As we help new Aero Workflow customers set up their accounts, we always have a discussion about how they price their services so we can help them maximize the value of Aero’s reporting. It’s always a long discussion because “Fixed-fee” and “Value Pricing” can mean different things to different people. Based on our discussions with thousands of accounting and bookkeeping firms over the last five years, we’ve come up with definitions for a variety of pricing strategies and some pros and cons of each one.
Hourly billing is the simplest pricing method. The firm charges customers an hourly rate for its services. It states its rate upfront and then bills customers after the work is done for the number of hours spent on the work.
The most obvious “pro” of hourly billing is that it’s easy to implement: a firm calculates its hourly cost, adds the desired profit margin and arrives at a billing rate. This allows the firm to guarantee a minimum margin. It also makes it easy for the firm to calculate metrics like income per partner or job costing by team member.
However, there are some downsides to billing by the hour. An increase in efficiency necessarily means less income (although that is sometimes offset by a higher margin). Accurate time-tracking is essential but can become burdensome without the right software tools. Because customers cannot be billed until after the work is performed, the firm is vulnerable to write-downs or write-offs. Clients don’t like surprises and will often balk when the bill is for more time than “it should have taken.” Perhaps the biggest downside to hourly billing is that it limits the firm’s income to the number of hours the owner and staff are able to work.
Fixed-fee pricing is when the firm prices its services at a fixed rate regardless of the amount of time spent on the work. Services are often bundled together into ‘packages’ that allow a customer to choose a service level and price that works for them. Firms price their services based on internal metrics and perhaps market research, rather than the time it takes to perform a service. Fixed-fee services can be billed before or after the services are delivered and can be one-time fees or regularly recurring. Fixed-fee pricing sometimes means that the firm charges all customers the same amount and may even post prices on their website.
Charging clients on a fixed fee basis rewards a firm for increases in efficiency by improving margin without changing income. Because the amount of time spent on work is transparent to the customer, increases in efficiency are seen as value-added rather than ‘gouging’ (wow – I’m paying the same amount as before, but now my monthly reporting is ready 10 days earlier!). If the firm bills its clients before the work is performed, fixed-fee pricing can eliminate Accounts Receivable with all its associated headaches. And clients love the certainty of knowing ahead of time how much services will cost.
The big downside to fixed-fee pricing is that the firm’s income is fixed, but costs may not be. Poorly priced services or a lack of cost control (the dreaded scope creep) can result in a decrease in profits. Systems like Aero are designed to help firms manage fixed-fee services, but the firm has to be aware of the pitfalls to prevent problems.
Wikipedia defines value pricing as “a pricing strategy which sets prices primarily, but not exclusively, according to the perceived or estimated value of a product or service to the customer rather than according to the cost of the product or historical prices.” The price of the services is negotiated ahead of time. Value priced services can be billed before or after the services are delivered.
The upside of value pricing is that there’s potential for greatly increased income. If a firm is offering services that are highly valued by its customers, it can really increase profits with value pricing. If a fixed price is agreed upon, value pricing can offer the same benefits as fixed-fee pricing: efficiency is rewarded, AR can be eliminated, and clients like the price certainty.
There are downsides to value pricing as well. Cost overruns can reduce or eliminate profits. Communicating the value of their services can be a challenge for firms that don’t have a lot of expertise in sales. And figuring out how to arrive at a price that reflects the value to the customer can seem a little like crystal-ball gazing.
Multiple pricing strategies might be best for your firm
Very rarely do we run across a firm that follows one pricing strategy 100% of the time. Firms generally utilize two or more strategies, depending on the situation. A firm that is generally fixed-fee may charge by the hour for some services (most often for services like catch-up, clean-up, and GL conversions). Firms that charge by the hour often use value pricing to set their rates. For example, a firm may charge $50 an hour for monthly bookkeeping services but $200 an hour for CFO services. The same person might be performing the work, but the value to the client differs, so they can charge more for the CFO services. Or a firm that usually charges based on fixed-fee packages might value price special consulting projects and charge by the hour for training.
What is your pricing strategy? Share it in the comments, we’d love to hear about it!