When you sit on a sales call with a potential new client, feeling good about how well you presented and how much better you were than everyone else, and then they ask the one question, "What's your blended hourly rate?"
That is the moment that you lose the sale.
You are no longer selling a solution to their problems or business transformations, but instead you have entered the world of the "hourly rate game."
You are now on a list of 3-4 other agencies who all do the same thing as you do. Your only hope of getting picked is for the buyer to pick the lowest price from the list of agency's prices.
You have fallen into the commodity trap.
To escape this commodity trap, you must change the way you value what your agency produces and services. This will require more than just using the word "premium" on your website.
Many times in the industry when people write about pricing, they do not go deep enough.
There is a tendency for them to view pricing models as generic-type documents, and they tell agency founders to "sell value" and "not sell time," without discussing the dangers of cash-flow problems associated with outcome-based pricing when scope is unstable.
Also, there is no discussion of the conflicts that arise from what is in the compensation plan for the sales team versus what the agency has in its profit architecture.
We need a better framework for agencies and agency owners.
In order to move from being pressured by pricing to being empowered by pricing, there must be real decision criteria applied to the decision regarding pricing, based on risk, stability of scope, and measurability of outcomes.
Quick summary
Agencies are typically commoditized when their pricing structure encourages direct comparison.
To break out of this "pricing pressure" cycle, agencies need to remove the connection between fees and the time spent on work.
When agencies use broad positioning, they create a "sea of sameness," and the only option left for differentiation is price.
When using time-based billing, margins are limited and an adversarial relationship is created with your client.
Choosing a pricing model is simply a way of allocating risk.
Evaluate whether your project has enough scope stability, whether the outcome of the project can be measured and whether your pricing model is commercially fluent prior to quoting a fee.
If your project involves a great deal of variability or low measurability, avoid forcing value-based pricing onto these types of projects.
Adapt as we move into an era where Artificial Intelligence is going to drastically decrease the execution time of executing projects. Agencies that use time-based billing will have their revenue decrease substantially unless they adapt to deliverable or outcome based pricing models.
The cause of agency commoditization
A buyer will consider your services instead of your competition's services as being interchangeable when the buyer perceives an alternative service as being "identical" to your service; therefore, cost is the sole criterion for determining what to purchase.
How are agencies so often blind-sided by this situation?
Time-based billing justification
The basis of agency operations today is time-based billing, which is the greatest flaw in traditional agency operations.
Time-based pricing leads to two significant problems:
- Efficiency penalizes an agency. If an agency implements extensive internal processes to improve its efficiency, it will receive a reduced price from time-based billing when it invests in highly skilled staff and technology (i.e. AI, etc..) to create an outstanding campaign in a shorter time frame than what an agency would typically pay.
- Clients become auditors of time sheets instead of assessing the effect of the work produced. Clients evaluate time sheets (i.e. whether the junior designer required 4 hours to create a logo) rather than evaluating the value of the agency's services. Thus, the conversation between the agency and client becomes focused on cost control instead of
Broad positioning - The sea of sameness
When your agency's positioning is generic like "A full-service digital marketing agency that helps modern brands grow", you leave yourself wide open for commoditization.
When agencies are not specialized (either by vertical or by business model), or employ a distinct method of operation, they have lost the leverage to charge a premium price.
Premium pricing requires scarcity.
If a buyer believes that they can find 50 other agencies to conduct a basic SEO audit, or build a basic Shopify site, they will control the purchasing process.
Buyer-controlled purchasing
When agencies do not have an established position in the market, the buyer will dictate how the Agency will engage with them.
Because of this, many buyers have created large RFPs (Requests for Proposals) that contain very detailed line-item breakdowns, blended hourly rates, and fixed price caps.
These buyers have also set up their procurement departments to require all vendors to submit their pricing in the same format (i.e., standardized spreadsheets).
Procurement is using these standardized spreadsheets to take away any nuances between agencies and to force agencies into a direct, head-to-head cost comparison.
Accepting the buyer's standard pricing spreadsheet means that you have essentially accepted commoditization.
Core pricing factors for agencies
Creating a value-based pricing strategy is not something that happens overnight.
Declaring that your agency is going to be a value-based agency on a Monday, only to go bankrupt by Friday, will be a very quick, but painful learning experience.
Pricing strategies for agencies are essentially an ongoing process of Risk Management.
There is no one-size-fits-all model for establishing a proper pricing strategy for a specific engagement; all pricing strategies must be determined based on the circumstances surrounding the engagement.
Before sending a proposal to a client, Agency leaders must consider three Operational Criteria that must be strictly adhered to in determining the Agency's pricing strategy for that engagement.
Outcome measurability
Will the results of the agency’s work be able to be separately identified and quantified in money terms?
When a Performance Marketing Agency carries out direct response advertising on a CPA basis, it will be easy to quantify both the ROAS and the CAC. There is a clear return on the advertising cost, making it possible to have Performance Pricing or Outcome-Linked Pricing.
However, when a Public Relations Agency carries out a corporate reputation campaign, it will be almost impossible to quantify the exact financial return for a specific press mention.
Attempting to charge based on the value received is fraught with danger due to the potential for endless debates over where and how the value is derived.
Scope stability and predictability
Will the scope of the project remain stable throughout execution?
Creating a standard lead generation website using an existing set of brand guidelines provides a high degree of project scope stability. In this instance, both the deliverables and fixed project fee are readily identifiable.
However, if the project is for an all-encompassing digital transformation and software integration and the customer does not have an agreement on the internal workflow, there is a very low chance that the project scope will remain stable.
In this case, a fixed fee contract would likely be a recipe for disaster.
The agency would incur costs as the scope expanded and, therefore, it would need either a very strict time-and-materials safeguard or an Agile/Sprint-based pricing model.
Commercial fluency and risk appetite
Will the agency be able to manage the risk of receivables?
In executive value pricing arrangements, the agency is assuming most of the client’s risk. By agreeing to a lower base fee and receiving a percentage of the client’s gross revenue growth, the agency is making an investment in the future success of the client.
Agencies that are struggling financially, or that do not have super efficient project management processes in place, risk crippling their ability to pay staff when using high-margin pricing models.
Agencies must have a strong handle on their utilization rates, delivery costs, and cash flow before taking on risk using outcome pricing.
Operationalizing the models - Trade-offs and examples
Without execution, theory is useless!
Below are some examples of how modern agencies have been able to effectively operationalize pricing strategies into actionable operational models, including the messy aspects of how packaging and language works.
The low-stability strategy retainer
Scenario: A high-growth tech startup hires a Strategic Advisory Agency.
The Tech Startup has pivoted its product and is going to be changing the exact deliverables it expects from the advisory agency on a month-to-month basis.
This situation creates a risk for both parties regarding fixed retainers.
If the agency's contract states that they will provide "three strategic initiatives each month" for the same flat fee, the client will invariably want to push the boundaries of what constitutes an "initiative."
As a result, the scope will expand, and the margins for the agency will completely collapse.
The solution for this situation is to use capacity-based sprints to define the engagements.
The agency should not define each deliverable, instead, the pricing is based on a defined period of access to a specialized team.
Proposal Translation - "The monthly advisory fee of $15,000 guarantees you one dedicated strategic sprint each month. A dedicated strategic sprint consists of two weeks of intensive work by our senior strategy experts, working together as a team. Every month, we will work together to determine your priorities for the month's sprint. All additional work that occurs during the dedicated sprint will carry over into next month's capacity to keep your budgets fixed while creating full flexibility in your priorities."
This approach allows the agency to maintain their margins.
Mixed strategy and execution bundle
In a mixed strategy and execution bundle type scenario, an agency provides high-value strategic positioning for clients but also executes many lower-value items (such as blog posts and social media posts).
Unfortunately, one of the pitfalls of this type of service is mixing the rates between the two.
That means if an agency lumps together both the high-valued strategy and low-valued execution into one fee (regardless of how much each was valued), the client will likely compare the total fee to other agencies (for example, overseas agencies that only provide low-valued execution services).
The remedy for this is to separate the intellectual property from the manual labour.
Have a significantly higher fixed fee for the strategic portion of the project and diagnosis. Then have a subscription to a standardised rate for the execution of the project.
In the example proposal below: Phase 1 consists of the "Strategic Architecture." This phase has a one-time fixed cost of $25,000 for rebuilding the go-to-market engine.
For Phase 2, execution and rollout post-strategic delivery will be handled by a flat-rate subscription fee of $6,000 per month, covering up to four specialised assets each week.
By breaking out the strategic component of the proposal from the execution component, the agency isolates the commodity pressure on execution.
If, after Phase 1, the client decides to find a less expensive execution provider, they can do so; the agency will still have captured the high-margin strategy fee upfront.
Hybrid pricing for ongoing executors
Another pricing strategy for ongoing executors, such as CROs, is to price it based on their value linked to the client's success.
For example, if a CRO enables a client to redesign its checkout flow and the redesign results in an additional $3 million in annual revenue, the agency will have left massive amounts of profit on the table if it only charges a standard amount for the project (for example, $20,000).
Hybrid pricing for value maximised through the use of a CRO is a better option.
The starting fee to cover operational costs is your baseline, and then you will take a percentage of the additional sales generated.
The important factor here is that the agency must establish clear parameters around the attribution of sales generated by the agency's services.
This proposal is titled "Base Implementation Cost: $15000" – this is the base fee for implementing the technical aspects of the client’s checkout process and the revenue the agency will receive (benefit) for successfully executing their services.
The agency will receive a 5% revenue sharing on any new sales generated by the new optimized checkout process compared to the average earnings over the first twelve months of the new conversion rate.
The agency will maintain this relationship for a period of six months (period of performance) after the implementation of the new checkout process.
Thus, the agency will be able to increase their revenue by creating better opportunities for sales, and in doing so, both the agency and the client benefit from increased revenue.
The agency keeps enough cash flow to continue paying their payroll.
Value-based pricing flaws
There is a good chance that every marketing agency on the internet will find themselves inundated with consultants, bloggers, and authors claiming that it is time for every agency to switch to value-based pricing.
This rhetoric is promoting a very dangerous way of thinking about pricing for the majority of the time.
Pricing based on the perceived value of what your services will deliver is very subjective and should only be used in very specific instances.
In most cases, if you try to base your pricing on the value of the end result, you are putting yourself at great risk by making an assumption that may prove to be incorrect.
What if the environment is unfairly controlled?
If your agency has no control over the end result of your work, do not try to price based on that result (what pricing based on result), it is a trap.
Consider an agency that provides lead generation for a very complicated B2B Software Company. The agency delivers numerous high-quality leads to the client’s sales organization.
However, does it matter how many high-quality leads are provided if the client sales organization cannot close business or if the client company has a product problem (the customer) that creates enormous shut off and churn of customers?
If an agency is compensated based on sales revenue, the agency takes on a significant amount of risk when many of the problems associated with the sales of that business are beyond their control.
Therefore, in these types of situations, agencies should price based on what the agency controls (clients' bases or earned leads or meeting booked with qualified leads), and not the ultimate business outcome.
Cash flow problems stemming from outcome pricing
With outcome-based pricing, the agency inevitably suffers from delayed payments on the work they produce for the client until the time the outcome is achieved.
A client may want to reward their agency with a bonus based on their year-over-year sales growth for the past year, but in order to meet that goal, the agency has to cover the cost of providing that work for 12 additional months.
Most agencies that are small to mid-tier do not have the cash flow necessary to support financing all of the work by an entire team of highly skilled Senior Creatives and Media Buyers for 12 months while waiting for a value based payout on the bonus.
For a smaller agency with limited resources, being able to successfully and consistently produce deliverables that are equal to what they have spent on that work can be much more beneficial than attempting to estimate what they would earn from that work based on a value pricing model.
Evolving technology and procurement processes and defending your fees
The way in which agencies price their services is changing rapidly due to the advancements in technology and the development of more sophisticated corporate purchasing departments.
Responding to pushback on pricing
Corporate buying departments have a method of taking an agency's proposal, breaking the proposal down to its raw material components, and determining the costs associated with each of those components.
Inevitably, they will want to know, "What is your hourly breakdown for this project that is $100,000?"
If you provide that information, you will have entered into the commodity trap.
The best way to avoid this situation is to politely disagree with the premise of their question, and instead refocus the conversation on risk and outcome.
When asked for hourly breakdowns, the successful agencies explain their operational model. They clearly state that they base their fees on the value of their intellectual property, the specialized processes they utilize to ensure successful delivery, and the risk they are transferring to their clients.
They specify the boundaries of scope. This includes what is included in the scope and how to handle situations when changes happen.
At the same time, they protect their internal margin structure by not itemising the hourly time spent on each task.
AI delivery disruption
Artificial Intelligence (AI) is about to destroy the hourly fee for agencies that only charge based on hours worked.
In the past, if an agency charged $150 per hour for a copywriting project that took 20 hours, the agency would have charged $3,000 for that service.
Today, using a combination of advanced language models and automated research workflows, a team can do that much better work in just four hours.
Thus, if the agency continues to bill using an hourly rate, the revenue that the agency would have brought in from that service drops from $3,000 to $600.
The agency has just lost its profit margin through the use of modern technology.
Agencies must now shift to Fixed Fee pricing, Deliverables based pricing, or Outcome based pricing.
When a client pays for a finalisation, the client is purchasing the final asset and its strategic oversight, not the number of keystrokes required to produce it.
The separation of time from money is no longer a nice-to-have; it is a matter of survival.
Tactical proposal structure
How you present your price will dictate your client's reaction to it.
That is why agencies that are stuck in the commodity trap, present a single price in the bottom of the long proposal.
This creates a binary decision for the buyer. Either they are going to buy or they are not.
This methodology lacks the ability to provide the buyer with a choice.
Agencies that are at the premium end of the spectrum; use Choice Architecture. They provide three separate tiered pricing options in the same proposal.
Option A is the core execution of the service.
Option B provides the service plus strategy, execution, and advanced reporting.
Option C provides all of Option B plus rapid response service level agreements (SLAs) and dedicated senior partners as well as complete team training.
By offering three options to the client, the psychology of the client changes.
They used to ask "Should we hire this agency or one at a lower price point?"
Now they instead ask "Which tier of service should we purchase from this agency?"
By changing the question, they have realigned their focus from comparisons with other agencies to comparisons with tiers of service offered by the agency itself.
Conclusion
Agencies are not commodities
Agencies have successfully allowed themselves to be perceived as a commodity because of poor marketing practices.
Fear of being rejected by potential clients combined with the use of outdated pricing methods has resulted in a devaluation of agency services by many agencies.
To avoid falling into this trap, agencies must develop a culture of operational excellence.
This requires having the strength to not accept revenue from a client if the client is attempting to force the agency into a "race to the bottom" situation.
Additionally, agencies must restructure their sales compensation programs so that account executives are compensated based on the margins generated by their sales rather than just on the total revenue generated by their sales, which may not leave enough money for the agency itself to operate.
Pricing power reflects an agency's ability to establish the value of its services, limit its exposure, and ensure that buyers do not dictate the terms of the agency's operations.
Frequently Asked Questions (FAQs)
What is a good approach for transitioning legacy clients?
Don't try to change them all at once; create a plan for an incremental, strategic rollout of the new pricing to legacy clients.
Start by exclusively implementing the new pricing model to new clients. This gives your team confidence in the new model and creates a financial "safety net" for your organization.
For established customers, find simple transition points to facilitate a transition between existing rates and a pricing structure (for examples, contract renewals, a major change in project scope, or the introduction of a new service line).
Frame the transition using client benefits of having predictable budgets, shorter turnaround times, and aligning project objectives with client strategy.
However, if a customer is firmly against moving from a loss-generating hourly pricing structure, assess the profitability of retaining that customer as a client.
How do I deal with scope creep in a fixed project fee?
Scope creep is usually caused by poor writing, not by the customer's needs.
The agency must detail everything that is not included when defending a fixed fee. A clear definition of what's included and what's not is absolutely necessary.
Create a strict change order policy. Provide an outline of the project's initial scope, including the number of revisions permitted (and any limits for each phase of the work).
If the client requests work that falls outside of the initial scope definition, the project manager should stop all work and request the client sign a change order for additional cost before proceeding.
Does hybrid pricing work for agencies that specialize in offering only one service?
Absolutely. In fact, it is one of the most secure ways to do business.
An SEO company, for instance, may perform a full technical audit and reconstructing of a client's website, charging a substantial fixed price for this service.
Once a client has received that initial work, it is possible for the SEO agency to transition to a hybrid contract whereby it would charge a flat monthly retainer for ongoing content optimization support and tie that retainer to results (performance bonuses) exceeding defined benchmarks for organic search traffic and qualified leads.
Receiving a monthly retainer establishes a stable revenue base while at the same time allows the agency to realize the financial benefit of its specialization.
How do agencies adapt their compensation systems for new pricing models?
This is probably the biggest internal reason for failure.
When an agency shifts from selling quantity of sales to selling high-profit margin strategy while continuing to pay the sales force a standard commission on all closed business (regardless of the profit margin), the system fails.
Salespeople, in their desire to close the deal at any cost, will price the strategy products/brands at losses to obtain the sale and destroy the profit margin before the actual project begins.
The compensation plan should incorporate the profits of each deal within the commission structure in order to ensure that commissions reflect the profit margin on the deal being sold, and/or provide incentives (bonus opportunities) for selling high-margin, standard deliverables over low-stability/custom contracts.
Finding ways to align the financial incentives of the salesperson with the agency's pricing strategy is essential.