This is the second post in my series on the topic of pricing models and contracts. The final one will be published on August 26. You can check out the first post here, and even if you’ve already read it, there are a lot of good comments vertically as it relates to the thinking behind some of these models and the actual execution of them.
Matt Umbro and I were chatting yesterday morning and he said it’s amazing that for something so important there is still so much debate around pricing. I 100% agree, and here’s my theory why:
Part of it is that pricing drives a lot of the decision to hire or not hire a particular agency. Obviously, the agency has to be good and meet other criteria set by the client, such as:
- Expertise level
- Reporting and transparency
- General culture fit
Since pricing is easily quantifiable, it generally is weighted the most. Being analytical and linear in our thinking, PPC nerds want to know, “if I have x pricing, I’ll get y client.” So there’s a lot of debate about what “works” despite every situation and every client being different. I do think that no pricing model is the “right” one, meaning one that’s best for every agency and for every client, though there are definitely some that are better than others. And that’s ultimately the goal of this series – to help you determine which pricing model is the best for you whether you’re on the agency or client side.
Hourly rate is an easy model to understand because it’s a way that many professional services are charged. Just keep track of your hours and then send the client an invoice at the end of the month for those hours, multiplied by your hourly rate. The ease of understanding is the main thing I like about this model. Another is that your hourly rate will be consistent (obviously) and you can count on its consistency no matter how much work there is or how much time and effort you have to put forth on a project, you’ll always make a profit.
There are a lot of disadvantages to this model too. For the agency, it creates squabbles with the client about how long tasks should’ve taken versus how long they actually took. Maybe there were obstacles you ran into that justify a longer time but the client doesn’t think those should matter. Or maybe you needed to spend time researching a topic. Or maybe you made a mistake and needed to spend time correcting it. If you pay a professional rate, it’s reasonable to expect professional service but not perfect service since we’re all humans and making mistakes is inherently part of being human.
There are also questions about what constitutes billable time. Our former (haha) attorney used to bill us for reviewing emails from us, which were inquiring about why he hadn’t responded to previous emails! And all clients hate getting billed a portion of an hour like 0.1 hours (really, you worked for six minutes?) or getting billed in minimums of quarter-hours for quick chats that lasted half that time. There are lots of good thoughts on the lunacy of hourly billing from Alan Weiss.
By its nature, an hourly rate also puts the client and agency at odds because the former wants to minimize costs and the latter wants to maximize revenue. Of course, it’s unethical to intentionally take longer just so you can generate more revenue but also, of course, some people actually do that and the client is none the wiser.
With one client, we decided to charge an hourly rate because the work was production-focused and not strategy-focused. At one point, I remember our folks spent non-billable time creating macros to do the work faster, which allowed us to complete the work faster and make the client happy but generated less revenue for us. We did the right thing for the client in the long-term, but for the company in the short-term it’s hard to coach your team to generate less revenue. So for that and a bunch of other reasons above, I really just like to stay away from the hourly rate model.
Minimum Monthly Fee
A minimum monthly fee is healthy for both the client and for the agency. It ensures that no matter how little work needs to be performed on an account every month, the agency will generate some revenue from it. They have overhead and salaries to pay, regardless of whether the client has work that month. While clients want to pay the lowest price possible for obvious reasons, they also want their vendors to be financially healthy so they can service the account well through proper and on-going training, attracting great talent, etc.
A minimum monthly fee also protects the agency for those situations where the client signs a long-term agreement in exchange for discounted fees. Without a minimum monthly fee, they could simply stop PPC with the agency at any time, effectively creating a month-to-month agreement.
The clients who typically want this are ones with wild seasonality – especially high peaks and especially low valleys. It’s often a hard sell for them to pay a minimum monthly management fee that is close in range to the spend, even if that minimum is an average for the entire year and what they’d pay regardless if amortized. My advice in these situations is two-fold: If it’s a big, brand name client and one who is likely to stick around with you for a while, it’s sometimes worth the risk of not including a minimum. You can also hedge your bet by including a claw back. If the client wants to cancel in the middle of an annual agreement, they pay back the percentage discount. This gives the client and the agency the best of both worlds: a long-term agreement for the agency and a discount for the agency.
Flat Fee Plus Percentage Of Spend
Still another option is to charge a flat fee plus a percentage of spend. We take on a handful of small business clients, and this is how we make the economics work for these lower-spend accounts while still providing a high level of service. This is different than a minimum monthly fee, which is the minimum amount we’ll charge a client every month. So if the minimum is $3,000, the percentage is 10%, and they spend $20,000, the fee is $3,000.
A flat fee plus a percentage of spend is a fee that is paid on top of the percentage charged. So if the flat fee is $3,000, the percentage is 10%, and they spend $20,000, the fee is $5,000. (BTW, these are all placeholder numbers and aren’t the real numbers we use for our clients.) The things I like about this model are that instead of simply charging a higher percentage of spend, if the client increases their spend, their effective percentage decreases because their flat fee never changes. I also like it because the flat fee is generally a low enough amount that it’s not cost prohibitive and because it’s being charged every month, it subsidizes other months where the client wants to pause or dramatically decrease spend.
Pay For Performance
Pay for performance, as I alluded to in the comments of the first post, is great in theory, but nearly always doesn’t work out. When I first started Hanapin, we entered into a handful of pay for performance deals. In the end, they didn’t work out because people’s intentions – both on the agency side and on the client side – are different when they first start out than when the actual payout happens. A handful of examples:
When the client wants a 100% pay-for-performance deal, generally speaking they want something for nothing. Many startups try this approach when they are cash-strapped so if performance is great, they pay you (or sometimes that money goes to other activities) but if it’s not, then there’s no risk to them. And not having any risk is the biggest weakness of this model. They’re not incentivized to complete tasks that help you win for them.
A great analogy and explanation comes from a recent post on inbound.org:
“If you want a baseball player that’s been the batting champion the past 3 years, you’re going to pay $20M+/year. You’re going to pay that even if they suck on your team. There might be some incentive-based pay in addition to the fee they can command on the open market… but not 100% performance based.”
In many cases, the metric you’re being measured on is out of your control. While you influence it, you don’t control it. Sometimes it’s:
- Actual revenue which may be generated by sales reps
- An industry that gets hit by legislation or the economy
- Internal initiatives that are more important for the company to accomplish that actually hinder your performance.
And because you’re paid out on metrics that have now become less important to the client, they’re not incentivized to complete tasks that help you win for them.
In some cases, in the beginning everyone was happy with the concept of a payout. But when the payout happens, our emotions can get the better of us and make us think the deal no longer works. Either the client is paying out “too much” because the agency killed it for them with little effort or the agency is getting paid “too little” because they put in more time on the account than they anticipated.
In the cases where Hanapin has successfully negotiated pay for performance, it’s where we’re getting paid a healthy amount every month for our services *and* on top of that, we’re bonused for hitting the client’s moonshot goals – goals that are above and beyond what would normally be expected of us. In other words, the client is making so much money above their budget, they’re more than happy to pay you for the extra effort.