How should a company price for services?

Rodney Davis: You know, people often struggle with how to price services, it’s something that in my career, I’ve been in the service space almost as often as I’ve been in the product space, so I have a very keen sensitivity to how you price services, and one thing I try to tell entrepreneurs all the time is, valuing a service is always down to how much time it takes to deliver that service. 

And so, unlike a product where you set it, and the machine runs and therefore it’s very predictable, the time it takes to deliver that product, and therefore the underlying materials that go into it and associated costs. In services, you have to manage the resource to deliver that service in as efficient and way possible. So on pricing services, at the end of the day it’s time and then whatever else goes into delivering that service.

Well, what I tell clients or what I do when I price, is first you figure out what it’s going to cost you to deliver that service. Then you determine what margin you’d want to make on that delivery service, just like you would for a product. As in products, at the end of the day, you have to then compare that to what the market will pay.

So if you, and the reason why that exercise is good for many entrepreneurs is once you’ve priced what that product should cost based on your service delivery costs, you realize whether or not you’re efficient or inefficient, because it indirectly tells you you’re reasonably efficient. So I tend to price independent of the market first, internally, and then compare that to what the market rates should be for that service.

And if I’m way off on the market, either high or low, it might mean I’m either way more efficient than the market, or way more inefficient than the market, and then I have to go back and look at my service delivery model, but at the end of the day, the market dictates everything.

In some cases, if a person costs you $10 an hour, for example, it’s not uncommon for when using very simplified metrics to have that person charged out at a billing rate of somewhere around $30 an hour. If you’re paying somebody $40 an hour, it’s not uncommon to have a metric that says the billing rate for that person is $120 an hour.

So it’s typically a three to one ratio for most professional services, in terms of what that rate should be, but then again, you’re guided by the market and you’re guided by the level of efficiency in delivering the service. 

What if the value of the service is worth more than the hourly rate?

Rodney Davis: That’s where the market prevailing rates are incredibly important, because I might deliver a service that takes me three hours in time, but my 40 years of experience in dealing with matters similar to that enabled me to do that in that amount of time, whereas somebody with far less experience who’s at a similar charge out rate might take three or four times that, because it might be a new industry to them, or it might be a new problem that they’ve not yet encountered.

And the important thing about that is that whatever it is you ultimately charge the client should be agreed upfront. When you’re in the service industry, you should not be trying to figure out what you’re going to get for a service after it’s been delivered, because once it’s been delivered, it’s gone. The benefit of it to the client is either already received, or the cost of lowering that service has already been incurred. 

Is it fair for a client to pay for every hour of service?

Rodney Davis:  The law profession, still is one of the few remaining professions that just bills by the hour and they expect to be paid for every hour. That they deliver regardless whether or not they’ve operated efficiently or not efficiently. There have been some firms that have come in with a block-based pricing for M and A activity, for financing activity or for particular corporate services that they provide, but by and large, the legal industry still does charge by the hour at the stipulated rates. It’ll be interesting to see how that’s evolved.

It’s evolved quite a bit in the last 30 years, I know, if you were looking at this question 30 years ago about the law profession, the accounting profession, to some extent the engineering profession, they would have all said, we get full billing for whatever we bill, in terms of hours.

In industries like I.T and marketing and advertising haven’t had that luxury, they definitely don’t get to do that for their clients, never have, and probably are better at pricing than the other three, so as competition has seeped in, I’ve known a few law firms that have really struggled with the idea of not being paid for every hour. 

And in fairness, I think from the law side, it’s complicated for a client to understand what the scope of an engagement might be, it’s complicated for client or a lawyer to predict what may or may not unfold in a legal matter because of the amount of things that are outside of the control of the client. It’s very hard as a client to walk into a relationship where somebody says, I know where you want to get to, there’s a lot of moving parts in getting you there so I can’t tell you what it’s going to cost, but whatever it does cost, I need you to make sure you commit to paying me for that,

I mean, think about that as a consumer if you went to buy products, as opposed to services, how you would react to someone saying to you, I could sell you this ball, but I’m going to have to let you know later how much you’re going to pay for this ball, you’re going to be like, it’s still a ball at the end of the day, the service that I’m being delivered, it can be defined, and to the extent that it can be defined, you should expect a lot more or pushback from a client about unknown pricing.