Standard Service Pricing – Easy Enough but Not So Easy

Pricing services is easy from the outside but is difficult for the insiders. How much should you charge?  What should be your hourly rate? Should you even charge an hourly rate? And, how does this reflect your own self-worth? All these questions hit you at a personal level when you are selling your own services.

The historical standard approach would be to charge per hour like lawyers, accountants, independent consultants and even how cosmetologists used to.  While this is not always the best practice, let’s explore this approach before we investigate the alternatives.

Industry Benchmarks

The first challenge is determining the hourly service rate. On this issue, the benchmarks are actually pretty non-definitive. Consider the data on lawyers, accountants and consultants:

• Experienced lawyers have charged $1,050 per hour and more for their time, but most lawyers achieve nothing close to this bill rate. Newly minted lawyers might be lucky enough to be in an established firm where their clients pay $250 per hour for their services. But those who take a more entrepreneurial route realize that sometimes, they are lucky to charge $100 per hour.
• Standard small business accountants might have a standard rate as low as $150 to $400 per hour. Established forensic accountants on the other hand can easily charge upwards of $1,200 per hour.
• Senior strategic consultants often charge $1,100 per hour or more. While this might be nice for some, most independent consultants just starting out find it difficult to sell themselves for as low as $25 per hour.

In all three of these service industries, the benchmarks deliver a factor of 10 or higher uncertainty in bill rates.

Comparable Equivalents

Trying to improve on the benchmark approach, many service firms have focused on “comparable equivalents.” For instance, the lead lawyer at an established and specialized, yet boutique law firm may compare their expertise and service quality equivalent to that of a lead attorney at a large but relatively broad-service-area legal firm.

The use of comparable equivalents leads to an improvement in the meaningfulness and accuracy of the benchmark approach, yet the determination of what constitutes the comparable equivalent is made by the consultant him/herself. This approach is fraught with error. Does the lawyer think too highly of him/herself or is he/she being too timid?

Demand Adjustment

The next level of improvement might be to take a “what the market will bear” approach. Starting with the rate identified through self-determined comparable alternative, the service worker goes to customers and states his/her rate—then if he/she sells at that rate they raise it, or if not they lower it.

In theory, this sounds great. In practice, both established and entrepreneurial service firms find it problematic. The problem lies in separating the signal from the noise.

For the entrepreneur professional service worker, they may find that they have insufficient demand for months at a time. When sales are low, it is not determinable whether it is due to bill rates being too high or that the entrepreneur professional service worker hasn’t found the right customers for their service. Though it is possible that the bill rate is too high, it is more common to find that the entrepreneurial service worker, like most other entrepreneurs, simply hasn’t found his/her market yet.

Similarly, established professional service firms will have had experience with the waxing and waning of demand. Services are generally a derived demand, not a primary demand. Meaning, the demand for services is often derived from the demand to accomplish something else. Services are an enabler in accomplishing that other goal, but the client is not purchasing the services for the sake of enjoying the services alone.  While bill rates may be adjustable in response to demand fluctuations here and there, generally large services understand that demand is not driven by rates alone.

For example, consider the mergers and acquisitions industry.  In the years immediately following the ’08 recessions, there simply weren’t many mergers and acquisitions to serve.  Today, that market is in recovery.  Price changes for serving this industry wouldn’t have impacted the demand for the services.  The need to execute mergers and acquisitions determines the demand, not the bill rates.

Adjusting rates according to market demand is a reasonable approach, yet the appropriate timescale for rate adjustments is not the same as that of the fluctuations in demand. For both the established and the entrepreneurial service firm, the rate of fluctuations in demand will outpace the appropriate rate of changing bill rates. The adjustment of bill rates is more appropriately executed in response to strategic or overall market trend factors, meaning they may follow a long-term trend that develops on the timescale of years. In contrast, large fluctuations in demand happen frequently, on the timescale of weeks.

Separating the signal from the noise, or the real changes in pricing power versus the temporary fluctuations in demand, is associated with experience.

The Standard with Room for Improvement

Using comparable equivalents coupled with strategic adjustments is the standard approach to professional service pricing. Yes it has its challenges, but it is a standard approach that can be found in just about every service firm.

A careful reader may have noticed that I have deliberately used the term “standard’ rather than “best practice.” While charging per hour according to bill rates is common, there are at times better ways to price services: project-based service pricing.