Value-Based Pricing For Your Tech Services 2: Pricing Models

In our previous article, we gained an understanding of value and how it relates to price. This article describes the most common pricing models you will use in your tech services.

Hourly Pricing

Hourly pricing is as straightforward as it gets. But underpinning the hourly pricing is a cost-plus model. Hourly pricing focuses on the cost to the provider or person-hours rather than the value delivered or outcomes. But it is a good starting point.

	Vendor	Customer
Pros	Easy to implement	Easy to understand
	Scoping is lower stakes	Flexibility to address changes
Cons	Higher hurdle for proof of competence	Fewer assurances on time and cost
	Cost-based pricing and lower margins	Usually lower pricing
	Maintaining the relationship may still require the vendor to assume responsibility for scoping mistakes despite the contractual standing

Project-Based Pricing

Project-based pricing revolves around a fixed cost for a fixed scope for a project. This model offers predictability and a clear focus on outcomes for the customer. It gives customers clarity and confidence in the costs, but the company assumes more risk. But the most significant risk is expressed in the Agile Manifesto as "Customer collaboration over contract negotiation."

	Vendor	Customer
Pros	Scope and fixed-price acts as proof of competence	​Clear understanding of costs
	Presumption of risk allows you to increase price to command a higher margin
	Increased efficiencies are extremely lucrative
Cons	Scoping processes need to be strengthened	The vendor is incentivized marking completion, not project success
	A scoping mistake can destroy margins	Can create a false sense of security
	Change requests need to be aggressively managed
	Cashflow is worse because it is dependent on completion

Milestone-Based Pricing

Milestone-based pricing applies the lean principle of smaller batch sizes to the project-based pricing model. This approach offers a balance between flexibility and structure, allowing for payments to be made upon the completion of specific agreed-upon phases and for making adjustments as we move forward. Agile contracts are an example of a milestone-based model.​​

	Vendor	Customer
Pros	Consistent cashflow	Flexibility to readjust strategy
	Scope change translates to an increased revenue opportunity	Address the underlying problems in both fixed and hourly pricing head-on
	The risk from scoping mistakes is greatly reduced
Cons	Need strong product leadership for the duration of the project	Fewer guarantees on costs
		Harder to understand

Subscription

Subscription pricing is an ongoing, periodic charge that provides customers with services and support. This model encourages long-term relationships and can lead to a stable, predictable revenue stream. It's ideal for services that require continuous upkeep, updates, or regular input. For the client, it ensures both ongoing and emergency support.

	Vendors	Customers
Pros	Very high-quality revenue: consistent, sticky, and high-margin	The customer has support for emergencies
	Can develop automations for improved margins	Benefit from lower costs from scale of vendor
	Creates opportunities cross-selling
	Increases company valuation more than other forms of revenue
Cons	Need a minimum scale to be cost efficient	Cost is usually more than equivalent hours worked
	Estimating costs can be difficult without real-world data, especially for your first few deals

Retainer

Retainer pricing is an agreement where clients pay a recurring fee, typically monthly, for a minimum number of hours. This model guarantees availability and priority service over non-retainer clients. It's best suited for clients who need consistent work but not enough to justify a full-time position. For service providers, retainers mean predictable income and deeper client relationships.

	Vendors	Customers
Pros	Consistent revenue that increases customer consistency	The customer has access for emergencies
	Create opportunities for cross-selling
	Easier to implement than a subscription
Cons	Can be disruptive to the team until a minimum scale is reached	Use it or lose it setup continuously makes the customer question value

Performance-Based Pricing

Performance-based pricing ties the provider's compensation to the value delivered, such as cost savings or revenue growth. It's a high-stakes model that rewards successful outcomes and is more common in sales than tech services. Venture studios use performance-based pricing for tech services. In addition, some tech services companies offer it for savings cost savings. This model is rare for tech services, but the key to implementing this model is to provide proof of value delivered or good data practices. This is a great practice to maintain.

	Vendors	Customers
Pros	Highest margin with likely >10% value capture	Minimum risk to customer
	The implementation itself is the proof of competence	The highest chance of success because of complete alignment of goals
		Get data infrastructure to conduct better experiments.
Cons	Compensation includes factors outside the control of vendor	Higher overall cost than if you can develop the expertise in-house
	Need to develop data practices to showcase outcomes

Pricing Model And Tech Services Strategy

Choosing the right pricing model is critical to the health of your tech services business. By considering the pros and cons for both your company and your customers. Two things to keep in mind:

1. You can mix and match models.

2. You can capture some of the goodness of other models by following their best practices despite what the contract says.

Your pricing model critically impacts both the sales and delivery of your services. Subscribe to our blog or follow us on LinkedIn to ensure you don't miss out as we explore this connection further.