The Pricing Newsletter
October 2018 issue
Halloween is just around the corner. It's a time when people spend their hard-earned cash for candy, only to give it away for free.
Does that sound like a good pricing strategy to you?
Pricing question from a reader
Today's question comes from reader M. B.
A company wants me to write some custom software. It's eager to get started, but there is a lot of uncertainty about its requirements. How can I quote a price when I don't understand the company's needs?
Pricing out a custom service can be extremely challenging. Attempting to do so in the realm of software engineering is even more difficult.
Not only do unclear requirements prevent both you and your customer from understanding a project's value, but they also prevent you from figuring out the time and resources that will be necessary to complete it.
Nevertheless, the reality is that few companies will be willing to cut a blank check and simply hope for the best. They're going to want a fixed price, or, at the very least, an estimate.
Let's take a look at some of the most common ways that business owners like you can and do compensate for unknowns when setting their prices:
- Padding the bill -- Many developers add a buffer or management reserve to guard against contingencies. Not only is this approach illegal for many government contracts, but it fails to eliminate the original source of risk. The price of dealing with unknowns can exceed even the most generous padding.
- Pricing the parts that are understood, and carving out the rest for follow-on projects -- This method works best when the unknowns are loosely coupled to the work that is well-defined. Should the unknowns affect the entire system, this technique may lead to expensive rework and tedious re-architecture at a later date. It may result in costs that spiral out of control and schedules that appear to have no end, resulting in the potential for serious damage to your reputation. The separation of scope into phases will also add a great many unbillable hours of negotiation and paperwork to your efforts and increase the likelihood that future phases will either be canceled or delegated to another party.
- Offering a fixed price for the parts that are well-understood and charging hourly for the parts that aren't -- This method will reduce your exposure to the risk of misestimation, but open you up to another risk. Your customer may become upset should the bills for the "hourly" portions begin to spin out of control, especially when it's not clear whether a given effort belongs in the "fixed-price" bucket or the "hourly" bucket. Additionally, many businesses will like the idea of accepting an unknown price about as much as you like the idea of accepting an unknown scope of work.
- Adding explicit assumptions, but allowing renegotiation should they prove false -- While it would appear that listing assumptions is a means of risk avoidance on the part of the contractor, it's actually a stealth form of risk acceptance. Sure, the contractor's customers will be on the financial hook for any incorrect assumptions on your part, but they will still be upset with you that your assumptions were incorrect. Additionally, the need for renegotiation on a potentially unlimited number of points may cause the contractor to look at you as though you're a shyster attempting to nickel and dime it at every turn.
- Waiting until your customer figures out what it wants -- This approach seems to be quite sensible. It isn't. While this method eliminates the danger of mispricing on your part, it opens you up to several risks:
- You may appear overly passive and unable to tackle the complexities of the job.
- Another party might swoop in and accept the contract.
- The company may cancel the project or decide to tackle it internally.
- Once the details have been ironed out, the contract might be made available to you at a time when you lack the capacity to accept it.
- There may be insufficient time to acquire another contract to fill your calendar. Principles are great and all, but the ability to pay one's bills tends to be a highly desirable trait for many business owners.
None of the options above is perfect; the one that best meets your needs will depend greatly upon your individual circumstances, the nature of your unknowns, and the preferences of your customer.
That said, there's another approach that will de-risk the contract for both you and your customer, increase your earnings, and enhance your ability to command high rates in the future.
Let's take a step back and examine the situation:
- You've identified a very real problem facing your potential customer: it cannot articulate what it needs to buy.
- Many businesses spend oodles of money for outside companies to solve their problems.
- You're a person who solves problems for businesses that are willing to spend money for assistance.
Do you see where I'm going with this? Couldn't you offer to sell the company some analysis services to help it figure out exactly what it needs?
Beyond the income that an analysis service could generate, think about the benefits that would accrue:
- You'll build experience and a reputation for providing high-margin services (consulting) that are less likely to be offshored to the lowest bidder (development).
- You'll be able to make new contacts at the firm, many of whom will be empowered with significant decision-making authority. These individuals could serve as internal advocates for you at present and at other firms in the future.
- You'll gain additional insight into how your software will be evaluated and used in production. This will allow you to better tailor your proposal, product, and pricing to your client's circumstances and preferences.
All too often negotiators spend their energy attempting to shift risk onto another party. Worse yet, many negotiators convince themselves to accept very high levels of risk in exchange for the tiniest sliver of opportunity for profit.
There are plenty of methods that business owners can employ to ensure that both parties wind up better off. You just need to be able to identify them.
Questions come from readers like you. If you'd like your questions answered, send them my way.
Pricing in the news
- Dignity hit as Co-op cuts funeral costs in price war - Is this a death knell for expensive funerals?
- Privates Matching Public Prices - Now even universities are competing on price.
- Frieze Art Fair establishes tiered pricing structure for debut Los Angeles event
- Venezuela asks Colombia to help combat gasoline smuggling - Heavy subsidies can create black markets? Who would have guessed?
- Senate backs White House on effort to require drug prices in ads
- Pricing Out Chiara Ferragni's Over-the-Top $1 Million Wedding to Rapper Fedez
- CCI orders investigation into pricing practices of super-specialty hospitals in and around Delhi
- Lab-Made Diamonds for Less: Why De Beers's Plan Worries Rivals - How much should the biggest natural diamond producer charge for artificial diamonds?
- Exec pushes back against drug hike 'moral requirement' quote
- MoviePass seeks to bolster stock with 1-for-500 reverse split - The stock already split 1-250 in July. Behold the awesome power of stupid pricing models!
- Fed up by crazy hospital bills, state makes passive-aggressive T-shirts - Now I want to make some passive aggressive shirts about the prices of passive aggressive shirts...
Pricing article from the blog archives
- Freemium 2.0: An Intriguing Software Pricing Strategy - The days of the "Halloween candy" pricing model are numbered.
Notable pricing quote
"The bitterness of poor quality remains long after the sweetness of low price is forgotten." -- Benjamin Franklin
Shameless commercial plug
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