The one pricing question that changes everything about your agency

I believe there are five simple questions with answers that, between them, decide almost everything about the agency’s strategy. This pricing question is one of them:

Do we price our work based on what the agency puts in or do we price our work based on what the client gets out?

Cost vs. price

There’s a difference between cost and price (and I’ve written briefly about the difference between cost, price and budget before).

Cost is how much money we spend, mostly in the form of labour and tools, to do the work. Economic factors mean our labour costs are going up and we want to pass these cost increases on to our clients in order to maintain our margins.

Our clients are told (presuming they are paying any attention at all) that our costs are actually going down because of AI (and perhaps for some agencies that’s true).

To calculate our rates, we add up our direct costs (salaries, taxes, pensions, training, software and the non-billable time of their managers for supervising their work); make an assumption that every person we have will be exactly this amount of busy; then we add on our overheads (including our investment in AI, which is probably costing as much as it’s saving for some agencies at the moment); and then an amount of profit we’re happy with; and make some decisions (or refuse to make said decisions) about who pays for expenses, us or the client; and what’s left is an amount that one unit of this person’s time costs.

The price is then how much the client pays to buy one unit of this person’s time.

Some agencies don’t know about the difference between cost and price, so they charge the client the same amount that the unit costs.

If that’s you, then you can calculate exactly how much money your agency can make because it’s simply:

How much profit we built into the rates

x

The number of units of time we have available if everyone was this amount of busy.

We can make more money in two ways:

1. We can make staff more than this amount of busy and sell extra units of time that don’t feature in the calculations (staff don’t like being busier than you said they would be…and I assume we don’t either, because we’d have included those extra units of time in the calculations in the first place if we did); or
2. We can price the time at more than it costs.

That’s the difference between cost and price. We might calculate that a unit of time (and we’ll use a blended day rate for ease of illustration but, believe me, a blended day rate is almost never a good thing) costs £800…then we sell it for £1,000.

Here’s what we need to know about that:

• We can sell £800 of something for £1,000 only if the client believes it’s worth £1,000 (if we don’t know how to make something feel like it’s worth 25% more, we should talk)
• One client might believe it’s worth £1,000…another might believe it’s worth £900…but both are more than £800, so you’re winning
• If you negotiate down from £800, you’re doing the work for less than it costs you to do it. No, your margins can’t handle it
• If a client tells you that they believe your £800 is worth £600, that client will be hell (here’s a case study you might enjoy)
• If you sell enough of your time for more than it costs then it doesn’t hurt so much when your employees are less than this amount of busy
• If you sell your time for more than it costs then it doesn’t hurt so much when your costs go up
• If you sell your time for more than it costs then it doesn’t hurt so much when you overservice (which you will, up to a point, because every agency does, up to a point)
• I’ve made a fundamental assumption that you’re cool with selling something for more than it costs because of the field you’ve chosen to work in. This is literally the only reason marketing exists. If your first thought when I floated this idea was “this is unethical” then go and get a new job
• I’m ignoring the fact that most agencies don’t calculate a rate based on costs and just try to charge what they think is “the going rate”.

If all of this seems a bit complex, it’s because it is. Time and materials or cost plus pricing are totally viable, for the time being, but don’t think that either represents the simplest way of pricing your work.

But, if you do price this way, here are a few recommendations:

• Maintain a live Google Sheet or Excel spreadsheet that shows your current costs, or a (very) few agency management systems will calculate this for you and, even then, it’s not perfect
• Set utilisation targets for every team member and make an update on your breakeven point a consistent feature in your All Hands meeting (you know who typically charges in this way? Lawyers. You know who’s not shy about telling the team they’re losing money and they need to sell more? Lawyers’ bosses. Like a law firm, marketing agencies are professional services businesses and are generally improved when we start to learn some of the lessons from those businesses)
• Stop thinking about profit as what’s left over and start pricing it in
• Stop thinking about overheads as your overheads and price them in too (and imagine a situation where you have to talk a client through each overhead that goes into the cost you’ve calculated - can you justify them all, or is there some waste?)
• Start charging for speed: if you think about AI as something that might make you more efficient, then you’ll do the same amount of work in fewer units of time and therefore make less money; if you think about AI as something that gets to an output more quickly and therefore creates value more quickly, then you’ll price higher than cost

Train all of your client-facing staff to sell (I can help): you want every person to understand how busy they need to be for the agency to break even (utilisation target) and give them the ability to get themselves busier (sales and client service skills). Not equipping your team with sales skills (perhaps you feel like you need to go to every client meeting yourself or the agency misses out on opportunities?) is a recipe for undercharging.

Get these things in place and your time and materials/cost plus agency will, in some cases, make more money than a lot of agencies who price in the other way.

The other way to price

Instead of pricing based on what the agency puts in, you can price based on what the client gets out.

This is subjective:

• Some clients will want to pay for the value they get out of the work - which could be many multiples of your costs - and about 8/10 won’t. “What the client gets out” can also mean a fixed price for a completed job, like a campaign or an audit. The commonality between them is that we’re thinking about what the finished product will be and how the client experiences it, rather than thinking primarily about the work we think we have to do. The result is usually a better outcome for the client (and, by extension, the agency)
• Some clients will get more out of the same work than others (which is why you can and should justify charging more money to a bigger brand who stands to make more money: there’s simply more at stake)
• If everything is a bespoke price, you don’t ever have to tell a client that your prices are increasing because your costs are increasing (the price is not directly tied to the cost)
• You can (and should) forecast a return, but it’s up to the client to decide whether that return is enough to commit to doing the work (because there are many other things they could do with their money instead. Some of those things can be done by you, so you’ll want to provide alternatives, rather than a single option)
• There’s an element of being good with data (maybe AI can, in this case, help you), but really, it’s about being good at understanding clients and the situations they find themselves in: they have £X and they need to generate at least £Y return, can you do that or not? How?
• You will want to fully understand the situation before you start thinking about what you’ll do. If your pricing is time and materials-based, you’ve got X units of time that you need to sell and, miraculously, the solution will be lots of that available time.

Again, this is about sales skills, but there’s a significant difference in approach: in most cases, you know you won’t generate that return with a few hours of time and you need to pull a team together to deliver something meaningful. It becomes about scoping and scale, not utilisation and being busy. This means:

• Your sales process will be different. It might be centralised around one business development/client services person or team. It will take longer to fully understand the situation and the value you might create (and that’s a good thing: a lot of agencies ask me to improve their sales process and “qualifying too quickly” is an almost universal problem)
• Even when you cost the project based on the hours you put in, you’ll want to state a price that’s more than that. Unlike time and materials, you don’t get paid more for correcting the errors you make along the way…and you don’t get to charge the client for changing their mind unless you’ve scoped the project properly and your statement of work is watertight
• Doing things faster (again, hello AI) is actually a good thing in this pricing model, for everyone. When you charge for time, you get paid less if you do things faster, which means that a) some clients think you’re doing things slow on purpose to maximise your fees and b) some clients are expecting your prices to go down because of AI. When you have a fixed price, you make more money when you do things faster; when the client has a competitive environment, they make more money when you do things faster. This is especially true further up the food chain: the CEO wants the thing done now and is willing to pay a premium for that to happen
• On that subject, the further up the food chain you go, the more likely it is that the client will pay you for the value you create. Pricing this way will encourage you to make the changes to your sales process (and perhaps personnel) that are needed in order to sell higher in the organisation. That marketing manager might not even know what’s at stake for the business and perhaps wouldn’t know who to talk to even if you told them
• You’ll have more of a moat against freelancers. As the networks collapse in on themselves like the dying stars they are, more and more extremely talented people are going into business for themselves (and even mid-sized agencies are losing more talent to self-employment than to other firms). Smart people know that if you’re selling 1x unit of their time with lots of overheads, they could make more money by selling the same unit of their time with fewer overheads. However, if we want to generate big outcomes for big clients, the percentage of freelancers who are equipped (skills - commercial skills as well as delivery skills - and collaborators) to make it happen is quite low. We go far together.

The answer to the question

I’ve gone out of my way to make it clear that pricing based on what the agency puts in can work. You can continue to operate in this way, at least for now (even though LinkedInfluencers have already proclaimed that this is dead)...but doing so means certain things have to happen in your agency. Some of those are outlined above and I can think of some others that have come up in certain situations too.

Sometimes you’ll want to be able to facilitate either way of pricing and leave it up to the client to decide: some do want to grab a few extra hours in certain situations, which might suit you fine.

If you are pricing based on inputs and you want to explore pricing based on outcomes, I can help. You might decide that things are better as they are; or that the agency isn’t ready for that change in the short term; but at least you’ll know what needs to be done.

I might write about the four other fundamental questions in future, or maybe that’s a talk. Stay tuned.