Pricing models affect your agency in many ways, like the movement of gears in a machine.

Your pricing model affects the rest of your agency—and your quality of life. Which of the 3 models is best for you?

There are three pricing models for marketing agencies—hourly, milestones, and value-based.

Your pricing model has a big impact on every aspect of your agency—profitability, of course, but also positioning, sales, project management, client service, staffing, accounting, and your stress.

The right pricing model will drive your agency forward—so you can get paid fairly to work with clients you love. And the wrong pricing model will create an endless cycle of long hours, low compensation, and arguing with clients about what’s a fair price.

Let’s take a look at the pros and cons of each one—including a deep dive into their agency-wide implications—to help you decide if you should switch.

In a hurry? Scroll down to see my guidelines for which pricing models to pick, based on how many years your agency has been in business.

Hourly Pricing (aka “Time & Materials”)

This model charges the client an hourly rate for everything you do. You might charge a single, agency-wide “blended” rate—the most common approach—or use different rates by employee seniority.

You create an hours estimate up front, and “get additional hours” as you need them. Most agencies bill once a month, but some will do weekly or twice a month.

Pros to Hourly Pricing

Theoretically, you get paid for every hour you work—Time & Materials promises to make every billable hour a paid hour.

It’s a lot easier to scope work if you’re doing an hours estimate—or when you’re not committing to a binding scope. Instead of scoping everything up front, you can do a “good enough” scoping and adjust within the flexible hourly budget as you go.

Project management tends to focus on tracking hours—which makes sense, given that an agency’s “inventory” is hours, regardless of the pricing model. This makes it somewhat easier to track budget consumption, versus a milestone approach.

Hourly can be a good (temporary!) solution for new agencies—if you don’t know how long something will take, hourly can protect you against some overruns. But hourly should be an interim choice—as soon as you can switch to milestone or value-based, the happier you’ll be.

Cons to Hourly Pricing

Clients will push back if you exceed the hours estimate and hadn’t gotten their approval beforehand—hourly pricing isn’t a free pass to charge whatever you want. Your PMs will be getting a lot of “Well, why didn’t that take X hours?” pushback.

You’ll get sucked into discussions about whether a task you estimated at 5 hours should—in the client’s mind—require 5 hours. If you don’t want clients to use your employees as human mouse cursors, don’t use hourly.

Although every agency should be on top of time-tracking, it’s a must-have when you do hourly billing—if the time isn’t loaded to your time-tracking system, you can’t invoice the client.

Charging different rates by employee type—instead of a single, agency-wide “blended” rate—gets clients overly involved in your resource planning decisions. Seeing a task was done by a junior developer makes the client wonder if you should have had a junior developer do it—or whether paying extra for a senior developer was worth it, too.

Hourly pricing limits how much money you can make—to make more, you have to hire more people or raise your rate. Your market limits how much you can charge per hour, so hourly creates dis-incentives to be more efficient.

Finally, it leads to nickel-and-dime decisions—where a 2 minute phone call should, in theory, be a 0.25 hour billable item. This can lead to clients not picking up the phone when they should, because they’re worried it’ll cost them $40.

When an hourly client starts demanding detailed invoicing showing each time entry, the relationship is not going well—they don’t trust you any more.

Milestone Pricing (aka “Fixed-Scope, Fixed-Bid”)

You commit to do a certain scope for a certain price—typically billed on a milestone basis. This can include projects and monthly retainers.

Pros to Milestone Pricing

Milestone de-couples price from an hourly rate. As you become more efficient at particular types of work, you should get things done faster. If you work on a milestone basis, you pocket the efficiency improvements.

Clients like that they can predict what they’ll pay and when they’ll pay it. This can help when you’re working with non-profits and other clients that are highly budget-driven.

Milestones can also make it easier to project-out your own cashflows—if you know you’ll finish a milestone at a certain point, you know you’ll get the money within a particular period after you send the invoice.

Cons to Milestone Pricing

If you’re not good at scoping, you’re going to under-estimate the work—which wipes out the potential efficiency savings. You have to delegate scoping to skilled people, or else risk their under-estimating things, too.

As soon as you start work, things change. Perhaps the client needs something new, or you realize you don’t need to do something you originally planned to do. Your PM gets to massage the scopes—scope changes to cover new work, and makegoods to cover work the client agreed to pay for but that’s no longer necessary.

If a client doesn’t agree a milestone is “done,” clients may hold you hostage by withholding payments. (To be fair, you’d do the same thing if you were in their position—but you know they should trust you.)

When there’s an incentive mismatch about the definition of “done,” it can lead to an adversarial relationship. You want to get a “done” signoff ASAP so you can get paid and move on, while the client wants to be absolutely sure “done” is done, because once they pay, they lose their leverage.

If you do lots of new types of work, you’re practically guaranteed to go over budget every time—because there’s never a solid opportunity to learn to get better.

Value-Based

This pricing model tends to include two sub-categories—either a royalty or other commission on client revenues (e.g., pay-for-performance) or else charging a client more because that particular client will get more value from the work.

Pros to Value-Based Pricing

This is the best way to align your incentives and your clients’ incentives—because the more they make, the more you make.

When you’re charging a flat rate, you don’t get rewarded for finding bigger opportunities. A few years ago, I was doing a $200 task when I found an opportunity for the client to get $50,000. I told them about the opportunity—it was the ethically correct thing to do—but I really mis-priced that.

For a recent proposal, I identified that my work would likely help my client increase their revenues at least $500,000. I gave them two options, including one that involved a value-based model. Interestingly, they did not choose the value-based option, which makes me assume I had under-priced the other option.

Cons to Value-Based Pricing

You need to be very confident about getting results. Most agencies aren’t, and that’s OK—but figure that out before you start doing value-based pricing.

Value-based also requires a shift in mindset, from deliverables to results. That can be tough, especially since you’re generally paying your team based on their deliverables—that’s a mis-match on pricing model vs. labor model.

Finally, you need to find a solution to track results in a way that your clients can’t “game” the system.

The Implications of Each Choice

Let’s take a closer look at the implications of your pricing model—hourly, milestone, or value-based—on various aspects of your agency.

Positioning

Value-based pricing helps you stand out, since you’re aligning your goals with your clients’ goals.

Milestone pricing can stand out if you’re promoting that you can do “X for $Y,” but it also leads to becoming commoditized since people are comparing the price for that scope.

Sales Process

Sales is a lot easier in hourly pricing, since you don’t need to scope everything beforehand.

Milestone pricing is the hardest from a sales perspective, since you’re effectively guaranteeing a set of deliverables for a specific price (whether for a project or a retainer). Two solutions include doing “paid discovery”—where the client pays you do to an audit, create a plan, or otherwise evaluate their situation—and scoping that includes a precise list of inclusions and exclusions.

Value-based pricing is appealing for its results focus, but some clients may get scared off after they run the numbers on your payout—never mind that you’re getting a fraction of what they’re getting!

Project Management

Hourly is relatively easy in project management, since you’re PM’ing hours and you sold hours. The catch is that your PMs are chasing people to submit their hours, since you can’t send invoices ’til the hours are in.

Milestones are tough in project management, since you need to be constantly tracking how close you are to “done”—since you don’t get paid ’til the milestone is done. It also can create animosity, when your PM says something isn’t included and the client thinks it is—or the client thinks it is and the PM isn’t sure.

PM should be straightforward by the time you’re doing value-based work, since you should know the process by now and thus avoid overruns.

Client Service

Milestones are tough as an agency pricing model—your account managers will be pushing back to clients about whether a milestone is truly done.

This is especially true if you’re doing web development. For instance, you might have finished the design and development (and thus, you’re “done”) but the client hasn’t finished loading content (and thus thinks the site is not “done”). You can manage expectations about this, but there’s still going to be head-butting.

Hourly requires lots of expectations management as you run low on budget. Coming to the end of budget shouldn’t be a surprise, but that requires a client service person who’s brave enough to keep the client updated along the way.

With value-based, clients should generally be happy—unless you haven’t gotten results for them.

Staffing

You’ll ideally match your labor model to your pricing model. That is, if clients pay you hourly, they you ideally pay your freelancers hourly, and you track your salaried employees’ hourly equivalent based on their actual billings. And if clients pay on a milestone basis, you’ll pay freelancers on a milestone basis, too.

If you have a seasoned staff, any model can work—although the high labor costs may make hourly tough.

If you have a junior staff—especially the person doing project scoping—be careful about milestone pricing. You’re going to get burned, or you’ll get sucked into every proposal because you’re the only person who knows enough to confirm the numbers. That’s the opposite of making yourself “needed but not necessary.”

Accounting

Milestones are terrible for consistent cashflow. You’ll have huge payments and then no payments. If you do milestone billing, you should explore getting a Line of Credit to cover these ebbs and flows—but be careful that you don’t over-extend yourself. And structure your milestones properly—none of that 50% up front, 50% on completion. Split milestones into at least three parts (for instance, 50%, 30%, 20%), and make monthly retainer fees due in advance.

Hourly billing is good for consistent cashflow, since you’re invoicing on a regular basis. If you invoice monthly and payments are due Net 30—and clients pay on time—you can be fairly confident that you’ll get paid 31-60 days after you do the work.

Value-based can be iffier, depending on how you structure it. If you’re getting a royalty (commission) component, you might get a huge payout—but you’re dependent on when the client launches things. And you also need a lot of trust—coupled with double-checking the client’s numbers.

Profitability

Value-based has the highest potential to help your profits, since you’re getting a share of your clients’ results. But that assumes you’re good at getting results—if you’re mediocre, you won’t see the payoff.

Hourly has a cap on profits—in the U.S., most agencies aren’t charging more than $200/hour for routine work. If you’re at $200/hour already and want to boost your profits, you’ll need to switch to cheaper labor or find other ways to boost margins (like switching to another pricing model).

Milestone profitability is often a seductive mirage—be efficient and you’ll be more profitable. Yet that’s easier said than done, and you end up like many agency owners—lamenting that their employees and contractors didn’t have to bear the cost and the pain of going over budget.

Stress

When things are taking longer than expected, milestones create a lot of stress—your team’s promises of “almost done” aren’t reassuring when you know the milestone was supposed to help cover the next payroll. If you’re coaching the client service team, you’ll be guiding them on a lot of scope change conversations.

Hourly creates its own stress, on managing client expectations that will fit their hours budget.

Value-based pricing can have huge payoffs—but if your team has been working on something for a long time and you’re not getting results, you’ll need to decide whether to keep going or cut your losses.

Picking the Right Pricing Model for Your Agency

Pricing model depends, in part, on your agency’s business sophistication. Consider your agency’s lifespan—here are some rough ranges to consider:

  • 0-3 years old: If you’re new and not sure the effort required to deliver work, hourly can be a good temporary solution as you build your portfolio and your PM expertise. Or you can do milestone billing, but be sure to charge extra up front—to cover poor estimates—and be ready to still go over budget.
  • 2-5 years old: By now, you’re probably confident about the effort required to complete a particular set of work. Now’s the time to optimize that—charge milestone prices and get the work done more efficiently. When you’re doing retainers, keep a close eye on what you’re delivering—I consistently see agencies over-delivering by 50-100%.
  • 3-8 years old: At this point, you should be using value-based pricing on at least some of your work. You know the results you’re getting, and you’re increasingly confident about the likelihood of getting those results.
  • 8+ years old: You now have plenty of experience. If you’re not doing value-based as the majority of work, ask yourself why? At this point, you should be confident about the results you get for your clients. You should also be tired of getting only a fraction of the client’s reward.

For more on the topic of value-based pricing, read Implementing Value Pricing by Ron BakerValue-Based Fees by Alan WeissPositioning for Professionals by Tim Williams.

What if you’ve been in business for a while but you’ve recently shifted your agency’s services—for instance, from doing web development to doing online marketing, or from digital advertising to inbound marketing? That restarts the clock on the new services—but you should be able to learn from what’s worked before.

Many agencies use a combo of models—for instance, milestone pricing for work they do all the time, and hourly pricing when they’re doing something for the first time.

Ultimately, you have to find the pricing model that works for you—but be sure it’s an intentional choice, not something you fell into because you didn’t know better.

Question: What pricing model(s) do you use?

Image credit: Equipment photo by Timitrius, via Creative Commons