It’s not just you… creating a pricing strategy IS daunting
There's so much to consider: Are your rates competitive yet sustainable? Are you valuing your expertise appropriately, or could your prices be turning away potential clients? These questions are common, but tackling them is crucial for your agency's growth.
Effective pricing isn't just about numbers; it's about aligning your value with client expectations and market standards. Whether you're a freelancer starting out or expanding your agency's services, your pricing strategy directly impacts your ability to attract clients, maintain profitability, and sustain long-term growth.
Where do I start?
The first crucial step in crafting your pricing strategy is to establish your baseline. Your baseline includes your direct costs (salaries and benefits), indirect costs (rent payments, office supplies) and your profit margin. If you’re an Algebra wizard, here are what the steps will look like:
Total cost per hour/(1-profit margin)
We will need to do a few pre-calculations to get to this formula. Let’s do this together.
Before we start, let’s calculate your total costs. Your total costs include direct and indirect costs. Using the tabs below, calculate all of your total monthly direct and indirect costs.
Direct costs
People:
- Salaries, wages, and benefits for employees directly involved in client projects
- Freelancer or contractor fees if outsourced talent is utilized
- Overtime or additional labor costs during peak times
Materials:
- Costs of specific materials or resources directly used for client projects (ex: software licenses)
- Costs of third-party tools necessary for project execution (ex: project management tools)
Travel:
- Travel expenses related to client meetings
Indirect costs
Overhead:
- Rent or lease payments
- Utilities (water, heating, internet)
- Maintenance and repairs
General administrative costs:
- Salaries for administrative staff (HR, finance, operations)
- Legal and accounting fees
- Insurance premiums
- Subscription fees for business software (ex: CRM)
Marketing and sales costs:
- Advertising and promotional expenses
- Costs related to lead generation activities (SEO, PPC, advertising, content marketing)
Now, let’s do some math (with ABC Agency’s example).
Many of us got into the Agency business because we are creatives or strategists, not mathematicians. So, let's go through this formula together.
ABC Agency is a small agency with 3 employees and a primarily remote work setup. Here is how they were able to calculate their hourly rates. Bonus tip: this formula can be applied to all types of pricing models, not just hourly. This can be used as an internal metric of how much you are spending versus earning.
Step 1: Calculate baseline total costs
This will be how much you spend per month, and below is what the formula looks like.
Direct costs + indirect costs = baseline total costs
ABC Agency’s direct costs include:
- Employee 1 salary and benefits: $8,500/month
- Employee 2 salary: $3,500/month
- Software licenses: $500/month
- Client travel expenses: $200/month
- Other direct expenses: $300/month
Total direct costs = $13,000/month
ABC Agency’s indirect costs include:
- Marketing and Advertising: $1,000
- Miscellaneous (office supplies, insurance, etc.): $600
- Total Indirect Costs: $1,600
Direct costs ($13,000) + Indirect costs($1,600) = Baseline total costs ($14,600 a month)
ABC Agency's baseline total cost is $14,600 a month
Add 20% for incidentals
Baseline total cost + incidentals = Total cost
Now that we have our baseline total cost, let’s add 20% for incidentals. This will help build in profit for any surprise expenses and potential scope creep as you build your process.
Baseline total cost ($14,600) x 0.20 = Incidental cost ($2,920)
Baseline total cost ($14,600) + incidentals ($2,920) = $17,520
ABC Agency’s total cost is $17,520 a month
Divide total costs to an hourly rate
Total cost/142 = total cost per hour
Why 142? Assuming that ABC Agency’s team works 22 days a month and 8 hours a day, they have 176 billable hours. However, ABC Agency is putting aside 20% of this time for administrative hours (research, learning and development, doing things like adding up their hours per project). So, they assume they have 142 billable hours a month (22 days x 8 hours - 20% admin time).
Total cost ($17,520)/142 = Total cost per hour ($123.38)
ABC Agency’s total cost per hour is $123.38
Calculate Total cost per hour with a 20% profit margin
Total cost per hour/(1-profit margin)
Now, let’s add some profit. This will help cushion ABC Agency during slow times, build up cash as they grow and scale their agency, or just put aside some fun money for bonuses, team dinners, and other opportunities. ABC Agency would like to make a 20% margin.
Total cost per hour ($123.38)/1-profit margin (0.8) = $154.25
ABC Agency rounds up this cost to $155 per hour
Now that you have your hourly price, hold onto it
We will revisit this hourly price in the next lesson!