What is the best pricing model for your SEM agency? Should you charge percentage of spend? Hourly billing? Fixed retainer? What about commission share or do you simply pop a margin on top of click cost?
Here are my thoughts and a deep analysis of my own agency, and what I think is the best pricing model.
For many PPC (and SEO) agencies, the debate of what to charge, how to charge, what the structure is and how often is never ending and heavily divided. This not only varies from agency to agency but also varies from sales person to sales person, through to different account managers in the same company!
How much for setup? Do we even charge for setup? What percentage should we take? Is 20% too much? Can we cover costs at 10%? What are other agencies charging? Should we set a minimum management fee?
Does this sound familiar? I for sure know it does. I’ve been asking these questions for the last 5 years and still never really had an answer I was comfortable with.
Recently at a Google partner event hosted by Alex Langshur of Cardinal Path he addressed this issue in some detail. It really left me thinking about our approach to pricing and how we can improve it.
I sat down and gave myself some time to sit back and really have a look across a range of clients to see if I can make some headway into where we went right with pricing and where we went completely (and horribly) wrong.
Luckily for me, a couple months ago I introduced time tracking across all areas of the business so it was relatively easy to work out time spent on clients. If you are not tracking time I strongly recommend you do. There are some great tools like Toggl that are easy to use and have free options you can utilise.
Before I go into detail I thought I’d give you some background to the main pricing models.
1. Percentage (%) of spend Pricing Model
This is by far the most common type of pricing model that I see when it comes to digital agencies pricing their services. Most of the time it comes with a minimum spend attached to it to cover the basic costs of servicing even the smallest of campaigns (ie a $1000 a month campaign takes just about as much time to manage as a $3000 a month campaign).
To understand where this type of pricing model comes from we need to go back. Back to days when we didn’t have Google, Yahoo, Bing, Facebook or whatever. We had traditional media like Outdoor, TV, Print and Radio.
It was an interesting time as transparency was largely unheard of. An agency would typically take around 7-10% service fee on all media bought. The kicker for the agency was that when a media agency bought adspace or placement, it would have a defined discount or ‘rebate’ (probably around 10%) from the media outlet which in most cases was not disclosed to the client.
Lets do the numbers on that with some nice round figures. Your client goes and spends $100,000 on TV ads for the month. You bill them $110,000 so you get your service fee (say 10%) and so you can pay for the media (in this case $10,000 is your service fee). Then you go out and buy the media placement but you only need to pay $90,000 because you have your 10% rebate on your $100k adspend. Looking at the above you make a cool 20k on a 100k buy, with the client getting 100k worth of value. Sweet deal right?
It gets even better! As the media goes live, you have not even paid your invoice yet because you have previously negotiated 60-90 day payment terms which means that even after the ads have gone live, you have the money sitting in a high interest account for a few months. Add a few thousand in interest and you are doing pretty well for yourself.
Naturally when digital comes in and these agencies start moving towards providing digital services, that % of spend model is simply translated across to digital channels. It’s a proven model that worked before and so therefore it should also work for this type of media right? Well, that really depends on who you ask.
To dig a little deeper, lets do a little pros and cons for taking a percentage of spend:
- As you do a great job and the client increases their spend, you get rewarded through increased revenue.
- Easy to sell (initially under small spends anyway)
- Easy to quote – you effectively don’t need to think about how much you should charge, its basically a fixed percentage of spend. The only thing you may need to think about is whether there is a minimum fee and whether you are charging setup for the campaign.
- Largely accepted – a percentage of spend is something clients, especially well established clients, understand quite well. Many companies are comfortable with this model and have experienced similar pricing structures for many years (ie the traditional rebate + service fee model mentioned earlier)
- Matches the competition – your competitors are most likely also using a percentage of spend model so using a similar model may take pricing out of the equation.
- Smaller spends may not cover the work load required, even with a minimum service fee.
- Does not align you with the goals of the client – For you to ‘win’ in this situation you need the client to spend more. For the client to ‘win’ you need to return more for less spend. There is a misalignment when it comes to achieving the right outcome. This can be detrimental to the relationship later down the track.
- Allocation of resources – with a percentage of spend the allocation of resources is usually not well defined. You may find yourself spending more time on a client due to different circumstances and if you are simply taking a percentage of spend, then the time, effort and money allocated to that client may not be profitable for you business.
- Accounts & Administration – Once the month is over there needs to be a specific calculation for each client when it comes to billing. It’s not a matter of just charging a management fee, there needs to be a calculation of the management fee based on spend every single month for each client. That’s a lot of work on its own.
- Cashflow – When you charge a percentage of spend, in order to know how much to charge the client you have to wait until the beginning of the following month in order to work out what you need to charge the client exactly. If you are working with larger companies many will ask for 60 day payment terms. This means work done in June will only get paid in September.
- Matches the competition – I did say earlier that this was a pro but it can also work against you. If you are to match the competitors pricing model then pricing may in fact become the differentiator, and you don’t want that. “They said 10%.. you’re telling me 20% for the same thing”. By offering the same in terms of pricing you can effectively be commoditising your service where the differentiator is only price. Using another method allow for further negotiation techniques which I will get into a little later.
2. Set Hourly & Pay-for-time pricing model.
Hourly rate is something a little less common in the SEM/SEO agency arena.
Why? There are various reasons as to why but I’ll take a stab based on myhttps://jimmydata.com/new-site/new-site/imes is it quite difficult to understanding how many hours it will actually take to service a particular campaign or project.
Other times you may not be sure exactly what to charge as an ‘acceptable’ hourly rate. Added to this when you sit down and properly calculate how long the work will take, inclusive of optimisation, reporting and consulting, you may feel the client won’t be willing to pay that amount, especially when a campaign is a relatively small spend.
The fact that a standard percentage of spend is easily grasped by the majority of clients. They spend X a month and therefore need to pay you a percentage. They have been doing this for years so it is very normal and generally widely accepted as a payment structure. Going down a different path may throw a real spanner in the works.
I also feel it is extremely difficult for agencies to let go of the potential upside of charging percentage of spend. If the client doubles their spend and you are just charging a fixed hourly rate then you miss out on extra revenue right? Most SEM specialists and PPC specialists are usually quite confident that they will yield results for their clients, eventually getting them to spend more. If the retainer sets aside a fixed cost due to dedicated hours on that client, then what happens when the spend goes through the roof? The opportunity cost of going against a percentage of spend model is just too high to stomach.
Those that use the hourly spend model justify the model in that it covers their costs, allows for margin and provides a very clear cut structure to their billing. They also understand that if the client suddenly spends 3x then its possible they will miss out. Of course, there is the possibility that the retainer can be adjusted to accompany for more work coming in but who really wants to go back to the client and ask for more hours in the retainer?
- Charging hourly allows you to protect your margins and ensure campaigns are profitable.
- Gives you more scope to negotiate. You don’t need to drop your price, you can just do less hours and reduce the scope of your work. Again, you protect your margins.
- Alignment with the client – charging hourly allows you to keep alignment with your client’s needs and campaign goals. Your goal is to get them to achieve results, not just to spend more money. With set hourly retainers it is easier to maintain client:agency alignment.
- Client selection – by charging what is required to make your margins you are effectively weeding out clients who will try to squeeze you or ask for too much of your time which is difficult to control when on the percentage of spend model.
- Doesn’t match the competition – This could really go either way. Not matching the competition in pricing models can move the conversation away from pricing and focus on other competencies that you have. Comparing a Ferrari and a Lamborghini to a neutral person can be difficult and ultimately could come down to price. By comparing the Ferrari to a Rolls Royce then you have a differentiator that isn’t price. It provides leverage.
- Consistency across services – Many digital agencies take on a number of different services, whether it be SEM, SEO or general consulting. Charging for time spent means you can bundle and offer more services in the one single retainer. It’s more consistent and makes services easier to price.
- Lower potential upside. With this pricing model, if the client decides to double their budget due to your great work then you won’t benefit much from that.
- Difficult to judge hours – if you have not run many campaigns in the past then it can be hard to know how many hours need to be in your retainer. You could underestimate the number of hours required. On the flip side you could overestimate and price yourself right out of the market.
- Doesn’t match the competition – This one again. Like I said earlier, it could go either way. You could either be giving yourself a differentiator or you could make your clients baulk at the concept, losing them altogether especially if you price yourself out of the market for smaller spending clients.
3. Commission based pricing model
I haven’t really looked into this one as a pricing model for my agency but I know that is is quite common among PPC agencies (and some SEO agencies) to go the commission of sales route. I think a big reason for this is due to the fact that a lot of PPC and SEO specialists have some history in affiliate marketing. Affiliate marketing is all about performance based income so this model is perfectly acceptable and sustainable to some.
I can see the upside, I really can. The drawcard here is that in a perfect scenario, it is the ultimate win-win for both agency and client, especially in the short to near term. The client has little risk and only pays for performance and the agency gets rewarded nicely for the work they do. How often does this happen and what happens when it doesn’t work out so well for the agency?
In this scenario the client always takes less risk than the agency. The agency on the other hand, assumes some really big and potentially problematic risk here. Risk that they may not perform and will not be paid accordingly for their time. They also take the risk that the client will not disclose all sales, especially in the long term after the initial hard slog is done.
The question for agencies with this model and why I could never justify going down this route is this: why should I have to take on your business risk? Why should my agency absorb the risk and its not even my business! Business is risky and tough at the best of times so why exacerbate that any more than needed? If this is the case then give me equity and shares in your business then I’ll re-consider. Other than that, It’s not something I can justify.
If this particular pricing model can work for you then fantastic, I respect that but its not something I am willing to put into practice. So without looking at the pros and cons here, I’m out.
4. Taking Margins on clicks (undisclosed)
Where do I start when it comes to taking margins? Even though taking margins on the cost per click is still quite common among agencies, with the growth of self service platforms and ultra transparency, its popularity for this pricing model is starting to wilt.
There is a lot of negative association with margins and I understand that. We don’t do it but if you put it into perspective, its actually quite a sound and probably the most traditional form of pricing available in any industry.
Let’s put it in very basic perspective. If you sell shoes, you buy them for $50 and sell them for $100. That’s a nice clean profit margin of $50. What’s wrong with that?
For whatever reason, digital is a completely different beast, especially when the unit is CPC. CPM and large media buys are one thing, but when you go as granular as CPC, things start to change. Yes a unit is a unit is a unit, but if we say a click cost is $3 then it better be $3, all other trading concepts and pricing margins is suddenly thrown out the window.
I cannot pin point why that is the case and it’s definitely something for another post (or a book even) but that being said, clients generally do expect that the cost per click is the cost per click unless margins are specified in advance. In no other media is this expected other than that of CPC. Bizarre, yes. True. 100%.
- Clients absolutely hate it and any scent of margins on clicks will destroy your relationship with that client.
- Difficult to optimise when there are margins in place. How can you effectively work towards a CPA when optimisation and adjustments are down to the cent, yet you are taking dollars?
- Reporting – Reporting takes much longer. There are more check and more processes involved. Reporting becomes a headache and is generally extremely stressful. Not even JimmyData can help you with your CPC costs here!
- Outdated – Working off margins is on the decline in PPC. Relying on this as a business model may leave you stranded down the track as your processes and systems become outdated and your clients have left you.
- Suspicion – clients get suspicious especially if they have first hand industry knowledge. A quick search on Google’s keyword planner can ring alarm bells. A suspicious and untrusting client is not one you want to work with. It’s stressful and unpleasant for all involved.
That is my quick rundown of some of the different pricing models in the marketplace. Of course there are hybrid models being used by in general, these are the most popular.
By no means are any of the above exhaustive lists and you probably have more that you could put in there but I think I have covered the core pros and cons for each. I’ll now move on to my own business and where this all fits in.
Looking Internally at our pricing model
To be honest, currently we have quite a messy pricing model based on fixed minimums, percentage of spend, project based and a few hourly projects. We do not take margins or commission based pricing which is good because I don’t think I could deal with the stress of either!
Saying that, our core pricing model is percentage of spend for the majority of clients and prior to July, it was my intention to keep it that way.
However after looking through my client list and doing the numbers I have decided to move away from charging a percentage of spend and onto a more defined, preset hourly billing model.
Why I’m moving to a defined hourly, pay-for-time, billing model
This is why:
This is probably the biggest reason why I am moving to an hourly billing model. Charging based on what your clients spends leads naturally to a “good client” being one that spends more. This should not be the case. In an industry where KPI’s are so variable, getting a client to spend more is not always the way to a better result.
Sometimes it is the KPI to get the best result, take a real estate agent for example. Their goal is relatively simple, get as much money for the home owner as possible. The higher price you get, the happier the home owner and the more commission you get. It’s a great win win and the KPI is fixed; a higher price.
But as a digital agency, it just doesn’t work like that. A “good client” to me is one that stays for years and years. A “good client” is a client that uses you as their digital counsel and asks for your advice first because they trust you to give them guidance. A ‘good client’ is one that you do really cool stuff with where your work yields fantastic results. And that same ‘good client’ happily pays you handsomely for the work you do.
A good client should not be the one that spends the most. In fact some of the most difficult clients I have had to deal with have had the biggest budgets. Then when you look at the output in time (and stress) the additional spend and extra revenue was not worth it.
Alignment ensures minimal conflict of interest, lets just get the best results.
Here is a great piece on the client/agency alignment, and also a situation which works well for both. I can’t see this type of relationship developing if our goal is to get them to spend more. See what I’m saying?
2. Profit and Protecting Margins
This might seem completely against what I talked bout in point 1 but making a profit and alignment go hand in hand. If you are not making profit then you and the client are not aligned. Being aligned actually means you benefit and they benefit. It must be mutual. You and your agency are important as well and you absolutely need to make a profit, otherwise you cannot keep the business running and eventually you will no longer be able service that client.
Moving to a preset hourly model allows us to not just align ourselves with the clients goals but also allows us to ensure profit. After running thousands of campaigns in the past we know how much time is involved to not only set one up but manage it as well.
With our current percentage of spend model we sometimes make a healthy margin, probably more than we would if we were charging hourly. Other times we lose money hand over fist. What ends up happening is we rely on profitable clients to counter the effect of the non profitable ones.
As I mentioned earlier in this post, a few months ago I implemented time tracking for all staff. Let me just say, this is not to keep an eye on what they are doing, but rather to work out where we are spending our time and how we can run the business more efficiently. It also gave me a clear understanding of which clients eat up most of our time by allowing me to accurately calculate the hourly yield.
Lets look at an example where we are currently using a percentage of spend model. I have taken the below snapshot for 1 of our delivery consultants and how many hours they worked on a single client in both April and May:
What happened here? Well we started on a higher spend and through optimisation, we reduced CPAs across the board and by removing irrelevant terms we didn’t need to spend as much money to achieve a better result. What a fantastic result! Client was over the moon and we patted ourselves on the back and took a pay cut for our good work. Huh?
Yes thats right, because we worked hard, improved the campaign and achieved the clients goals we actually got paid less! Does that make any sense? It doesn’t seem fair to me and I highly doubt this is what the client would want either.
Only one of the problems here is that we are getting paid less for more work. Another big issue here is that at $114 per hour in May, we are making no margin which means no profit. In fact we are making a loss.
When I factor in the costs of running the business, outgoings, holidays, tax, productivity, staff and other hard costs, we need closer to $150 an hour in order to cover blended costs, let alone make a meaningful margin. By being under that $150 mark we are losing money which means we then need to rely on margins from other clients to cover this loss.
If we were billing per hour we would not have this problem. The client would understand what is in the retainer and we would work according to that. If we need more then we need to explain why and get them to sign off on more hours. More work should mean more billing, not less. That is profit and alignment.
3. Scope of work
This is often overlooked when working on a percentage of spend basis where the scope of work can largely be limitless. Going back to the hourly example I used earlier, the scope of work can change and when charging percentage of spend there is very little you can do about it.
Agreeing on scope of work that fall under those hours defines what is expected. Once this is cemented and work outside the scope of the hours is required, it is quite justified to go back to the client and say you need xxx as running a particular type of campaign will be an extra xx hours a month so we need an adjustment to the retainer.
If a defined scope of work is not in place then you feel obliged to do the additional work even though an increase in spend may not reflect the additional hours involved. A worst case scenario occurs when the same spend needs to be spread across several types of campaigns. More work and little to show for it.
For example you may be running a very straight forward search campaign for a company selling corporate merchandise. Initially this is what was expected and it has been working well. Then one day the client asks for you to do those nice product image ads. PLAs! These campaigns are ridiculously time consuming yet your client has 10 products they want to promote on PLAs and an extra $2000 a month to spend. Even worse, they ask for it to be absorbed in the current budget. What type of percentage could possibly cover the work involved?
Don’t forget, you are good at what you do. You can yield a profit for your clients so naturally at some point, they will want to do more work. Defined hours allows you to grow proportionally to the workload. Of course if the client increases spend by 5x then you will lose out on the upside, but how often does that happen? For us the risks far outweigh the reward in this respect.
4. Room to Negotiate
Negotiating with a client can be tricky. Currently charging percentage of spend really only allows us to negotiate on the percentage figure. Is it 20%, 15%, 10%.. less? All we are doing here is narrowing our margin in increments. This can go on until we lose all our margins completely or we are working simply to have that client on board which is a disaster just waiting to happen.
Charging based on set hourly numbers give us scope to negotiate. It gives us negotiation options that is not purely based on price. Instead of reducing our hourly fee, we protect our margins by reducing the scope of work. Want to pay less? Easy.. lets just take some stuff out.
Some stuff we can play with for negotiation:
- Weekly or Monthly reporting? No reporting? Less reporting means less hours required and therefore a lower retainer.
- Types of campaigns – Maybe we don’t do ‘all of the above’. Can we take out dynamic retargeting, PLA campaigns, Display Ads. what can we remove to lower the cost?
- Setup – maybe the client can provide adcopy to save some time and reduce setup costs.
- Communication – Reduce the number of hours for adhoc or set communication times. How about we remove the monthly or that weekly WIP?
As you can see we are never reducing our hourly rate, instead simply reducing the scope of work required. At all times you are ensuring the campaign is profitable by protecting your margins and seeking alignment. Reducing your fee is not alignment. Coming up with an agreeable scope of work with the client that is also profitable for your business is alignment.
5. Differentiation from the competition
I’ve mentioned this a few times as both a pro and a con for the hourly or ‘pay-for-time’ billing model. The con is that a client, in the pitching and negotiation process, may baulk at the concept, especially when your competitors are out there pushing the percentage of spend which is what they have been traditionally dealing with. Some clients may want to stick with what is familiar.
Well this is the exact reason why I have put this here. A percentage of spend is very familiar to the client. If you are pitching for their business then no doubt, they can’t be entirely happy with how it has all gone so far right? Then why would they want to go back to what they are used to?
Charging what everyone else charges doesn’t allow you to differentiate yourself from the other agencies that are pitching for the same business. By coming in with a different pricing model you have immediately set yourself apart.
By not doing what everyone else does you can move yourself away from being a player in a commodity market where price rules. Focusing on other areas instead of how your percentage of spend differs from another agency allows you to show expertise and instil confidence in the client, moving you away from the price debate.
Again when it comes to negotiating you now have scope to work with that isn’t your percentage of spend.
6. Business Planning and Resourcing
As a business owner we kind of hope that we can get an extra 50 clients and not have to invest in any more staff or a bigger office. That as we know, is completely unrealistic. Yes we can automate a lot of the processes like reporting (thanks Jimmy!) but growing and scaling also requires hands on resources.
When you factor in holidays, sick leave, actual worked hours and productivity, there remains just a set number of hours per month that can be utilised to servicing clients and managing campaigns.
Going down a set retainer models allows me to do the numbers in a straight forward manner. I can monitor how many ‘billable service hours’ we are doing for the month and most importantly how much bandwidth is remaining until we need to resource up.
If we can’t fit a new project or a new client within our current resource structure then we need to bring in more resources and hire. The great thing is we can now do this well in advance as the pipeline grows. This creates an organically growing organisation that is happy and not overworked (and profitable!).
7. Administration and Processes
Finally the reason I will be shifting our pricing model to an hourly billing model is that it is easier for us to manage in terms of administrative tasks like accounting and billing. Initially we had someone dedicated to work out monthly spends for each client. They then calculated the management fee which then goes to accounts to send off the invoice.
Today we have somewhat automated a part of this by using JimmyData to automatically send off a report to accounts every month to do the billing. No doubt this saves time but it still means that accounts need to go through every invoice and ensure that we are charging the right amount for the right month before sending them off.
Moving to a more fixed model means accounting can become much more streamlined since the numbers don’t need to change too much month on month. We can schedule invoices to be setup automatically and assuming there are no additional line items we are done and good to send. How many hours will that save in terms of admin? End of month and billing can be improved exponentially by using cleaner and more consistent billing.
A quick thing to note is that a nice bi-product of this is faster invoicing and better cashflow.
This is by no means an attempt to put an end to the debate of what the agency pricing model should be. In fact, I’ve probably enlarged the flames! I’m sure many people after reading this will probably disagree with me and my logic but that’s fine.
Looking at my business I feel a more fixed billing model based on pre defined hours is the way forward for my agency. To me, it provides clear alignment, gives me scope to negotiate without affecting our margins and can help improve our internal processes and aid scalability.
If you came across this post and were unsure about what the best pricing model should be, I hope this round up has assisted you to make a decision, whether it be sticking or moving to either a percentage of spend or a fixed billing model. Whatever you choose I hope you find clarity like I have.
I would love to hear your feedback on the above and any experiences or suggestions you may have. Please leave your feedback in the comments section below.