By I’ve noticed that customers generally fall in one of two categories. On the one hand you have the customer who is willing to pay the most, yet they demand the least. And on the other, you have the customer who will always insist on paying the least, but usually demands the most.
And for marketing agencies trying to establish themselves, that’s where the problem begins.
How do you price your services? Which type of customer do you target? Do you choose to have one standard price for everyone or do you choose to go with a more dynamic pricing model?
The truth is, it’s quite complicated to find oneself in such a situation. What every agency must strive for is to get customers on board that pay them well and go on to become long-term retainer clients that can act as their LIGHTHOUSE clients, and who will effectively do all the work for them.
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The rule of 2,000 in agency pricing
The rule of 2,000 in pricing is absolutely key for marketing agencies to understand how much they should be charging their customers, which in turn helps them determine their revenue.
There might be instances where you have to enter into negotiations with customers on the fly where they ask you how much you would charge them for your services on an hourly basis.
Using the rule of 2,000, however, even if you’re not skilled at Math, you can have a quick workaround at your disposal that will help you in such situations when making crucial decisions.
It starts with assuming that when a customer hires your marketing agency, you will work 40 hours per week for 50 weeks in a year, excluding two weeks for vacations and other things.
Therefore, 40 hours x 50 weeks = 2,000
Now, this is where it gets tricky. As an agency owner, you must determine beforehand, by looking at your balance sheet and other expense statements, how much revenue you need to generate annually in order to sustain yourself and your agency.
So, let’s say that you determine that you need to make at least $100,000 a year. Keeping the rule of 2,000 in mind, this means that your hourly rate comes out to be:
$100,000 / 2,000 = $50 per hour
Therefore, the next time you’re amidst a crunch negotiation with a customer where you have to make a split-second decision of telling them how much you would charge them by the hour for your services, you can use the rule of 2,000 and have an answer ready.
Furthermore, if during such a negotiation, depending on the scope of work that is being discussed, you suddenly realize that $100,000 might not be enough and you need $200,000 for sustenance, you can quickly do the Math and determine your hourly price to be:
$200,000 / 2,000 = $100 per hour
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Say ‘no’ to an hourly price structure
Even though I’ve talked about the rule of 2,000 and how it is a robust strategy that will help agencies during their quick negotiations with customers, I can’t emphasize enough how much having an hourly pay structure actually does more harm than good to agencies.
Don’t get me wrong; while charging customers on an hourly basis is a great way to start when you’re just a freelancer or a consultant, in the long run it’s the worst strategy to bill customers.
Firstly, an hourly pricing structure does not allow you as an agency to leverage the value that you’re providing a customer. You’re effectively trading your time for money and there is no way for you to charge for an idea that you may have had while you’re on a holiday and not working.
Secondly, as an agency, it’s vital that you always show customers that you're aligned to help them make a profit at all times and are committed to serve them towards achieving their goals. Having an hourly structure does not allow you to do so since you won’t be working half the time.
And last, but not least, when you choose to be on an annual retainer structure, you’re basically asking your customers to look at your agency as an investment, rather than a monthly expense. Therefore, if a customer decides to leave your agency earlier, you’re not at a complete loss.
Before we get into the benefits of having a retainer price structure for your agency, let me ask you a question. What do you think is the ‘per hour’ price of a freelance marketing consultant?
According to a survey, a freelance marketing consultant charges $41 an hour on average.
Therefore, taking the rule of 2,000 into consideration, that comes out to be $82,000 per year. That’s not bad, right? For a freelancer to make over $80,000 a year seems pretty decent.
However, what people tend to forget is that a freelance marketing consultant will not work full time for those designated 40 hours a week for 50 weeks a year. There will be other customers and time lapses since not everyone works on one thing all the time.
As seen in the image above, the average utilization rate for a freelance marketing consultant is 53%, which means that they would only work a little over 50% of the time for a single customer.
Which is why, due an hourly pay structure, the annual revenue actually turns out to be $43,460 and the hourly rate works out to be approximately $22, which is a little over half than before.
Similarly, in the case of marketing agencies, the average hourly rate that they bill customers is $125 and the average utilization rate for them is 60%. This means that agencies work only 60% of the time with a single customer and, therefore, their hourly rate works out to be $75 instead.
What this means is that if your agency has determined that in order to sustain itself it needs to make around $250,000 a year by charging $125 per hour to customers, you’ll be in for a shock.
You might sign a contract stating those figures, but in reality you won’t be able to honor it.
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Say ‘yes’ to a retainer price structure
Having a retainer price structure not only delivers value to an agency since it provides them with a sense of security with regards to work, but also proves to be valuable to customers since they are assured that they can depend on the agency at all times instead of just specific hours.
However, the simplest reason behind a retainer pricing structure working best for digital marketing agencies is that the current pricing model that they have is completely broken.
What this means is that most of the agencies go out of business within a few years of starting up because they don’t have a robust pricing strategy in place to help sustain themselves.
Because agencies are under constant pressure to get new customers, they end up over-promising and under-delivering. This means that they end up spending more time IN their business rather than ON their business, which hurts them in the long run.
When it comes to digital marketing, no matter how much expertise you might have under your belt, if you’re not constantly working on accentuating your intellectual power, you will fall behind.
Agency owners must value the importance of the concept learn, do, teach, which states that every professional must spend a third of their time learning new concepts, a third of their time executing them, and rest of the time teaching others how to handle that stuff in their absence.
This can only be achieved when you’re not under pressure to clock more hours to earn more.
Therefore, if you have nine hours a day that you work, it has to be divided up equally into three segments of three hours each for learning, executing, and coaching others. This means that you cannot bill a client for nine hours since your effective utilization rate for a 9-hour period is only 33%.
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The red herring pricing strategy
While incorporating a retainer structure to price your services, it’s ideal to have more than one tier or retainer level that you can offer your customers, thereby providing them with more value.
Having the presence of packages like low, medium, and high to choose from tends to show customers that your agency is serious and has expertise in the domain you’re functioning in.
The red herring pricing strategy, as the name suggests, is a strategy where you deliberately choose to set a premium price for the topmost retainer level that you offer to your customers.
The purpose of the premium price for the topmost tier is to make the lower tiers more attractive.
Such a two-price strategy is exactly what movie theaters incorporate while setting the prices for the different sizes of popcorn they sell. For example, they might set the price of the small popcorn bucket at around $10 and then sell the large popcorn bucket at around $11.
In this case, however, it’s the small popcorn bucket that acts as a red herring since it drives people to purchase the larger popcorn by giving them the impression that it’s the better deal.
People are forced towards purchasing the larger popcorn bucket even if they actually came to purchase the smaller bucket. And even if they choose to purchase the small bucket, the movie theater still stands to gain since they already have their margins incorporated in the prices.
However, just like there are some people who always fly business class irrespective of the price of the airline tickets, you would surely get the odd customer or two who would rather pay you the premium prices for your topmost retainer level just because it suits their personal compact.
Therefore, using the red herring strategy to set a premium price is a win-win situation for you.
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How to determine your premium price
Once you know that using a retainer pricing structure and a red herring is the way to go, the question that remains to be answered is how do you actually determine that premium price?
Do you set the price based on what your customers can afford? Do you base it on how much the competition is charging? Or do you estimate it based on the type of problem you’re solving?
One way to go about setting your price is to calculate your costs and then either double or triple that amount. The reason why you need to sell your services at three times your cost is not just the profits, but because everyone forgets a few expense-related aspects when calculating costs.
Maybe the cost of the wifi, video editing software, and video conferencing tools to name a few. Therefore, in situations like these, it makes sense to have a red herring price of around $500.
You’re not doing anything unethical here. You’re not setting a premium price because you’re trying to rip customers off, but because there would always be costs that you don't account for.
This is one of the major reasons why digital marketing agency owners are broke. Not because they’re bad people or incompetent, but because they don't understand the cost structure.
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Perceived authority and value-based pricing
One of the first things we talked about on Season 2 of the Conquer Local Think Tank was the concept of perceived authority and how it can help you grow your digital marketing agency.
Recommended Reading: The Key to Growing Your Digital Marketing Agency
Perceived authority is when people come to your agency because you’re famous, are known to be an expert in a particular area, or are associating with other people who are experts.
Therefore, if you’re able to build enough authority for your agency in the market, it automatically puts you in a commanding position where customers will be willing to pay you the premium prices you set for your products because they will treat you as an investment rather than a cost.
The key here is that the prices you set for your services, even if at a premium, come across as valuable to the customers since you’ve created a perceived value for yourself in front of them.
Instead of asking customers to pay a premium directly without building any value, which will probably come across as exorbitant, you instead build a perception for your agency that shows them that you’re building a partnership together where you’re working towards a joint cause.
Value-based pricing is all about showing customers that you’re winning together and when clubbed with having high perceived authority, it gives you an unrivaled competitive advantage.
How can Vendasta Help You
When it comes to building perceived authority and being in a position where you can charge premium prices for the services you provide, Vendasta can help you drive a lot more value.
In addition to using their white-label end-to-end commerce platform that empowers your agency with the best-in-class digital solutions needed to service customers, you can also now work towards earning your certification and calling yourself a Certified Digital Marketing Agency.
Furthermore, you can build your perceived value and enhance your digital marketing prowess by joining the weekly Think Tank sessions with me where I will personally coach and guide you.
So, start today and become one step closer to charging premium prices for all your services. 