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Cost versus Value Pricing

Posted by Stephen Wrighton on 24 Jun 2019

I’ve been a consulting software developer for sixteen of the almost seventeen years I have been professionally building software. This means that I interact with customers to determine what they’re after as far as building a piece of software to meet the particular business need for that customer.

And for all that time, the estimates I was told to generate, the way I interacted with those clients was via Time & Materials.

What this meant is that every hour I worked, was an hour I billed. It was a direct, one-to-one relationship between my labor (my employer’s cost) and the price which the client paid.

Now, there is some benefit from this, almost entirely from the vendor side of this. Using Time & Materials means that we will always make a certain amount of profit. No matter how happy the client is at the end of things, we will have made something. What that something is depends entirely on the client’s bill rate, but it will always be something.

From the client’s point of view, they can ask for anything at anytime, and the Time & Materials developer will usually agree, as that’s just more work, which means more value for the vendor.

There is a supposition of dynamic responses to changes which advocates for the process indicate as a primary reason that Software Developers should choose Time & Materials as their preferred billing method.

Like I said, for years, I have been a consultant style software developer, and and one that was not responsible for how the pricing models were defined and applied. While I may have been the technical lead in later years, that did not come with it any actual power from a “how business is performed” point of view.

Something else that should be known about me is that I’m capitalistic in the extreme. I believe in capitalism, and the free market. I mean, deep in my bones, believe in it.

Which is why I have always disliked Time & Materials. Now, this was not something that I had ever expressed, after all, I was just a peon, I was not in charge, nor could I effectively wield influence to change things. Thus, I accepted that the businesses used Time & Materials and carried on.

Now, you may be asking why I dislike it, and the answer is simple. Karl Marx invented it.

As exchange-values, all commodities are merely definite quantities of congealed labour-time – Karl Marx

Yes, the same Karl Marx who is responsible for providing us Marxism.

But above and beyond that, Time & Materials generates a distinct issue for the vendor. Think about it, as a software developer, my current rate is $185/hour. Say, I estimate a project as taking 100 hours, that means the ESTIMATED cost is going to be $18,500, and a forty percent overrun of that estimate kicks us up to $25,900. These are simple, and reasonable numbers.

Straightforward even.

The problem comes in that I’m in no way incentivized to meet my estimate. Quite the opposite really. If I overrun, I make more money. In fact, I’m functionally punished for meeting or exceeding my estimates. And while I’ve gotten fairly good at generating my estimates, they’re still just that, estimates.

What’s even worse, is that this could lead to hurting the long-term relationship with the client. For while a forty percent overrun on those 100 hours is only an additional $7,4000, that same forty percent overrun on a thousand hour estimate is an additional $74,000. That could be a business ending estimation over run; especially for a small startup. And regardless if it’s a $7,000 or a $70,000 overrun, the client will very likely not be happy at the end of things due to it.

In my opinion, it’s not the best option for clients.

BUT, I have recently been promoted. I’m not in a position where I can impact this business behavior, and change it.

Thus, I’m now advocating value-based pricing on our projects. Value based pricing, is pricing something based upon the perceived value to the client, rather than my costs as a vendor. This means that the clients will have a defined price by which we will produce something to meet their business needs.

Sure, this means a bit more effort in regards to sales and talking with clients as we have to actually figure out why we’re building something, and how it is going to actually provide value of some type to the client. And then we’re going to have to give that value a dollar number. There is a lot that’s going on which makes this both better and harder from my company point of view as well.

Excluding my innate distrust of anything Marxist, what this ultimately comes down to is that my project proposals are less about the explicit piece of software I’m going to be building, and more about the business needs that I’m going to be solving.

Frankly, that’s where my focus should be the entire time. I’m an IT Business Consultant. That is supposed to mean that I’m there to help businesses be better through IT and Software Development/Processes. I’m not supposed to be there to type the screens I’m told to type with no concept of the bigger picture.

Words are important, they define us, our ideas and our ideals. Words truly make up our reality in so many diverse ways.

So consider this entire article in this way, I’m supposed to be providing value to a business, not exist as a cost to the business.

When the price is based on cost, it’s telling both the me the vendor and the client that I’m there to perform a task, and charge you for it. I’m a resource to be used to solve random problems that may or may not resolve anything. I’m not concerned one way or the other, I sold you my hour; it’s irrelevant how said hour is now used.

When my price is based on value, I’m adding value to the business. That’s my goal and my purpose in being there; to resolve the problem and to make it better than it was before. I’m a partner who works with you to deal with things. I’ve not sold you an hour; I’ve helped you generate value.

My company’s motto is “Be the Geek.”

We’re all supposed to be the best that we can be. We should be striving for the best, and helping our clients deal with their I.T. needs to the utmost of our abilities.

And I can’t think of a better way to help our clients, than to drive value to their companies.

Image provided by Shot by Cerqueira

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