632: Transitioning from Hourly Billing to Effective Pricing Models | Jonathan Stark

On this episode of the Conquer Local Podcast, we’re joined by Jonathan Stark, who has over 15 years of experience in software development, consultancy, and training. He’s delivered sold-out talks on three continents, authored five books including “Hourly Billing Is Nuts,” and hosts the popular podcast “Ditching Hourly.” 

Jonathan collaborated with major brands like Staples, Time, T-Mobile, Cisco, and Intel during his consulting tenure. He curates a daily newsletter focused on pricing strategies for independent professionals, and as the President of Jonathan Stark Consulting, he’s passionately dedicated to eradicating hourly billing and promoting fairer pricing practices worldwide.

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Transitioning from Hourly Billing to Effective Pricing Models

Introduction

Jeff Tomlin: Welcome to the Conquer Local Podcast! Our show features successful sales leaders, marketers, thought leaders and entrepreneurs who will inspire you with their success stories. Each episode is packed with practical strategies, as our guests share their secrets to achieving their dreams. Listen in to learn the highlights of their remarkable accomplishments and get tips to revamp, rework, and reimagine your business. Whether you’re a small business owner, marketer, or aspiring entrepreneur, the Conquer Local Podcast is your ultimate guide to dominating your local market. Tune in now to take your business to the next level! 

I’m Jeff Tomlin and on this episode, we’re pleased to welcome Jonathan Stark. Jonathan has been in the software development, consultancy, and training space for over 15 years. I’m really looking forward to this talk. He has delivered sold-out talks on three continents, authored five books, including “Hourly Billing Is Nuts,” and he’s the host of the popular podcast, “Ditching Hourly.” He curates a daily newsletter focused on pricing strategies for independent professionals. And as the president of Jonathan Stark Consulting, he is passionately dedicated to eradicating hourly billing and promoting fairer pricing practices worldwide.

Get ready Conquerors for Jonathan Stark coming up next on this week’s episode of the Conquer Local Podcast.

From Agency VP to Value-Based Pricing Advocate & Educator.

Jeff Tomlin: Jonathan Stark, welcome to the Conquer Local podcast. Great to have you on, man.

Jonathan Stark: Thanks for having me. It’s an honour.

Jeff Tomlin: Hey, well, tell us a little bit about the journey. How do you go from the Fortune 500 world all the way to starting your consultancy, and yeah, what does that journey look like for you?

Jonathan Stark: Yeah, it was a little bit of a gravitational pull plus an obsession on my part. So I had been working for clients doing software development by the hour at a pretty popular dev shop, like a sort of software development agency. And it just hit me like a bolt out of the blue one day that we were probably losing money on our best developer, and we were making a lot of money, profitability-wise, off of our most junior developer. And I spent about two weeks trying to rectify that in my mind because it’s like, well, if we were going to grow the business, we’d try and hire a bunch of people who weren’t that good, which made no sense to me. So I thought about it and I thought about it until my thinker was sore. And I realized after about two weeks that hourly billing was the problem. And once I identified that I was like, well, if we were giving fixed prices of some kind, our best, fastest, most accurate developer would be the most profitable by a mile. All of a sudden it aligned. And then the more I thought about it, the more I thought about how hourly billing affects the relationship between you and your clients. The longer it takes you, the more you make and the worse it is for them in both ways. It costs them more, and also their opportunity cost is just they want the software shipped. They don’t want it shipped in six months. They want it yesterday. This and a bunch of other things caused me to go out on my own because I brought this information to the owner of the firm, and I was the VP, and I was like, “Chris, we need to do something about this.” And he understood it in theory, but he was like, “But how would we make that switch? I mean, everything about this business is predicated on a billable hour.” And I didn’t have a good answer for that, so I went solo to try and figure it out for myself. And then I was just running an agency using value-based pricing and productized services and advisory retainers and subscription-type things, and it went great. But all of my friends from the old world, my hourly billing friends, they kept asking me, “How is it possible that this is working? How are you not getting killed on every project? Is it really better?” Yes, it’s way better. So then they started to ask me to teach them how to do it. And over the course of years, I built up a sort of body of work around all this pricing stuff. And finally, in 2016, I published my first book on it and basically from there, I never looked back.

Switching from Hourly Billing to Value Pricing for Services

Jeff Tomlin: All right, so I want to get into it then. So what’s the… Hourly billing sucks, and you explained that. I think that makes sense. So what are the alternatives?

Jonathan Stark: Sure, there’s a bunch of things I advocate, but you could set a price, a fixed price in a bunch of different ways. So let’s start here. Hourly billing is not pricing. Generally, the way it works is you give a client an estimate for how many hours you think it’s going to take. They multiply that by your hourly rate. They give you a green light or not. But it doesn’t matter if you say, “This is an estimate, this is an estimate, this is an estimate.” They have to make a buying decision based on the number that you gave them. And if it goes over that number, it’s a nightmare for them and for you. The project starts to get very uncomfortable if you’ve gone over their budget. So hourly billing is not pricing, it’s just billing in arrears for some time spent. And what I try to have people do is switch to pricing. So start pricing and stop billing. And there are a whole bunch of ways you can price services. So for service business people, especially, I mostly work with independent people like soloists. There are three ways that I advocate setting prices, depending on what kind of work you do and what kind of work you want to transition to. The three big ways are to value-price projects. If you’re doing custom projects, which are sort of non-trivial collaborative engagements where the client is involved to maybe not heavily involved, but they’re involved along the way and you’re doing status reports and design review and all of these things with the client over the course of months and it’s got some done state, some point at which it will mission accomplished kind of thing, to me, that’s a project. And if you’re going to continue to do project work, then I would say value pricing is a great way to potentially dramatically scale up your profits. We can go into whichever ones you want. The two other ways are productized services, and the last way would be some kind of product or info product.

Jeff Tomlin: Okay. So my baseline knowledge here, I’m a big fan of value-based pricing and we’ve gone through exercises to revamp our pricing a number of times. It makes a lot of sense to me. You’ve got a value metric, and you basically structure it so that as the client gets more value out of that product and gets more usage out of it, the price scales with it. Help me understand how you can do that on the service side of things. I have an idea, but I want to make sure I understand how you’d scale that.

Jonathan Stark: Sure. So if you want to stay solo, so if you don’t want to scale up by hiring people, which is a way to scale up an hourly model, you just hire a bunch of people that are junior and you mark up their time. So that’s an approach that can work if you want to be a manager, if you want to be a boss, but if you want to keep doing the thing that you love doing, then that’s not a really viable approach. So you need to figure out some other way to create leverage in your business, otherwise, you’re going to be stuck at this maximum income forever. So value pricing is a great way to potentially scale up your income, disconnect your time for money, and scale up the amount that you can charge. And the air quotes “trick to it,” the growth comes from getting bigger and bigger clients who get more and more value out of the expertise that you’re bringing to the table because if you’re delivering higher value, you can set your prices higher and they’ll still be completely acceptable to these bigger and bigger clients. So when I first went solo and I explained, I said, “Dad, I quit this great job where I was the vice president and I’m going to hang out my own shingle.” He was like, “Are you going to hire people?” And I said, “No.” And he said, “Well, how are you going to scale up the business?” And I said, “By getting bigger clients.” And if you charge based on value, not time, you can set a six/seven figure fee for something that you’re very well known for being an expert at. And if they’re in a very high-risk situation and the project that they’ve got going on is going to have big downstream effects for, I don’t know, ten thousand, a hundred thousand employees, all of a sudden writing me a check for a hundred thousand dollars isn’t that big a deal because it decreases the risk of screwing this big thing up even a little bit. So if you have tiny clients and they’re barely getting any value of what you do, it won’t help you at all. So there’s that. You need to be having bigger and bigger and bigger clients who get more and more value, and that way you can raise your prices.

Quantify Client Pain, and Scale by Targeting Ideal Mid-Sized Clients

Jeff Tomlin: So I like that, that as you’re talking to your potential client throughout the sales process, you have to understand exactly what their pain is that you’re going to be solving for them, and most importantly, be able to quantify that so that you can put a value against it.

Jonathan Stark: Right. Yeah. That’s correct. And it’s napkin math. I mean, you’re not going to get an exact number out of them, but if you’re talking to a client that has a million dollars in payroll every month, and they’ve got this project that’s going to increase their productivity across the organization, and they brought you in because they recognize you as the expert at this software packaging, Salesforce or whatever it is that they have and they know it’s misconfigured and they know they’re not getting their investment out of it, then a price that you could set that would be reasonable to them, there’s a lot of wiggle room there. So you don’t have to have an exact number or what’s the budget for this project, but you do need to understand the success metric. What is the needle they’re trying to move and what would that mean for a company like this? So if you could increase productivity by 10% across even a couple hundred employees, that’s going to have a meaningful bottom-line impact for this business. And if they believe that some contribution that you can make is going to either increase the odds of that or deliver it to them more quickly, then that’s worth real money.

Jeff Tomlin: And if I heard you correctly, as you go through your process of scaling your business and profitability, your ideal customer profile is changing and you’re going upmarket as you get better at your trade.

Jonathan Stark: Yes, there’s a spot where consultants, I think they can kind of top out because at a certain point if you’re known as an expert at some particular thing, there’s a certain point where the company gets so big that they have someone like you that is an employee. So for example, if you’re a pricing expert, let’s say, they might have an entire department. Nokia, that’s a past client, they’re not really around anymore, but somebody like Staples or Starbucks, they probably have someone in-house, they might even have a team of people that’ll do this, and they’re investing hundreds and hundreds or maybe millions of dollars a year into that staff. So they might be too big for some expertise that you have. But there’s this sweet spot that I usually find with my coaching students where somewhere between 200 and 500 employees, the business has been in business for a while, they’re really familiar with their numbers, and they’ve got this bet the business project that they’re nervous about, and they got to get it right the first time. They want to get it done as quickly and painlessly as possible. And you are the person, you are the go-to guy or gal for this kind of a thing, and they’ll pay for that even if it takes you very little time.

Productized Services Lead to Doubled Income and Improved Client Relations

Jeff Tomlin: Yeah, I get it. That makes a lot of sense. So I’d like to hear a little bit more about the other two examples. You mentioned productized services and the other one-

Jonathan Stark: And just products.

Jeff Tomlin: So jump into those a little bit.

Jonathan Stark: Yeah. So productized service, it’s a hybrid between a product and a service, and it’s sold or it’s marketed as a product. So a lamp at Target might come in a box, it’s got benefits, it’s got a picture, you can see what it is and it feels very tangible and you can understand what it would be like to interact with the lamp, but it’s delivered. So it’s marketed and sold as a product with all the sort of very clear, tangible, as tangible as you can get for a service, like an experience of what it would be like after you bought this thing. But then the delivery for the client who does buy is delivered like a service. So the big difference between the productized services and just custom projects is that it’s for a fixed scope that you sell usually at a published price. So as you attract prospects and they come to your website or they’re exposed to your marketing materials, they see this very clearly defined thing that has features and benefits that are super obvious to them. “Yeah, that would be great.” And then boom, there’s the price tag, and here’s a button that will allow me to take the next step, which is usually not a phone call unless the price is very high. It’s usually not a phone call next, usually, it’s like an apply now or some kind of intake, or it could even be a buy now button or join the waitlist. But there’s some call to action there so it feels more like a product like they’re buying something like right now.

Jeff Tomlin: So give us an example of, thinking this way, what can it do to profitability overall?

Jonathan Stark: So the productized service specifically?

Jeff Tomlin: You could go through any of your examples, but as you start thinking about value pricing as opposed to hourly, what is a typical transformation in profitability when people start to make the shift in their mind?

Jonathan Stark: I literally interviewed someone yesterday who I had a coaching call with about a year and a half ago, and this guy’s a machine. He did everything that I said, and I said, “Well, how has it been?” And he said that he has doubled his income, he’s working the same amount. He likes his job, he didn’t really want to decrease his hours. He is working the same amount, he’s doubled his income, and he has massively improved his relationship with his clients. The experience of working with his clients is, in his words, just way more chill, and he’s doing way better and he’s got enough time on the side to be writing a daily mailing list, running a weekly podcast, and building a SaaS product while running his normal service business.

Value Pricing Risks and Aligning Scope with Client Outcomes Cautiously

Jeff Tomlin: Wow. So how could this go wrong? Are there any arguments against this approach?

Jonathan Stark: Oh yeah.

Jeff Tomlin: And what are the pitfalls?

Jonathan Stark: Sure. Hourly billing is very safe. You basically can’t get yourself in trouble financially with hourly billing. There’s no risk to it. If you work the hours and the deal is they’re going to pay you for the hours, then you get, assuming they pay, which is sometimes a big assumption, but assuming they pay, it’s safe. There’s no real risk, therefore there’s no real reward. So the point at which people start to look for someone like me when they get really frustrated is when they realize that the better they get, the less they make. So they’re working harder than ever and they’re not getting ahead because they have to put in more time. They need more clients because they’re finishing things faster. So they start to feel stuck at this, usually, it’s around 150 to $250,000 revenue per year, and they’re just stuck there and they’re working like a dog. I probably ignored the actual question because this is a total soapbox of mine, but it’s a trap. Hourly is a trap, but it’s very safe. So if you’re comfortable in there and you’re happy with hourly billing, then ignore me. That’s fine. But if you start to feel yourself in this trap, then there are only, I mean, there are probably half a dozen ways out of it for service providers, maybe more. But there are ways out of it without hiring a bunch of mini-mes to do what you do, only not as well.

Jeff Tomlin: Well, I could imagine people thinking through this for the first time, especially on the service side, and it’s probably something that we haven’t thought enough about over on our side, but I could imagine someone getting it and it feeling like a breath of fresh air because it is just like how a business increases their TAM. You’ve got different levers to increase the market that you serve and the total available amount that you can earn, and they’re typically things like increasing the actual audience size that you’re trying to focus on, or increasing the value per customer that you can get at the end of the day. So this seems like a way that people can break out of the earning potential that they have at one time.

Jonathan Stark: Yes. But like you alluded to, it’s dangerous. There is risk. It’s not without risk, but that’s why it has a reward. So the thing that usually… When people hear me talking about this or they encounter it somewhere else, a lot of people, a non-trivial percentage, but not most people, but some people immediately get it. Immediately they’re like, “Oh, I’ve always hated it. It never made sense to me.” And they go all guns blazing, they read one book, and they’re like, “Okay, all my clients are going to be like this from now on.” And they shoot themselves in the foot right away by giving a fixed price that is way too low, and they end up regretting it and wishing they had not done it. And they’ll blame the concept of value pricing perhaps, or hopefully, they’ll recognize that they didn’t really value price. They actually tricked themselves into thinking they value-priced it when really they did time and materials because it’s so hard to flip your thinking away from scope first to scope last, which is what you need to do with value pricing. With scope first, like most people that bill by the hour when they meet with someone and they’re in a sales conversation, they talk about scope, scope, scope, scope, scope, because the next thing they’re going to do is put together an estimate of how many hours it’s going to take to do all this stuff you told me to do. And it’s almost always too low because an hour or even a couple of hours is not enough time to uncover all the things that are going to happen in a six-month project. There’s going to be a lot of creativity, there’s going to be a lot of surprises. Like every single time something happens as a surprise. So for sure, your estimate is too low, almost for sure. So what happens when you switch to value pricing but you’re used to thinking about scope, scope, scope, scope, scope in the sales meeting? The thing that you didn’t talk about in the sales meeting is what the client is trying to accomplish. What is their goal? What is their business outcome that they believe this is going to contribute to? And it’s always something that has an increase or decrease in front of it. It’s like increase revenue, increase profits, decrease cost, increase or improve employee morale, increase customer satisfaction numbers, we want our CTO to be more well-known as a thought leader so we can attract more employees. It’s always an increase or decrease. There’s always some number. And if you don’t spend that hour that you’re talking to them finding out how they’re going to judge how good of a job you did, if you don’t find that out in advance, it’s like shooting hoops with a blindfold on. You’re just lucky if you hit the metric that they wanted. It’s just luck, and you end up doing best practices all day long, and then you get to the end of the budget and the client’s like, “Well, this isn’t going to work. This isn’t doing what we need it to.” And then the fingers start pointing because you didn’t find out what the goal was upfront. So with value pricing, you need to get really good at finding out upfront how am I going to satisfy this person. What is going to be a home run for that person sitting right across from me? Find out what it is going to take to satisfy them, and then you decide if you think you can contribute to that in a meaningful way. And if so, then guesstimate how much that’s going to be worth to a person like this in a company like this, within an order of magnitude is close enough, and then create some prices that are less than that, a fraction of that number, and then decide what scope you’re going to do at each one of those price points. So if this is worth a hundred thousand dollars to the person sitting across from you, almost for sure, then divide it by 10. Give them a price for something you’re going to do for 10,000, something you’re going to do for 22,000 and something you would do for 50,000, and set your scope in such a way that it will contribute to their outcome but inside of this budget that you’d be fist pumping happy to do.

Fixed Pricing Improves Client Relationships and Leads to Easier Sales

Jeff Tomlin: I can relate, especially as you’re talking about the hourly billing piece. The biggest pet peeve that people have working with contractors is the after-work orders. You scope something for X amount of a hundred thousand dollars, and it always comes in over budget no matter how much work you do to get them to map out their plan ahead of time, and it drives everybody nuts, doesn’t it?

Jonathan Stark: Clients don’t like hourly. It’s terrifying, especially if it’s a big outlay. I mean, if 10 bucks for some stuff, like whatever, but if you’re planning on spending a year on a project and you’ve got a team of people that you’re paying hourly to do it, that’s very risky for the client and no risk for the seller. I mean, Deloitte and a bunch of the other big consulting firms get sued routinely over them going way over budget. And then it’s just like, “Well, that wasn’t in the contract.” It’s like, “You said…” “No, you said…” And I just didn’t want to do business like that anymore. Even at a small scale, we had the same situation. It was very common to go overestimate, and I hated that. I hated having those conversations. So one of the beautiful things about fixed pricing, whether it’s value-based or otherwise, is that you never have to have one of those conversations again. Then you can much more reliably satisfy the client because you find out how they’re going to measure the success of the project, and you don’t waiver on the price that you gave them upfront. I mean, have you ever had done a home renovation, and you just feel like you’re… Yeah.

Jeff Tomlin: Don’t ever want to do another one.

Jonathan Stark: You just feel like you’re… Yeah, it’s brutal.

Jeff Tomlin: By the way, I can share our experience. From a product point of view, when we first made the move over to value-based pricing, it was like a breath of fresh air. What we experienced with the amount of leads coming in the front door increased dramatically because we made it easier to interact with us. Conversions increased on the backend because the conversations that we were having were just so much easier to have, and it was a win all the way around. And that was the biggest takeaway. It’s just the conversations that we’re having, whether we’re actually having them or we see the decision-making process that the leads are making throughout the buying journey, everything just got a lot easier, and it felt like we were running downhill instead of uphill.

Jonathan Stark: Yeah, yeah, it’s true. I mean, I know from teaching hundreds of people how to do this that certain people, they’re business owners. They’re solo business owners, whether they see themselves that way or not. And some folks just don’t want to do sales, even if it’s a consultative kind of sale that I think both you and I know is fun and it’s not pushy and it delivers value while you’re in the sales process, but some people are just either introverts or whatever and for those people, I think it can be a real long journey to flip their mindset away from cost plus, cost first and to scope last. So productized services, I think are a better fit for that group because you end up leaving money on the table, but in exchange for that, you basically don’t have to do sales at all. It’s much easier to close deals. They’re not even deals. I mean, it’s almost like you turn clients into customers instead of these sort of high-touch, long-term, custom, risky engagements.

Shifting from Time-Based to Value-Based Pricing for Better Results

Jeff Tomlin: Jonathan, I hope that we’ve got people thinking about the way that they price and got the wheels turning a little bit throughout the talk. If you were to leave the audience with a couple of takeaways, what do you want at the top of their mind?

Jonathan Stark: I mean, the number one thing is to just think about it for a second. Trading time for money makes no sense. It’s common, it’s the norm. But if you think about it makes no sense to make less the better you get. It just doesn’t. So once you recognize that, then it becomes choose your own adventure of what is the best way to price. Instead of billing for my time, how can I price my outcomes, my products, my productized services, and my projects? But if you don’t disconnect yourself from time, you’re just going to end up stuck. I mean, there’s just no way around it. So yeah, I mean, we could have a whole conversation around positioning because you need to be seen as unique, otherwise, you’ll get undercut by competitors who are terrible at what you do because the clients can’t tell the difference. So there’s a whole component there, but that’s a book unto itself.

Connect with Jonathan Stark at jonathanstark.com for more insights.

Jeff Tomlin: Well, if people wanted to continue that conversation with you, how do they reach out and get in contact with you?

Jonathan Stark: The best place is my website, honestly. So if you just go to jonathanstark.com, then right on the homepage, it’s like a “First time here?” and a bunch of free resources and a way to get my email and all that. If you can’t remember my name, just Google for the Ditching Hourly guy and it’ll come up.

Jeff Tomlin: Amazing stuff, Jonathan Stark. I do hope that we got some wheels turning throughout the conversation. It’s great stuff. Thank you so much for taking some of your time to sit down and chat with us on the Conquer Local podcast.

Jonathan Stark: Yeah, my pleasure. Anytime.

Conclusion

Jeff Tomlin: Lots of great learnings from our conversation with Jonathan Stark. Value pricing and productized services offer better alternatives to hourly billing for service businesses. By focusing on pricing based on the value delivered to the client and providing clear, tangible offers like productized services, service businesses can increase profitability and improve client relationships. I love value-based pricing approaches and clearly, I’m sold on his approach.

Shifting from hourly billing to value pricing requires understanding the client’s goals and desired outcomes upfront, allowing for more accurate pricing estimates and eliminating the need for constant scope discussions. Value pricing empowers service providers to break free from the time-for-money trap and in the end, achieve higher income and business growth.

If you’ve enjoyed Jonathan Stark’s episode discussing Transitioning from Hourly Billing to Effective Pricing Models: revisit some of our older episodes from the archives, check out Episode 620: The Power of Verticals and Go-To-Market Strategies with Corey Quinn or Episode 618: Mastering Partnerships and Go-To-Market Success with Barrett King.

Until next time, I’m Jeff Tomlin. Get out there and be awesome!