Pricing Models Every Digital Agency Should Use
Today, most of us in the digital industry have arrived here through a winding path of roles and projects.
Maybe you’re a web developer who started your own agency, or maybe you were a marketing intern who now manages a remote team of SEO strategists as part of a digital marketing agency.
If you feel like a digital rogue, you’re not alone. Often, leaders in digital get here without any formal training in running digital projects—in the fundamental principles that we need in order to build teams, work with clients, or build a sustainable, profitable business.
For digital entrepreneurs, it’s often the last thing on our minds to learn the finer points of sales strategy and pricing our projects. Money is sort of an afterthought. We can get so focused on our product and services that we just sorta hope that the pricing works itself out—that clients will magically offer us the right amount of money at the right time to keep our margins above 10%.
Hopefully well above 10%.
Here, we’re going to get some clarity about pricing. There are a few basic pricing models to use on digital projects that can help you formulate the right pricing strategy for your agency. Below, learn about pricing models and the pros and cons that each bring to real-world project scenarios.
How agencies work
It’s important that we talk for a minute about how the agency business typically works.
In a standard case, an agency needs to be making about a 50% gross profit to generate a 10-15% net profit.
Here’s a real-life example:
When we charge the client $100 for something, after accounting for the cost of good sold (often shortened to COGS, which basically refers to your staff and materials), we need to have about $50 left. And after paying for everything else that’s required to run a business (rent, insurance, tax etc), we need to be left with at at least $10-15.
This $10-15 is our net profit, and when it’s expressed as a percentage (10-15% of the original $100) this is also our profit margin. We’ll use our net profit to fund cash reserves, growth, expansion and the CEO’s holiday.
A 10-15% margin is not very high, so it’s really easy for that margin to be quickly eroded!
Whether that’s by poor estimating, discounting, or over-delivery.
The key takeaway is this: your agency probably isn’t rolling in it as much as you think! It doesn’t take much to annihilate a 15% margin. To manage that margin, there are a couple of different pricing models that agencies use, explained below.
Retainers are nice and simple: it’s where there’s an agreed pot of money allocated for work each month or year.
You agree on a certain budget, a ratecard for how much each person is charged out at, and you set aside the money and you draw down from that pot to fund projects.
Sometimes, you’ll still need to provide the client with an estimate, but you’re just giving a rough idea of how much of the retainer you’ll use. If you do go over the limit a bit for one phase or task of the project, there’s typically less scrutiny if you know there’s money somewhere in the pot to cover it.
If there aren’t retainers in place, typically we’ll decide to produce project estimates. These are usually fixed price or time and materials based—both of these are explained below.
Pros of Retainers:
Retainers are great from a recurring revenue perspective, and for ensuring consistent cashflow to keep your business humming, as you know how much money is going to come in.
Cons of Retainers:
The downside is that retained clients are typically very demanding. They’ve already agreed to pay a certain amount, and so they often try to work in a few ad hoc requrests to get more than they paid for.
Time and Materials (T&M)
A time and materials type of estimate is where the client agrees to pay based upon the time and materials used.
Time and Materials estimates are great for projects where it’s difficult to accurately estimate the size of the project, or when it is expected that the project requirements are likely to change.
It’s great for an agile project because the client agrees to pay for the team’s time, and it’s typically only loosely tied to deliverables.
Because this type of pricing is based on time and materials, it’s absolutely critical to keep clean and accurate timesheets and have a tool for tracking time that works for your team.
Pros of Time and Materials:
The advantage for the client is that they can keep changing their mind about the requirements, and not have to worry about the contract needing to be changed. They also get the benefit that if the job doesn’t take as long as originally estimated, they don’t pay for time they don’t use.
The advantage for the agency is that if the job takes longer than expected, the client should keep paying.
Cons of Time and Materials:
In reality, most time and materials contracts tend to be weighted in favour of the clients. They’re typically capped, and the client gets money back if the project is completed quickly. The agency takes the risk and has to pay for any overages.
Also, because in a time and materials contract, the scope is often not as clearly defined, sometimes clients try to dispute the hours.
A fixed price estimate is where the client agrees to pay a fixed price, regardless of the amount of effort applied to the project.
Fixed price estimates are great to use when there’s little uncertainty or risk in the project—a price is agreed and then paid, no matter what work is done to deliver it.
Pros of Fixed Price:
The advantage of fixed price for the client is that they know if they can secure the budget for the project, they’ll get everything that is offered for that price.
The advantage of fixed price budgets for an agency is if you can get the client to agree to a high price, and then deliver it more efficiently, you stand to make a bigger profit.
Cons of Fixed Price:
Clients can sometimes be nervous about fixed price estimates as they worry that they’re paying too high a price for the services being delivered.
Obviously, the disadvantage is that if you go over the budget, the client won’t pay any more money for the project.
There’s a range of different pricing models we can use: Retainers, Time and Materials, and Fixed Price are just a few of the standard ones. The right one will depend on your agency, the client and the project. It’s up to you to read up on these models, learn their advantages and disadvantages, and choose one that works for your business goals.