On cost-based vs value-based pricing

As part of the web design class I teach at LCC, we spend a little time talking about the different services that a web design company can provide, and that inevitably leads to a pricing discussion. That disussion is complicated, as you all know – there isn’t one price for a new website, or for an email newsletter! There isn’t even a range – the same website could cost less than $1000, or $100000, depending on context. 

So, there are two main ways to decide on pricing: cost-basis or value-basis. Cost basis means that you figure out how much it would cost you to provide this service, then add a reasonable profit margin, and call it good. Value basis means that you figure out how much value it would provide to the client, and then charge a % of that amount. 

Using cost basis means that you are usually undercharging the client. You aren’t making as much profit as you could be. Generally, you should use value-based pricing. (Nick D is a great author to look at if you’re interested in more details; Value-based Design is a good starting point.)

Let’s consider an example of an imaginary client who wants a new website. You meet with them and ask a few questions about what they are looking for. This point – the first meeting – is where cost and value pricing start to differ. Cost pricing is asking more technical questions, attempting to figure out exactly how you will build the website. It’s 40 hours of work? Ok, that means my price should be 40 times my hourly rate. I’ll use a theoretical hourly rate of $50/hour here, to make the math easier, and as a reasonable hourly rate for a slightly-experienced web designer/developer in many markets. That makes the website $2000 using cost basis. 

We don’t know if the client can afford $2000. We also don’t know anything about their budget; maybe they were expecting to spend $10000 on the project instead. 

Value basis starts differently; it’s about calculating the value that a new website would provide to the client. This can be very tricky when you’re starting out, as you haven’t done similar projects before, but it becomes fairly easy after a few projects. How many new visitors to the site? What is the expected value of each visitor? What is the expected conversion rate for a visitor? Etc….

These questions a) tell the client that you’re interested in them and their business, compared to a question like “WordPress or Squarespace?”, which doesn’t show them that you care about them. They also b) help you and the client explore what their budget should be for the project together. They might have a budget set, and then you can figure out if you fit within that budget (maximizing your profit for the project). Or they might not have a budget, and the value-based approach allows you to communicate the upside to them. If the value-based number comes out to $20000, charging $5000 suddenly seems very reasonable. And, on the opposite side, if the value-based number comes out to $200, you can suggest that it’s probably not a project that they can afford right now. (Importantly, note that you probably wouldn’t get hired for the $200 value project if you used a cost basis either!)

Value-based pricing is user-centered. It focuses on the client’s needs, and how you can meet those needs. When your minimum price is higher than value provided, it leads to positive discussions about changing the scope (making a less-complex website), or about shifting the costs across more time (building the website in phases). Cost-based pricing, though, generally leads to a “Yes, you’re hired”, or “No, you’re not” – there’s not as much room for discussion and dialogue.