Fling Media

Tuesday, April 25, 2006

Pricing a Project

Today we are going to break an unwritten rule for agencies, we are going to reveal an important page from our playbook on how we price a project. What is somewhat ironic is that we think it’s a pretty bad rule, that one of the last things we think anyone should hide from a potential client is how your pricing works.

It often seems in the design agency business that the status quo to pricing a project is the old car salesman approach, where no two cars sell for the exact same price and to negotiate the price you must pass scraps of paper back and forth until you reach an agreement.

I believe these days are gone. In the Information Age the consumer is in control, with the ability to discover exactly how much a thing costs, honesty and transparency must be at the heart of how you price a project.

How we do Sales

Since we’ve started Blue Flavor last autumn we’ve written a lot of proposals. When we first started talking about starting Blue Flavor we unanimously agreed that we wanted to do sales very differently than anything we’d done before.

We agreed that we didn’t want to have a “sales guy” doing all of our business development for us. Having worked with many agencies we recognized that we would be doing the client a disservice by not putting someone incredibly knowledgeable about our product as the primary contact for the client.

Therefore each of the four Blue Flavor principals shares the responsibility of all business development. Each of us acts as the primary conduit to the client for all projects. This way we can answer questions and provide expert recommendations at any point, reducing back and forth or having a middleman so-to-speak.

How do you put a price on something, when you don’t what it is?

We don’t always get a Request for Proposal (RFP), sometimes we literally get a big idea written down on little more than a napkin. While other times we may get 30-page RFPs that provide excruciating detail.

Regardless of how the client writes down what they need, they often only know the rough strokes of the how to reach their goal, not the specific nitty-gritty details, which are often where the majority of costs lie. But why should they? That should be what they are hiring us for, to help them find what they want, and more importantly, what their users want.

A crucial problem to accurately pricing projects is that proposals happen so early in the process, as the vendor we only have a couple of meetings, phone calls or a document to understand the project. We do our best to come up with a fair and accurate price, but it often feels like a shot in the dark.

What do most agencies do? Pad their estimates. And pad is bad.

You can’t negotiate up

A good friend always tells me, “You can always negotiate down, but when was the last time you negotiated up?” Good advice, but it somehow feels dishonest to overshoot a project just to give you room for negotiation.

Saturn revolutionized car buying by just listing the price by simply listing what a car costs. They talked to consumers and found that they hated negotiating for price, that they hated negotiate. They wanted to come in, pay a reasonable amount of money and walk away with a good car.

I think one key message here is a “reasonable” amount of money is subjective. Sometimes the client doesn’t know the cost of what it takes to implement a content management system for example, and sometimes they don’t fully understand it’s market worth. Sometimes they can overvalue the price based on bloated projects from their past.

The second key message is the value of the end product that is also subjective. What is gold to one person is lead to another. The business goals can demand far different emphasis on the same product and create very unique outcomes.

The point is, they are asking us “what is reasonable to us?” and looking to uncover the value we can add.

Pricing Poker: Bluffing, Budgets and Trust

One of the great mysteries of pricing a project is budgets… vendors always want them, clients never want to reveal them. We ask every client if they have a budget that they need us to work within, every agency I’ve ever worked on the other side of the fence with has asked the same. Very very few clients ever reveal this crucial detail.

Having been the client on many occasions, I usually have a price in mind. The problem is if I say I’m willing to pay $15,000 for something, proposals magically come back with proposals priced at about $14,999. On the other side of that coin, every book on consulting says never ballpark a project, even though the client always asks for it.

I find it funny… in a sad sort of way, that we often start out our partnership with bluffing, no one saying what they are really thinking… how much they are willing to pay and how much it should cost (again using scraps of paper in the car dealership).

The budget reveals a lot about the client and the project. We use it as a barometer of how serious the client is, if they have given their project serious consideration, how much they understand about the project, to evaluate possible return on investment scenarios, to help define scope, whether it is cost-efficient for us to pursue, and to see if we can even do the project within their budget.

Though every book I’ve read on the topic of pricing says to never ever ballpark, I have a tendency to do so. If they can’t disclose the budget I typically try to start throwing a few numbers from previous projects to help gage the scope of what we are talking about, call it a good faith effort to start the discussion.

I’ll say, “we worked on a project similar to yours and the final cost was _” I’ve had clients reply “that is _ times more than it would cost to do __!” The final blank often being some completely unrelated product relevant only to their business and impossible to compare other than on a pure cost basis. While other clients have said, “I don’t think you understand my project, because you are estimating far less than ___.”

While this is very awkward part of the discussion it is almost always followed by candor. It’s as if once someone starts telling the truth, it opens a door that can’t be closed.

Price what it costs

One thing we firmly believe in is pricing a project for what it costs. I have seen situations where someone comes up with a number, then doubles or even triples it randomly to pad the rate for unforeseen circumstances. Addressing uncertainty about the project by haphazardly increasing the price is a strict no-no for us, and not something I would suggest anyone do.

When we price out a project we not only price out what we know about the project, but also detail what we don’t know. We come up with worst-case scenarios, address risks, point out all the things we think could impact meeting the goals of the project.

When we make an assumption, we call it out. And if this price is going to get you three comps and three iterations, then we try to set that expectation up front.

To come up with a number try using the following formula:

task x time(complexity x effort) x rate = price

Let’s break this down, lets use the example of creating a mockup at say $100/hr (we’ll use simple numbers, because I was never good algebra): task is the quantity of the work, e.g. three mockups. Time is the value of complexity multiplied by effort, or hours to perform. This is the trickiest part of the equation as they are unique to every person or agency. For complexity, start by using a three point scale, 1 being easy or ideal circumstances and taking the normal amount of time, 3 being fairly complex taking 3x the normal amount of time. For effort, enter the ideal amount of time it would take you to complete the task, let’s say 10 hours to produce one mockup.

So for our example the formula would look like this:

1 mockup x time(1×10 hours) x $100 = $1,000

Three mockups would look like this:

3 mockup x time(1×10 hours) x $100 = $3,000

A slightly more complex mockup might look like this:

3 mockup x time(1.5×10 hours) x $100 = $4,500

And a complex or challenging mockup might look like this:

3 mockup x time(2×10 hours) x $100 = $6,000

And so on. Start with a three-point complexity scale using the quarter points if necessary (e.g. 1.25, 1.5, 1.75 etc). If you feel you need to use a five-point scale or even a ten-point scale I would imagine you haven’t figured out your hourly rate.

Know Your Hourly Rates

I talk to a lot of people about their rates, be it friends in the business, or vendors we subcontract to. It amazes me how many people don’t know their hourly rate. Many people charge by the project and take what they can get, but those prices should be factored on a baseline hourly rate.

If someone is doing billable work and doesn’t know their baseline hourly rate, I would bet they will be out of business in 18 months.

Figuring out your hourly is very simple (sorry, more algebra coming):

(expenses + salary) ÷ hrs worked per yr. + margin = hourly rate

This one takes a little more explanation. For expenses estimate your overhead, your rent, utilities, insurance, benefits, supplies, any cost of doing business per person, which can often be as much as 30-50% of your gross revenue per person. For salary, decide on a reasonable annual salary. Refer to the AIGA/Aquent Design Salaries site.

Divide that sum by the hours worked per year, meaning of the 2,000 hours typically worked per year (40 hours a week for 50 weeks) how much of that will be billable time? The other way to look at this problem is to figure how many billable hours you work per week a multiple by the weeks per year you plan to work (typically 1,500-1,700 hours per year). Then add in a reasonable margin, usually between 10-15%.

So the formula for a low-level web designer might look like this:

($20k expenses + $60k salary) ÷ 1,500 hrs + 10% margin = $58.66/hr

Of course everyone has different comfort level, certain cities cost more to do work in, there are a great number of factors that can affect rates. Knowing and understanding how these work is mandatory for both vendor and client.

Hourly vs. Project Rates

There are typically four methods of billing for projects, Per Project, Hourly, Per Diem and Retainer. I’m going to focus on the first two as they are by far the most common.

Traditionally most projects are charged on a Per Project rate. The idea here is that the vendor can accurately guess the scope and attach a fixed price at the beginning of the project. This in invariably never the case, so scope and price is often padded and margin added to protect the vendor from additional scope.

The theory of Per Project rates are very karmic, some projects the vendor underbid the project and makes less and others they are able to complete under their estimates and profit. The problem is one way or another somebody loses, either the client pays too much, meaning paying more than it’s market value, or the vendor eats into their profit.

Hourly billing is often associated more to your plumber than to a web project and has a pretty bad reputation. The fear with clients is what I call the “Stray Consultant,” where the vendor is simply billing for time and not producing any work of significant value. You tend to see the Stray Consultant quite a bit in very large organizations often with many middle layers of management.

One benefits to hourly billing is the client is responsible for increases of scope, protecting the vendor and the customer. If the project is completed early the client pays less, protecting the client. This puts the onus on both parties to communicate regularly and work more effectively.

This isn’t to say that working on an hourly basis is license to an open paycheck. Rather, budgets and requirements should be defined, watched and met. If the hours start to go over, this should be called as soon as possible, ideally before the hours are committed.

Blue Flavor almost exclusively charges on an hourly basis. Over our careers in the web we’ve seen requirements invariably shift, and often for good reason, to produce a better, more people-centered end product. We believe that the pricing structure should be flexible to reach that for every project, but also put some checks and balances in there to prevent overages in our original estimates.

Regardless of billing per project or per hour, we believe that any project is a partnership between client and vendor. That in order to mutually achieve a goal we must work together every step of the way. Communicating expectations of scope and cost is always crucial.

So What Inflates Rates?

So what causes a project to be larger than another? As the client it can be difficult to understand why your project costs more than your expectations (people rarely balk if the prices are lower than they expected).

Guesswork

The number one cause of high bids is guesswork. If the vendor has to guess the scope or it’s largely undefined, the vendor will assume a higher level of complexity. This doesn’t mean you need to outline every aspect in an RFP.

Simply be very clear about your goals and expectations. What do you expect to achieve through this project and what do you expect to have in hand at the end?

Overhead

Understanding a vendor’s overhead is very important, for example, the fancier the office will equal a higher cost. Ask your vendors about their overhead, how do they account for it in their billing? Ask about their margins and profit of past years. These are all questions you have the right to ask of your vendors.

Agencies and individuals both provide benefits here and should be weighed based on the goals of your project.

Experience

The level of experience of the people working on your project will increase rates, more senior people demand higher rates. As the client, you need to understand who will be doing the work and need to weigh the benefits of senior versus junior people doing the work. Ask for a rate sheet and ask specifics on who will be doing what. Don’t assume that because a principal of an agency won an award last year, means they will be working on your project.

Client Tips for Pricing a web Project

Ask vendors their hourly rate, ask them to breakdown their pricing structure

You need to know where you money is going and the vendor should be prepared to discuss how they bill. Hesitancy to do so can be a big warning flag during vendor selection.

Spend the time to write down your requirements

Well-written requirements or RFP is going to prevent dancing around price and get you talking about your project. It doesn’t have to be overly detailed. If you simply don’t know, most vendors, for a small fee will research and write the requirements for you (see the retainer tip below). This can be a great way to put your relationship with a vendor to the test and better-set internal expectations of cost and scope.

Don’t be afraid to reveal your budget

Tell them what you are willing to spend, paint the ideal scenario. If the vendor comes back and says it is going to cost a fraction below that without telling you what you are going to get for the rate, then I would pass and move on to the next vendor.

Don’t be afraid of hourly rates

A lot of clients want to pay by the project. Per project rates are hard to estimate when you are still addressing scope, so vendors will pad their estimates quite a bit. When comparing multiple vendors’ look at there hourly rates and what you are going to get for that rate. When done right, charging by the hour keeps everyone happy. Make sure to set budgets and look for means to ensure that budget will be kept in line on an incremental basis.

Don’t be afraid of retainers

A lot of clients don’t even think of putting vendors on retainer, but if you have a “big idea” and don’t know the scope and need help, putting a vendor on retainer is a great way to create a temporary brain trust. Basically say, “I will pay you $5,000 per month to help me figure out this problem.” But do so only after setting clear expectations of what you hope to accomplish after each day, week, month, whatever works for you.

Buy the Graphic Artist Guild Handbook of Pricing and Ethical Guidelines

I’ll let clients in on a big secret for creative projects, buy the Graphic Artist Guild Handbook of Pricing and Ethical Guidelines. It can be found at most Barnes and Nobles or Borders and is on most designers or agencies bookshelves. The GAG Handbook is one of the best tools for knowing how much things should cost, as it will most likely be referred to in preparing your proposal.

In Conclusion

Pricing is not a mystical art, rather pretty simple math, you just need to know the formula. If you are a vendor, know your market rates, know your costs and know your hourly. If you are a client, do your research, know your internal weaknesses and share your budget.

And for both sides, pricing is something that should be discussed up front by both sides without fear that anyone is going to reveal too much or too little. If both parties like and trust each other, there are always ways to work out an arrangement.

Remember, honest and transparency should always be at the heart of all projects.

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