. And those solutions are worth more to some clients than others. It's driven by customer demand and their willingness to pay. The strategy is based on three components, which we'll look at now.

What will your market bear?

Consider the limits of both your local market (where you do business) and your horizontal market (what you do). You can get granular and define your market as 'custom logo designs for consumer brands'. You need to find out what your competition is charging for similar work with clients of similar size. So how do you do this?

  • Ask: You'll be shocked at how many people will tell you
  • Go where the clients are: Instead of networking with other creatives, go to client events and trade shows and ask them what they paid
  • Get involved: Go to conferences, join trade associations, and sit in round tables and talk about pricing
  • Monitor: Set up alerts for freelance pricing guides and pricing surveys

What is the best pricing for differentiated businesses?

Dolansky says entrepreneurs often used cost-based pricing because it's easier. They may also copy the prices of their competitors, which, while not ideal, is a slightly better strategy.

In an ideal world, all entrepreneurs should use value-based pricing, Dolansky says. But entrepreneurs who sell a commodity-like service or product, for example, warehousing or plain white t-shirts, are more likely to compete on low costs and low prices.

For entrepreneurs offering products that stand out in the market—for example, artisanal goods, high-tech products or unique services—value-based pricing will help better convey the value they offer.

Package pricing

Package pricing can get a business up and running, but it can also result in your services being viewed as a commodity. Putting your prices out front before you've analysed the client's problem puts your needs (money) above theirs (effective solutions). 

You've removed the ability to find pain points and address them directly because you have fit their problem into your process. If your package pricing includes discovery and analysis, that won't be as big an issue.

Here are some examples of different package pricing options:

  • Brand package: A logo, website and business cards at one fixed price
  • Template customisation: Customised website themes for WordPress
  • Consulting workshops and day rates: Aimed at public or private audiences
  • Analysis or reviews: Analysis of existing projects at a fixed cost, including a report
  • Photoshoots and videos: A certain number of shots or amount of time

You can also offer price ranges (for example, 'CMS-based websites range from $5,000 to $20,000'), or consider minimum project costs. 'Projects start at $10,000' indicates you will not accept projects that are less than $10,000.

Performance-based pricing

Value-based pricing and performance pricing aren't the same things, here's the difference

Performance-based pricing means to base your fee on the performance of your work. You must affect a measurable outcome for your clients, such as higher revenue or increased efficiency. It's often tied to analytics, so it's common with web or application design, and with ad agencies and SEO experts that can measure media impressions.

You must have a bulletproof contract with clear metrics and clear terms – if you don't have legal support, don't use this model. It can result in great working relationships that closely align the buyer's goals and the seller's goals, creating the ultimate bond between you and your client. It's near-impossible to under-price yourself, as long as your metrics line up.

Equity pricing

You may be offered a stake in a business in exchange for your work, either in lieu of any cash payment or as a mix of equity and reduced cash payment. This approach is good for side projects or small engagements, but not if you're giving up a large number of cash bookings or clients and you need the money now.

Cost-based Pricing

This is perhaps the most common way to price the products that you take to market. With this model, you are going to use the cost of production as the basis for the final price that consumers see when they make a purchase. The multiple that you use to price your goods is going to depend on the industry in which you are working. Some industries see multiples around 2-3 times the cost of production, while other industries are around five times or higher.

For example, imagine you are in an industry which tends to sell products for around three times the cost of production. If you have determined that your average cost on one unit is $10, you will naturally look to sell the item for around $30 (if using a cost-based model). Multiplying your cost by three is a great way to get in the right ''neighbourhood for your pricing, but you can then tweak the final number until you hit a spot that you feel is a winner. For instance, if you see that many of your competitors already sell for $30, you may decide to move down to $27 or $28 just to have a slight edge on price. Or, if you think your product is of a superior quality to the competition, you could set your price at $35.

Market Pricing

As the name would indicate, this pricing model is all about the market conditions that you find around you. Fortunately, in the internet age, it is relatively easy to determine market pricing for just about any product or service. A quick internet search should lead you to the prices of your competitors, and you can then react appropriately. Trying to sell a product that falls well outside the market norms for pricing is always going to be an uphill battle, so the market pricing model is a smart one to use.

It is worth noting that using a market pricing model doesn't mean you always have to be the lowest priced product available. In fact, you might intentionally decide that you want to be the most expensive version of a specific type of good. The price that you choose relative to the rest of the market should match up with the marketing strategy you are using to reach your customers. If you are marketing your product as high-quality, it will make sense to have a higher price. On the other hand, if you talk about great value and affordability in your adverts, you better come in on the low end of the spectrum.

Portfolio Pricing

This is a great model to use if you are offering a service – or, more specifically, a selection of services. In the portfolio pricing model, you are going to set up a pricing structure that makes sense throughout your product or service line. For instance, if you run an accounting agency, you may offer basic tax preparation services for a certain rate. Then from there, your more advanced accounting services move up the pricing scale. It makes sense to price out all of your services in this way so that each of your customers feels they are getting a good deal.

Providing more service for less money would never make sense to your audience, so keep the portfolio pricing model in mind when structuring your overall price strategy.

Freemium Pricing

The last model on our list is one that will only work for a specific segment of the market. In freemium pricing, you give away your base service or product for free, in the hopes that satisfied customers will decide to pay for more advanced features.

This is a pricing model that is commonly used in the software world. A basic version of a piece of software may be made available to everyone for no charge, while an advanced version can be purchased for a flat rate (or a monthly subscription). Obviously, you can't use this model if you are in the business of selling sandwiches or something similar, but the freemium plan can work perfectly for some industries.

There will always be a feeling of nervousness when you take a new product, with a new price, out to market. Even with the use of great pricing models, you can never be quite sure how consumers are going to react. To give yourself the best possible chance at success with your pricing decisions, be sure to consider the use of some of the models listed above. Also, remember one key thing with regard to pricing – your prices can always be changed. If your first decision was not spot on, feel free to adjust as you go until you settle on a price that strikes a balance between affordability and profit margin. As you gain experience with setting prices, and as you learn more and more about your market, you should become highly accurate with most of your pricing choices.

How will your track record affect your pricing?

Your past experience will affect how much you can charge. If you have extensive experience with a particular type of client, technology or style of design, then you fall into the 'expert' category. Experts can charge more for their services. Clients see that hiring you means that they're more likely to get desirable results.

Success depends on where the company is at the time you get involved. If it hasn't received any outside funding, your ownership could be diluted once it does. If it has, you're going to be offered little equity, probably less than 5 per cent. If the company is funded but can't offer you partial cash, it's not worth it unless you plan to go and work there full-time.

Money can be messy, but it doesn't have to be. The key is to avoid getting emotional about pricing. No two projects or clients are the same, and there has to be a method to the madness. The sooner you get control of your pricing strategy, the sooner you'll find profitability. 

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