Restructuring agency billing and pricing models based on scope value with Jonathan Stark

Announcer:

If you’re going to take the risk of running an agency, shouldn’t you get the benefits too? Welcome to Agency Management Institute’s Build a Better Agency podcast presented by White Label IQ. Tune in every week for insights on how small to mid-sized agencies are surviving and thriving in today’s market. We’ll show you how to make more money and keep more of what you make. We want to help you build an agency that is sustainable, scalable, and, if you want down the road, sellable. With 25 plus years of experience as both an agency owner and agency consultant, please welcome your host, Drew McLellan.

Drew McLellan:

Hey, everybody. Drew McLellan here with another episode of Build a Better Agency. Glad to have you with us. We are going to talk about billing and profitability today. I will tell you more about our guest in a second. I know that that is a topic that is near and dear to many of your hearts, so I think you’ll find our guest fascinating and thought provoking. So stay tuned for that in just a second.

In the meantime, I’ve been promising you I was going to tell you about some of the speakers that we have coming at the Summit. A woman that owns a company called ScaleTime, her name is Juliana Marulanda. Juliana is an expert in helping agencies scale and systemize their business and really automate a lot of what they do around the process of the work. She is helping AMI agencies save hours a week, not only for themselves but for their whole team so that they can be more productive, spend more time doing different things than where they have been inefficient before. So she is going to be one of the breakout speakers. She’s going to talk about some of the mistakes that agencies make when they really think about how to get the work done efficiently and effectively. I promise you, you’re going to have some golden nuggets to take away to go right back and apply to your agency. So absolutely, absolutely worth checking it out.

Again, if you don’t have your ticket, please run over to the Agency Management Institute website. Go to the very first navigation button on the top left, which is BABA Summit, Build a Better Agency Summit, click and register. The tickets and the room block for the hotel will sell out. So I really, really, really want you to be able to move ahead quickly and join us and enjoy all of the great speakers, some of the ones I’ve already told you about, Juliana. Many other folks are going to be there to teach us how to do the work that we do smarter, better, more profitably, and have more fun. So we really want you with us.

My guest today to talk about billing is a gentleman named Jonathan Stark. Jonathan comes at the idea of billing in a bit of a different way. We’ve talked about value billing before, we’ve talked about time and material billing, and Jonathan has a little bit of a different take on how service industries like ours should think about billing for their time and for the deliverables, whatever that may be, for their client. So I think you’re going to find him very interesting and thought provoking. Of course, I don’t want to waste any more time because I want to get as much information out of him as I can on our behalf. So let’s do it. Jonathan, welcome to the show. Thanks for joining us.

Jonathan Stark:

Thanks for having me, Drew.

Drew McLellan:

Give everybody a little bit about your background, how you got to be where you are today and how you have come to form your thoughts about hourly billing, and then the way agencies make money.

Jonathan Stark:

In about 2005, I was managing a firm. At the time I think we had about 15 developers. It was a FileMaker development shop. We did some web stuff, but it was mostly FileMaker. We billed everybody out at a blended hourly rate of $150 an hour. I was the VP, and I reported to the owner. It was my job to manage the developers, and that included quite a bit of hours. I was always chasing them for hours. I was trying to come up with better tools to track hours. I was trying to come up with or building tools to funnel those hours into invoices, and then learning about how long it took to do certain things and then feeding that information back in. I did most of the estimates for new clients and trying to get a sense of how long it might take to do the thing that they were asking for so I could give them a reasonably accurate estimate.

Then it just gets into this cycle of then we’d send an invoice. We’d have a time sheet, if we were going over budget or it was taking longer than usual, we’d have a phone call where they would try and say, “Huh-uh, this took two hours last time, and it took four hours this time. Why don’t you knock off an hour?” We just talked about hours all the time.

It was in that context that I had an epiphany, which was that our best developer, who was getting paid quite a bit of money and could have worked really anywhere he wanted because he was well known, was probably not making us any money. He was fast, he didn’t need to do work two and three times, and his customers were very happy. Then we had a junior person who was basically a glorified intern. We paid him half as much salary-wise, he kept his customers just as happy, and it took him three times longer to do everything. So I couldn’t reconcile that. I had a real problem with that once I recognized that. I did a bunch of mental gymnastics and said, “Well, the really good developer, he helps train the other developers and teaches them how to get better.” Then I was like, “Well, wait a minute, that just means all of them are going to make less profit.”

Drew McLellan:

Less money, right, right.

Jonathan Stark:

So they’re all going to get faster, they’re all going to get better, and they’re all going to want a raise. It took me an embarrassingly long time to even start to question hourly billing as the source of this problem. But once I saw that, I couldn’t go back. I couldn’t unsee it. I was like, “I got to do something about this.”

Drew McLellan:

Well, I think even if agencies don’t bill by the hour, the way they bill the estimate is pretty much billed by the hour. They just don’t say it that way. They just roll it up into a lump sum.

Jonathan Stark:

That is not the way I would do it, but if you’re giving a fixed price… Well, maybe I don’t understand exactly what you said. Are you saying that most agencies come up with an estimate, and they say, “Ah, we think it’s going to be about $50,000, but it’s an estimate”?

Drew McLellan:

No, I think what they do is they say, “The client wants us to make a widget. It’s going to take the art director two hours. It’s going to take the copywriter four hours. It’s going to take the account person an hour.” So I add up all those hours, I figure out what our blended rate is, and then I tell the client, “It’s going to be a flat fee of whatever that dollar amount is,” which is still ultimately billing by the hour other than you now have lost the opportunity to go back and ask for more money if it took longer.

Jonathan Stark:

I’m a big fan of giving fixed rates, fixed prices, not fixed rates, fixed prices of some kind. The calculation model that you just described is usually time and materials or cost plus, it’s referred to as, and that scared me. What happened next in my story was that I left the firm to go try a new model. I didn’t want to risk 15 people’s mortgages on my crazy idea. I didn’t know how to make the transition at the time. I just knew I had to make some kind of change. I was not going to bill by the hour anymore. So rather than risk that firm’s future, I went solo and immediately started giving fixed prices. I thought at the time I was doing something called value-based pricing, but I really wasn’t. I thought I was, but it’s trickier than I expected. But I was giving fixed prices. I never ever once in my life have issued a change order of any kind, so I stuck to it. Come hell or high water, I stuck to it, and hell came up once or twice.

Drew McLellan:

I’m sure.

Jonathan Stark:

But even those times weren’t that bad. Back to your comment, I think a lot of people who give fixed prices do try that first, the sort of cost plus, and they come up with some more or less arbitrary percentage if it’s tack on for-

Drew McLellan:

Profit.

Jonathan Stark:

… administrative, profit.

Drew McLellan:

[inaudible 00:08:39], stuff we don’t know yet.

Jonathan Stark:

Yeah, there’s always surprises, right?

Drew McLellan:

Right.

Jonathan Stark:

The issue with that is that you’re limiting your profit possibilities, so you can’t have a huge home run. You can’t have something that’s massively profitable. It’s so frustrating because, if you instead based your prices on the value to the client, you have way more leeway to set a price that is extremely profitable and attractive to both you and the client. Then you come up with a scope after you set a few prices. You’re like, “Well, we could work with you in three different ways. Here are three possible prices that make sense given the value that we’re going to create for or the contribution we’re going to deliver for this outcome that you’re looking for. So here are three prices that are much smaller than that big number.”

Then you come up with a scope that would fit inside of those budgets, if you will. So if you scope lasts, you can have real profit for the first time, real meaningful profit for the first time. If you’re doing the sort of cost plus, you’re almost certainly not tacking 100% or 200% profit on top of the estimate. So you’re never going to have massive profits or really attractive profits.

But the real problem is, the real problem with approaching it that way is that you’re not having the value conversation at all. So when you meet with a client, you’re acting usually like an order taker, or maybe, maybe you’ve got a really good reputation and they’re curious about your opinion. But you’re not going to ask the questions about, “Should we even be doing this? Are we really the best firm for you? Do you really need to do this now? Wouldn’t it be better to do this at another time? Put it off, it’s going to be risky, and all of those things.” So at least in my world, more of a software-oriented world where we’re engineer mindset and we just can’t wait to build something. In the sales interview, we’re deconstructing all of the tables we’re going to have to create, and the fields and the tables and the layouts and the portals and all of the things we’re going to have to build. We’re getting all excited about that.

But we never have a conversation to find out if this is the right thing to build. The client’s not an expert at what you do, so why would you let them tell you how to do your job? It changes the whole conversation if you start by trying to talk them out of working with you by asking what I call the why questions, “Why this, why now, and why me?” Through that line of questioning, you separate good clients from bad clients because bad clients will hate this conversation, and good clients will tell you why they think investing money with you is going to be good for them. Then you can decide what level of confidence you have to engage with them if you really think you can move the needle they want moved and you agree that it’s a good idea, and you’re like, “I’m confident that I can do this,” then you’ve got a basis for creating a value priced proposal. The upside there can be significant. If you really know what you’re doing, the upside can be huge.

Drew McLellan:

Ron Baker, who exists sort of in our world, has talked about value pricing for a long time, and I’m sure you’re familiar with him. I’m curious how you approached having a conversation with a client that got them to articulate the value of the outcome of the work. “We’re going to do a new website for you. We’re going to do a new ad campaign or whatever.” How did you guide the client? Because a) the client may not know the answer to the question, may need some help getting to that answer, or b) it doesn’t really behoove them to make it sound like it’s going to be worth a lot of money to them if it’s going to turn around then and make it more expensive. So how did you conduct that conversation?

Jonathan Stark:

It’s those three categories of questions. You’re right. They almost never could just answer it. If you say, “Oh, how much is this worth?” it’d be impossible for them to give you an answer that even they believed. So it’s a process of uncovering. If you approach a sales interview in a genuine posture of service, you don’t need the work, you know you’ve got another sales interview in the next two days, you know you’ve got more leads coming in, you’re not desperate for the money, this is sort of a precondition for this, and you genuinely only want to work with clients that you believe you can hit a huge home run for, then you’re going to hit more home runs. You’re going to have better client relationships. You’re going to be able to say no to clients who are trying to keep the budget close to their vest or they’re like, “Why are you asking me these questions?” It’s like, “Look, it’s not going to be a good fit if you don’t even trust me at all.”

But if you come into that meeting, the three categories of questions are “Why this, why now, and why me?” The first one, why this? You politely and with some humor, ideally, question the decision more or less they’ve made that someone like you is what they need. So maybe they think they need, I don’t know, a custom-built internal workflow solution. That was my bread and butter back in the day. I’d come in there, and I would say something like, “Okay, I can do that. I’m happy to do that. I do it all the time. But have you considered just using Basecamp or have you considered using something else off the shelf or Zapier or plugging things together with no code solutions? Have you considered all of these other things?”

If they say, “No, that sounds interesting,” then the thing that I might propose, if I propose anything, is to just give them a roadmap for a relatively low fee, maybe 10 grand instead of 150 grand for a custom build, “I’ll just give you a roadmap, take Google Forms, plug it into Zapier or pump it into Basecamp, and you’ll be good to go.” That might be good enough. The thing that they were asking me for was going to be very risky, very expensive, and ultimately perhaps not even that satisfying. So that’s the why, this kind of question.

The why now question is probably self-explanatory. “What changed that caused you to call me or look for someone like me?” I want to hear that it’s urgent. I want to hear that Amazon is coming into their space and they need to gobble up as much market share as possible or they’re going to go out of business. Or they’ve got one chance to make this pivot. If they don’t do it, they’re going to lose their three biggest whale clients. I want to hear a highly urgent situation because that is going to increase the risk for them of screwing it up, and it’s going to increase-

Drew McLellan:

The value.

Jonathan Stark:

… the value of picking the safe option. So that’s why this. You’d ask questions like, “Why not put this off for six months? Why not study this for a while? Is this urgent? Is there some hard deadline, like it needs to be done before the next presidential election or the Olympics or something?” You find out if there’s real deadline pressure and what the real urgency where that’s coming from.

Then why me? Why would you hire someone expensive like me? You know I’m going to be the most expensive person you talk to. I wrote the book on this. If your marketing’s good, they’ll know that going in that you’re going to be expensive. But still ultimately, I want to hit such a home run. I had one client who said, “We’re going to build a statue of you outside of the building,” after I was done. I tell that story a lot of times in a sales interview. That’s the outcome I want. I them to be like, “This is the best money we ever spent. It was super expensive, but it was well worth it. We’d do it again.” That’s the testimonial I’m going for. So I want to talk them out of working with me if it’s going to be a big stretch for them budget-wise, if it’s going to put them at risk. I’m a very much like a do-no-harm kind of person.

There are plenty of clients out there who are in the situations that I’m describing and really do need to hire someone who’s best at the thing that they do. You don’t need a million clients to get these high profit jobs that only take a handful of hours and five, six figures in fees. That’s the way to answer your question. That’s how I guide them through this process of uncovering what it’s really worth to them. At the end, I’ve got everything I need to write a proposal, nice short outcomes-based proposal with three options in it. I just have this situation appraisal at the top that’s what they told me. “You’re in this situation, you’d rather be in a different situation, and these are the reasons you can’t hire anybody but me.”

Drew McLellan:

So in the proposal, if I’m understanding your sequence of events, it’s going to say, “Your world is broken. You need this widget. You have to have the widget now because of these outside and inside influences, and so I can fix your widget for $90,000, $60,000 or $40,000.”

Jonathan Stark:

I can improve their condition in one of three ways. A lot of times it would be like a do-it-yourself option, a done-with-you option, or done-for-you option. It depends on their scenario, but there are lots of different ways to slice this. Yes, there would generally be a significant delta between the three options. They would all be based on my guesstimate of what this is probably worth for a company in this situation, and I would scope each to be highly profitable. So at each price point, I would pick a scope that I would be fist-pumpingly happy to do for that price. Because I know there are going to be surprises, there always are, and I don’t want to hit the client with like, “Oh, I got to go back to the well for more money. Go tell your board it’s going to be twice as much as we thought.” I’ve never done that, and I would never do that to a client. I’d rather work for free for a year than do that, and I have.

Drew McLellan:

Again, though, you’re giving them the do it yourself, do it with you, do it for you, and you’re putting price points on it, but you haven’t really, if I understand it right, built out the scope of what you’re going to do yet. Is that correct? Because they have to agree on the price before you’ll decide what the actual scope is.

Jonathan Stark:

No. I would come up with a scope that I would do for that price and then propose that. It’s not always a DIY, done with you, and done for you. It’s not always that, but it is often that. Sometimes it’s different. Sometimes it’s a different nature of your involvement. The nature of your involvement is different in each one. I have a series of different ones, but it really depends. It could be all sorts of things. What it usually isn’t is option one is X, option two is more of X, and option three is even more of X. It’s always option one is X, option two is Y, option two is Z. So they’re different. It gets the buyer thinking about like, “Well, what would be the best way for us to engage with this person?”

A different way, a different concept could be… Depending on what you do, the first option could be something more like a half day strategy workshop with senior leadership. The second level could be something like adding in some sort of messaging with the sales team after the positioning and the messaging has been agreed to at the top, translating that throughout the rest of the organization, particularly the sales team, let’s say. Then the top level option, maybe you’d be getting involved with the sales team and coaching them on live calls for a period of three months or something. It’s all in the same area of expertise, but the nature of the engagement is completely different across the three options.

Drew McLellan:

Yeah, makes sense. I want to talk a little bit about the pros and cons that you’ve discovered in this pricing model. But first we’re going to take a quick break, and then we’ll come back and chat about that.

Hey, sorry to interrupt, but I wanted to make sure that you are thinking about how to connect with your clients by figuring out what they love and maybe a few things that they’re not so crazy about with your agency. At AMI, one of the things we offer are client satisfaction surveys. We do both quantitative and qualitative, so an online survey, but also interviews with some of your key clients. Then we come back to you with trends, recommendations, what they love, what they don’t love, lots of insights around how you can create an even tighter relationship with your clients.

So if you have interest in that, you can go under How We Help tab on the AMI website, and the very bottom choice on How We Help tab is the Client Satisfaction Surveys. You can read more about it. Whether you have us do it or you do it yourself or you hire somebody else, it is really critical that you be talking to your clients about what they love and what they wish was different or better. So do not miss the opportunity to tighten your relationship with your client whether we help you or not. Let’s get back to the show.

We are back with Jonathan Stark. We’re talking about pricing and just thinking about the… It’s not really even just about pricing, but it’s, how do you engage with a prospect to figure out what they need and if and how you can help them? Then, how do you price it in a way that sets you up for, as he was saying, a home run of profitability? You’ve been doing this for a while. I’m sure there are both pros and cons to the methodology. What have you discovered?

Jonathan Stark:

First I’ll say, well, I’ve been doing it since 2006, and it’s been very successful the whole time, so that is hopefully encouraging to people. But it takes a while to figure it out because you think you’re doing it and then you realize, “Oh, I’m not really. I’m still doing cost plus. I’m just raising the prices.” You’re really not having the right conversation. You’ll get better at it over time. You need a lot of at bats. So if you only are doing a proposal every six months and you just have a whale model where you have two or three big clients, it’s going to be really hard to get the practice to get good at this.

Ideally, you would have a sales interview a couple times a month. You always have the same person doing it, hopefully the principal or whoever’s in charge of sales, and they practice this, practice this, practice this ideally with smaller-sized projects so if you do screw up, you won’t blow your foot off if you price too low, because you also have to get good at managing scope and keeping the client on point, focused on the desired outcome and not the stuff they want you to do.

I would say it takes a while to learn it, but it dramatically transforms the nature of the client relationship. They come right down. When you give fixed prices, they come right down. They’re not micromanaging you. If you start to approach the budget, it’s like, “Oh, we’re 90% done, 90% to go. The budget’s basically gone.” This is for people who do estimates, hourly estimates. The budget’s basically gone. You can see the project’s only half done. The client starts to turn into a monster, and they should because you’ve demonstrated that you either don’t know how to control scope or you don’t know how to do an estimate.

Imagine if somebody was going to work on your house and they said, “Ah, it’d probably be about 15 grand,” and they keep coming back for more and more and more, and it ends up being 45. You would not be happy, and you’d be going over everything with a fine tooth comb. So my argument is, one of the things that’s bad about hourly billing is it creates a horrible trust model, the incentives are not aligned, and it creates clients from hell. It seems like, “Oh, all clients are bad. It’s like, “No, you’re torturing them.”

So it takes practice, but it makes your life a lot easier right away. The profitability might not be instantaneous, but as you get better at it and attract clients for whom you can do work that it’s even higher and higher and higher value, the difference between what it’s worth to them and your cost floor gets bigger and bigger and bigger. So it becomes easier to close deals that are highly profitable for you because they’re also highly profitable for the client, and the money they give you is… They give a dollar, you give them back two. After six months or whatever, you start hitting home runs a lot, you attract better clients, better work, all of that. I’m not going to lie. It takes a good 18 months to get the hang of it, assuming that you’re doing reasonably frequent sales interviews.

Drew McLellan:

When you are learning how to do it, what were some of the mistakes you made early on that you had to overcome with practice and the learnings of the mistakes?

Jonathan Stark:

The big one was I kept on scoping in the meeting in my head. It took me at least a year to break that habit where they’re talking to me… Because that’s exactly what we did at the firm, and it was such an ingrained habit that it just takes a long time to break it. I kept realizing it almost like the layers of an onion. I’d shed a layer of the onion be like, “Oh, now I’ve got it.” It’d be, “Oh, I still don’t have it. I forgot to ask this or I forgot to ask that.” Because if you’re in the meeting and you’ve already decided what you’re going to do, then you are not listening. You’re certainly not looking for or you’re not asking questions that are going to reveal that they’re asking you to do the wrong thing.

Drew McLellan:

Or they’re not using the right words to describe what they are asking for and that you hear them s