The Power of Discounting

Posted on March 13, 2012 by Joseph Ryan Glover

I’ve written before about the pros and cons of discounting but I want to share a stunning example of discounting madness that cost me a gig. On one hand, I’m in disbelief that the tactic worked but on the other I’m forced to respect the outlandish confidence of my competitor as they taught me a valuable lesson about pricing.

The situation was that a business partner and I had the inside track on a new site for a sizeable charity. We had the inside track because we knew one of the top administrators and we were invited personally to submit a proposal. Keep in mind that we’re just a two man shop so this was a great opportunity for us.

My business partner and I spent several days hashing out ideas and putting numbers together and came up with a proposal for a $40,000 site that offered a lot value for the money, made us a healthy profit and still offered a small discount to the client due to their charitable nature and the fact that we had some time available in our schedule.

Our prospects were looking good until the proposal deadline passed and our inside contact, who, it should be noted, was not responsible for the final decision, gave us a call to tell us that, unfortunately, we didn’t get the job. We were disappointed but we understood that that’s the way these things work. We fished for more information to help us improve our proposals in the future and, because of our friendship with the contact, a little more information than usual was forthcoming.

We learned that we lost the job to a big time agency—one with hundreds of employees—who was looking to do some charitable work. We also learned that the clincher for their proposal was that they were willing to offer a 50% discount on the work. A 50% discount was too much for the charity to pass up and they signed an agreement with the big time agency. The problem (well, it wasn’t a problem for the big time agency, just us and the client) was that the final quote for the work, in dollars not percentage signs, was $100,000. And yes, that was 50% off, but 50% off the big time agency’s usual fee of $200,000. After all, it costs a lot of coin to keep hundreds of employees around.
I’m confident in saying that the work my business partner and I would have done would have been of the same or (as time would reveal) better quality than the big time agency’s work. Unfortunately, the client was seduced by a massive discount even though the final price tag was 2.5 times our total project cost.

Clearly, the decision maker at the charity didn’t do her due diligence, but this isn’t a post about bad decisions clients make, it’s a post about the power of the discount, even when the discount doesn’t make any sense. People love a bargain and, apparently, their critical thinking ability goes out the window when the discount is deep enough. Keep that in mind next time you are pricing a project.

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Take Me Out To The Ball Game

Posted on August 2, 2011 by Joseph Ryan Glover

How many times have clients asked you to give them a ball park quote? They have provided zero usable information, nothing about the project is firm and they insist that they just want this number to get an idea of the scale of the project. They insist it’s flexible, temporary, provisional. The thing is, it never turns out this way and three months into the project you’ll find yourself wedded to that original, off-the-cuff number you dropped at the first exploratory meeting. The reason clients stick so tenaciously to such numbers is because of a psychological quirk known as anchoring.

In his excellent book Priceless William Poundstone writes about an experiment conducted in the 1970s by two psychologists Tversky and Kahneman wherein they theorized that suggesting an initial figure to a test subject caused that subject to use that number as a starting point for estimating unknown quantities. In their study test subjects were told the number 65 and then asked to estimate what percentage of African nations were members of the UN. The average response was 45%. They then tested a second group but salted them with the number 10 and their average response was 25%. Amazingly the group that was primed with the number 65 estimated nearly twice the true answer (23%) while the group primed with the more reasonable answer estimated much more accurately. Since the only difference between the two experiments was the size of the number the group was primed with Tversky and Kahneman attributed this result exclusively to the influence of the priming number and the concept of anchoring was born.

So what does this mean for web developers? It means that we should approach every pricing scenario as if we’re the psychologists and our potential clients are the test subjects. It means that the first number we put into a client’s head, the supposedly meaningless and provisional ball park figure, is going to serve as a reference point for the rest of the project, so it better be a good one. But how to pick a good anchor?

Tversky and Kahneman made a second discovery during their studies: they found that even if the initial figure was ridiculous, it still served as an anchor in the subject’s mind. In another experiment subjects were asked to estimate the average temperature of San Francisco and were primed with the number 558. Even though it is patently absurd that the city’s average temperature would be anywhere near 558 the number still served to pull the estimates well beyond the true value. How can we use this to our advantage? By going high on every ball park estimate. Start outrageous, if you think it’s going to be $20,000, say $50,000, because you can always bring it down later if you want.

This strategy has two benefits. One, it makes sure the anchor is in your favour. True, you need to be careful not to price yourself right out of the room — don’t estimate a million dollars on a $10,000 job — but if you estimate a number that sufficiently covers your true estimated costs and provides a significant buffer, you’re in a good spot. The second benefit is that once you have a better handle on what actually needs to be done you can approach the client with a revised number that is less than the initial estimate. You’ll be able to bring the number down, making the client feel like they’ve won a concession, while still charging more than you otherwise would have if you had went with a more accurate, less outrageous ball park figure.

Unfortunately, anchoring can also work against us in the day-to-day business of running a web shop. For example, repeat customers will frequently be anchored by the price they paid for their last project and because of this it will not be possible to achieve large project-to-project price increases. I call this “walking them up the ladder” and it’s a solid strategy in its own right. Knowing that it’s hard to realize sizeable price increases with repeat customers the key is to go high with new clients in order to set a respectable anchor for future projects.

One more drawback to anchoring: anchors set by others can also cause you grief. As an example, the proliferation of the $500 WordPress sites has seemingly primed a generation of clients to expect sub-$1000 prices. Potential clients see ads for generic, functionless, canned websites, get anchored by the price point, and then come looking for a custom site. They then complain when the quoted price is much higher than the $500 sites they’ve seen advertised. This scenario demonstrates how low anchors are doubly damaging because the client is not just psychologically fixated on the low number but also consciously seeking to prevent the number from going up because it is economically advantageous to them. The only way to counteract this type of anchoring is by communicating the true value that the quoted price represents and highlighting the significant drawbacks to using off-the-shelf templates.

So the next time a client calls you on the phone and brings you into a meeting “just to bounce some ideas of you” be prepared to price big. Because no matter what they say about “back of the envelope” “ballpark” “rough estimates” the number that comes out of your mouth will be engraved in the psyche forevermore. Make sure it’s a good one.

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What’s A Fair Price?

Posted on June 3, 2011 by Joseph Ryan Glover

William Poundstone, in his book Priceless, states that everyone has an internal value system that they use to price everything around them. These internal prices can be highly subjective if they are based on assumptions and intuition rather than facts and statistics. In the absence of consistent market information buyers often calculate their acceptable maximum price based on a crude, internal form of cost-plus estimating – even though they may be highly ignorant of the true cost of creating what they wish to buy – and if a proposed price goes beyond their calculations they rebel. We are all subject to these types of calculations and for better or for worse they inform our idea of what constitutes a “fair price” and this is why it’s possible for a group of people to broadly disagree on what is a fair purchase price.

Unfortunately for sellers, this Orwellian redefinition of the word “fair” to mean “fair by my estimation” means that we often leave money on the table to accommodate buyer’s personal prejudices. As web developers we operate in a blind market and this means that most people aren’t aware of the going price for web work. And because most people who are buying websites, unless they are agency clients, are probably buying a website for the first time they have no historical data to draw upon. This means that the first time a client’s subjective valuation of web work is tested against reality is when you offer your price.

With no idea of what the market price is for web work clients will fall back on cost-plus pricing to concoct their fair price. They do this because people don’t think in terms of value and because, frankly, it’s not in a buyer’s interest to think in terms of value. If they can get something for nothing then they benefit. This is why you sometimes find otherwise intelligent people who want a fully functional e-commerce store for $2,000; a patently absurd number that in no way reflects the value such a store represents. The irony of these subjective valuations is that they are demonstrably not fair because when one party realizes a disproportionate benefit at the expense of another then mutual advantage, the cornerstone of business relationships, goes out the window.

For this reason the concept of a fair price is tainted. What we need to focus on, rather than a fair price, is the idea of a just price – and here I use the term just to mean morally right, equitable and truly fair. The way to arrive at such a price is to adopt a pricing strategy that takes into account the value the work will realize for the client. Prices based on the value they generate are fairer, and more just, than a one-sided calculation that constructs a price based on imperfect estimations of cost. The end result of the value-based approach is a mutually beneficial agreement between two parties that recognizes each party’s contribution to the success of the project.

If we recognize that clients have preconceived notions about price and we want to adopt a value-based system then our only recourse is education. This means that when preparing a price for a green client it’s necessary to frame the price in terms of value realized in order to short-circuit their fair price calculations. By understanding that clients with little to no background will vastly undervalue web work you can work to manage their expectations and prep them for more reasonable numbers. In my experience, clients that are truly ignorant of the business of web work (as opposed to those trying to snake a low price) are more than willing to discuss their business’ goals and how the web can help them realize them and why that’s worth something. I’ve found that once you get clients talking about something other than money, once you get them excited over the prospects of a project, their subjective value judgments, exposed to reason, fall into line with reality.

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Two Kinds of Value

Posted on May 11, 2011 by Joseph Ryan Glover

The first kind of value is the one that makes you special. It’s the tangible or intangible extra that differentiates you from other developers. In salesman terms this is your “unique value proposition” and it represents something that the other guys can’t or don’t offer. It is crucial that you learn to articulate what value you offer that makes you special because this is what will win you jobs. Maybe it’s your years of experience or niche expertise, maybe it’s that you’re a great project manager, or you offer insightful strategic advice, or maybe you deliver under insane deadlines. Whatever it is, it all falls under the umbrella of “value” and when people are looking for a reason to pick you over the other guy this is what they will be basing their decision on.

The second kind of value is on the client’s side. It is the financial value — which is just a more professional way to say money — that the client is going to realize through your contributions to the project. To determine this value you need to ask: how much money are you going to help the client generate? If you are creating an e-com site for a client and they are going to sell a million dollars worth of merchandise a year then the value of your work is a million dollars. Why? Because, without you, the client would make zero dollars, because the site wouldn’t exist. Then ask yourself: what is a reasonable pay day for creating a million dollars? Your answer will be your price for the project. I discussed this kind of value-based pricing in the NYT pay wall case study and in that post I made an analogy to how much money professional athletes make: a star football player is paid $10 million a year because his team makes $100 million a year off his contribution.

There are a lot of developers who try to base their price on the first type of value as opposed to the second. Their thinking is that the more expertise, experience and general value they offer the higher price they can charge. And while this is true this mindset is one that inevitably leads to cost-plus pricing, which is a dead end in terms of making big profits. Even if you have a wizard’s level of expertise and you are able to get away with charging something like $250/hour you are still fundamentally limited by the act of billing by the hour. If you want to charge $100,000 for a million dollar job you’ll need to work 400 hours and, if you’re the master your hourly rate indicates you are, there really shouldn’t be any project that takes that long. Worse still you’re limited by the reality of our temporal existence — there are only so many hours in a day — and even the most dullard client can do a back-of-the-envelop calculation to determine if the project time frame jibes with the hour estimate. The bottom line is that when you price based on the first kind of value you are leaving money on the table.

The second kind of value is the antidote to cost-plus pricing but to wield it you must realize that its effectiveness grows out of the first kind of value. Why are you able to generate so much financial value for your client? What gives you that power? The answer is found in your unique value proposition — all of things that you offer that nobody else does will help persuade your client that you are the perfect partner to help them realize their goals. And make no mistake, that’s what you want to be, a partner, and to that end you’ll need to change the client/contractor power dynamic to one where you are seen less as a service provider and more as a business partner, an essential expert who is the best (or perhaps only) person for the job.

Of course, this requires a bit of salesmanship but articulating value doesn’t have to be difficult. You know what you’re good at and you know what other people suck at and you just need to put that down on paper, refine the language a bit, and make it into a sales pitch. When you go into your meeting you need to communicate to the client everything that you can do for them, don’t even mention price, just listen to their needs, offer improvements and demonstrate you expertise and enthusiasm for the project. Sell yourself — sell your first kind of value — because when the client buys into your vision for their project it will be that much easier to get a cut of the financial value you’ll help realize.

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Use Inflation to Justify Price Increases

Posted on April 21, 2011 by Joseph Ryan Glover

Inflation is the progressive increase in prices of goods and services over time and it is a facet of every economy. If you have had a salaried job you may have received an annual “cost of living” raise and this was meant to reflect that, in the past year, everything got more expensive because of inflation while your salary stayed the same. Employers give such raises so that their employees don’t make less money the longer they work for a company. As a small business it’s important to keep inflation in mind because its impact on profitability. For example, if you charged $5000 for a site five years ago and you charge $5000 for a similar site today you are actually making less money.

Most western countries announce the inflation rate on a monthly basis and it is reported as a year-over-year increase. A typical and expected rate is between 0 and 2 percent and these months usually get little press outside the financial pages of the newspaper. However, sometimes the inflation rate is higher, such as 3.3% inflation rate hike for March 2011, and a lot of ink gets spilled and the concept of the inflation rate reenters the public consciousness for a brief time. When this happens you must be ready to capitalize by adjusting your prices upwards.

As a small business it is often difficult to increase prices without customers balking. However, when inflation is high the increased press coverage presents a perfect opportunity to discuss price increases since it is likely that the client has read about inflation’s rise. Rationally, it’s hard to refute the argument that says you need to raise prices to match inflation since to do otherwise means you will make progressively less money over time and eventually become unprofitable. And since the inflation rate is an objective fact published by a third party clients have very little traction for attacking it. They are forced to acknowledge that the cost of living is going up and they must accept that higher prices are justified. Furthermore, if your client sells something they are most likely considering the impact of an increased inflation rate on their own prices and the shared plight of the small business person will help make your price increase go down easier.

If you do decide to raise your prices during a period of increased inflation coverage you’ll be in good company; big chains often announce price increases in their consumer goods when inflation is high and they do it for the exact same reason you do: because it makes a price increase easier to swallow. Ideally, a company should adjust their prices every month to match inflation so that they aren’t hurting their profitability. Of course, constant price change has its own drawbacks (customer revolt being the biggest one, logistical nightmare being the second) and this is why companies wait for an opportune moment to announce price hikes. As a small business person in a blind market you might be able to get away with adjusting prices up every month but be wary of trotting out inflation as the reason to the same client too many times. Consumers are used to being dinged by inflation only once and a while and if you use inflation too frequently to justify a cost increase you’ll sound like you’re making excuses.

Inflation numbers are published monthly by Stats Canada (or the analogous agency of your particular country) and they only take a moment to look up and commit to memory. I recommend, before going into price negotiation where the client might dispute a higher price, that you take note of the most recent inflation rate. It shouldn’t be the only tool in your price justification toolbox but it’s solid, objective ammunition to help deflect objections over price increases and no client can counter it without seeming unreasonable.

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All About Discounts, Part Two

Posted on April 11, 2011 by Joseph Ryan Glover

In part one of this discussion I outlined some of the strategic thinking surrounding discounts and the clients who ask for them. The core message of part one is “never give discounts” but to hold that line you’re going to need more than just strategic thinking, you’re going to need some tactics to counter the discount-seeking client.

My opening move, when a client asks for a discount, is to try and shame them. I do this by parrying their request with a variation of the line “I typically only offer discounts to charities.” This move demonstrates that I am not unreasonable when it comes to discounts but I only give them to those with legitimate need. It’s a strong counter because it implies that I don’t think the client is legitimately needy while emphasizing that this is a business relationship. It also forces the client, if they forge ahead with their request, to characterize themselves as a charity case and concoct some flimsy rationalization for why that is the case. Even if you’re too polite to pick apart their rationalizations you’ll still reap the benefit of shifting the power dynamic from “equal business partners” to “generous developer and pitiful client”. Of course, if your client is a charity, give them a discount you penny-pincher.

If the client won’t back down from their initial discount request you’ll need to try to feel them out by threatening to eliminate value. Some clients will accept concessions to reduce costs while others will be reluctant to pursue a discount if it means they have to give something up. Either way, remember this key point of discount negotiation: never surrender on price without securing a concession from the client. Luckily, there are many ways in which value can be removed. The most straightforward is to remove site features: for example, did the client want a blog? well, scratch that and you can drop $2,500 from the price. You can also ask for better payment terms (you could drop $2,000 from the budget if you were paid 50% upfront) or you could stretch out the development time on the project so that it becomes a “fill-in” job that you work on when things slow down. Client’s that need the discount will readily agree to these concessions while clients with money won’t care for them.

If you do decide to give a discount, make sure it’s a good one. And by good I mean that it exploits psychological blind spots related to the perception of price. I mentioned in part one that 10% is an acceptable discount. But is 10% really that different from 9%? Not economically but psychologically there is a world of difference, 10% means they secured a double digit discount! And besides, 9% just looks like they saved the sales tax. Likewise, don’t give a $900 discount, give a $1000 discount, the price difference is negligible but the clients will feel they have won a disproportionately larger discount. Finally, aim for discounts that result in a psychologically attractive bottom-line. Say your original budget was $20,800. Be sure to give the $1000 discount to get the price to $19,800 so that client can feel proud that they got the job “sub-$20,000″.

Unfortunately, psychology is a double-edged sword. A client that has successfully secured a discount in the past will always expect a discount on future work. This is why it’s important to hold the line as much as you can during initial price negotiations. However, there is a beneficial flip side to repeat clients that you know are discount seekers: you can build their discount into your original price. For example, say you estimate that a job is worth $20,000. Knowing that the client will seek a 10% discount you can quote $22,222 for the work. When the client comes looking for their discount you can pretend to agonize over the decision and come back a few days later with 10% being the best you can do for them. A 10% discount on $22,222 will put you right back at your original $20,000 so you lose nothing, the client feels like they’ve won a concession and everyone is happy. Of course, perhaps you shouldn’t make your price so obviously engineered to arrive at such a round number but you get the idea.

Finally, make sure any discount that you give is itemized in a revised proposal. Don’t fudge the numbers to make the price lower, present the first proposal complete with the original prices and add a line item at the bottom that shows the discount applied to the earlier total. If you want you can name this line item something like “preferred client discount” in order to give the client a case of the warm fuzzies. The purpose, however, is to never let them forget that you gave them a discount and having the discount front and centre on the official contract will make sure the client doesn’t forget you did them a favour.

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The $40-Million Dollar New York Times Pay Wall

Posted on April 4, 2011 by Joseph Ryan Glover

The New York Times (NYT) recently implemented a pay wall that is meant to force site visitors to purchase a digital subscription to view the newspaper. There has been a lot of discussion online about the logic and efficacy of pay walls but of particular interest to me is a blog post by Philip Grenspun wherein the Internet pioneer wonders “how did the New York Times manage to spend $40 million on its pay wall?”. I haven’t seen this number substantiated anywhere other than the original Bloomberg article that Greenspun’s post is commenting on but Greenspun’s post was picked up by Boing Boing as part of a larger post about the pay wall and consequently has a lot of commentary attached to it. What I find fascinating is the commentariat’s reaction to the $40-million price tag and that reaction is valuable to study even if the number is inflated.

Almost universally the feeling is that $40-million is an outrageous sum for the NYT to have paid to implement a pay wall. Greenspun’s post logically notes that “The New York Times already had a credit card processing system for selling home delivery” and that “a rack of database servers shouldn’t cost $40 million”, which of course it does not. The comments on Greenspun’s post mock the pay wall code and note how easy it is to evade the pay wall using css, javascript or even just the escape button. Likewise, Boing Boing’s commenters raise the same objections that the cost of coding the functionality cannot be $40-million dollars, so why is that the price tag? Some commenters try to dig a little deeper into the development process and enumerate the many costs that are typically overlooked such as research, systems integration, and marketing. All of these comments miss the point that whoever provided the pay wall doesn’t charge based on cost but instead have adopted a value-based pricing scheme in which they charge based on the value that they are helping the NYT realize.

Obviously I am not privy to the internal financial decisions of the NYT but surely we can agree that an organization as large and established as the NYT must have a stable of highly-paid, well-educated financial wonks on the payroll. If we can accept that then it only makes sense that these rational money-men would have prepared some sort of cost-benefit analysis before the pay wall project began in which they estimated the revenues that a pay wall would generate. The NYT would use this number to determine whether a proposed solution was worth the cost and if they went with a $40 million dollar solution they must be fairly confident that they are going to make more than $40-million dollars over the lifetime of the pay wall. This is, after all, how business works. Let’s, for the sake of a number, say that the NYT estimated that the pay wall will generate $100-million in revenue. Now, you may think there is no way on Earth that will ever happen and that the NYT bean counters are off their rocker and that’s a perfectly acceptable position but the NYT has the right to estimate their potential revenue any way they think is reasonable. The interesting part about the cost-benefit analysis is that the vendor most likely conducted it as well (or the NYT gave them theirs) and used those revenue estimates to arrive at the price they would charge for the work.

Greenspun states that he once created a pay wall for MIT Press, no small feat, and that “the invoice worked out to approximately $40 million less than $40 million”. I don’t imagine that he got paid nothing (but maybe he did) so, for the sake of a number, let’s say that Greenspun got paid $10,000 for creating the MIT Press pay wall, a price I calculated using a cost-plus pricing model that pegged his time at 100 hours (he says “it was only a few days of work”) and a rate of $100/hour. If we assume that maybe the NYT pay wall is a more complicated project than the MIT Press pay wall (just for the sake argument), maybe 10 times as complicated, it would take 1000 hours to develop and cost $100,000 using the same cost-plus pricing strategy. But now ask yourself: if the pay wall you created is used to generate $100-million dollars, is it really only worth $100,000? Aren’t the creators entitled to some of the financial value they have helped realize? I sure as hell think so because otherwise the NYT is getting something for nothing; they have been enriched by the expertise of another organization but hoarded all the value for themselves. Clearly, even if the NYT pay wall cost $100,000 (or whatever) it’s worth a great deal more and that’s what we are seeing with the $40-million price tag.

Think of the example of the professional athlete. Is a pro athlete really worthy millions of dollars a year? Is swinging a bat or throwing a ball really that costly? Of course not, cost has nothing to do with it, the player’s salary is based on the value he helps create. The company that pays the pro athlete’s salary understands that by employing the player they are able to generate revenue far in excess of the player’s high salary. The player knows this, which is why he asks for such a high salary in the first place. What the player and the employer have is a partnership where the player helps the owner get rich and in return they are paid a respectable percentage of those riches in recognition of the financial value they have helped generate. If such a pricing model is reasonable and accepted for professional sports surely it should be reasonable and accepted for software development.

I applaud the pay wall vendor for securing $40-million for their efforts. Both parties clearly felt it was a fair price since they entered into a deal with one another. I wish more developers would open their eyes to the fact that what we sell has value that goes beyond the cost of creating it. We are not wholesalers because we do not sell things at cost and we are not selling our hours or lines of code but the solutions to our client’s problems and if those solutions will generate substantial value then we are perfectly within our rights to negotiate for a portion of the value. To do otherwise would be irrational. The pay wall vendor realized, as we all should, that you don’t make someone else rich unless you also make yourself rich in the process.

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All About Discounts, Part One

Posted on March 28, 2011 by Joseph Ryan Glover

In every industry customers ask for discounts and you need to have a strategy in place for dealing with them. Discounting is such a big topic that I am going to split it into two posts. The first one will deal with the concept of a discount and strategic plans for handling discounts while the second post will be focused on tactics for handling the discount-seeking client.

In my experience there are only two types of discount-seeking client: the legitimately needy and those on a fishing expedition. The way to tell the difference is to begin to remove value from your proposal in order to lower cost. The client that truly doesn’t have the money to pay for the project will lose some value in order to ensure that some part of the project will happen. Clients that are on a fishing expedition are seldom willing to give up value to secure a lower price, they just feel duty bound to ask for a discount in every price negotiation because that’s what they learned way back when in MBA school. If you threaten to take away features that they want they’ll magically uncover a budget surplus to cover the discount they were asking for.

Clients rarely ask for a discount before they see your price and that gives you an advantage. A confident price proposal that outlines the value that you bring to the project helps dissuade clients from asking for a discount in the first place. By presenting prices as firm and non-negotiable there is little leverage for the client to initiate a discount negotiation. Nevertheless there are clients that will ask for a discount in the face of your reticence and it is important that you never agree to a discount without taking a few days to “think it over”. This is a classic car salesman tactic and it gives you the opportunity to a) actually think it over and b) sweat the client a bit and make it look like you really struggled with your decision. If you do agree to a discount present it as if it’s seriously eating into your bottom-line (which it is) and that you’re only making a concession this one time because the client really deserves it. Make the client earn every inch of a discount negotiation.

Sometimes a discount request is unavoidable because the client simply does not have the budget to cover the work and in these situations you need to stick to your guns when it comes to your initial quote. If you present a price of, say, $20,000 to a client and they come back with $5,000, you need to walk away from that project. Even if you would do the work for $5,000 you can’t take the job because the entire relationship will be sour from the get go. You’ll resent the client for being a low-balling cheapskate and the client will resent you for being a predatory price-gouger.

So how much of a discount can you give before it becomes embarrassing? I recommend a discount cap of 10% because anything beyond that you begin to look a little desperate and that you just pulled your original quote out of thin air (which you might have done, and that’s fine, but don’t let the client know that). 10% is a reasonable counteroffer that demonstrates that you are a reasonable and generous business person. The client will feel that have won a meaningful concession and you can feel pleased that you put an end to the discount negotiation without to much profit loss.

Be aware that some savvy clients that secure discounts by surrendering value often try to claw back that value through scope creep. This is where a client seeks incremental additions to a project during development that, individually, don’t add up to much but in total represent significant value handed over for free. Scope creep should never be permitted but should be especially forbidden when working with a client who has secured a discount. To this end it is important to make it absolutely clear at the start of a discounted project that any additional functionality requests or features will be quoted separately as part of phase two. If a client tries to weasel extra value through scope creep during a project you need to remind them of their discount and respond to every new request with the phase two deflection.

Discounting can also hurt you with other clients that don’t seek discounts. Thankfully, web development is pretty much a blind market in that different firms and clients don’t know what each other are charging and paying. Nevertheless, allowing discounts to some clients effectively punishes other clients that pay full freight and for that reason there should be a condition in your contract that instructs the client never to disclose that they received a discount. Of course, there isn’t much recourse available to you if the client does blab beyond denying them any future discounts but I have found that conspiratorially telling them that they are the only client that gets a discount and that they need to keep that fact under their hat creates just enough faux intrigue to keep their lips sealed.

Now that I’ve established some general strategies for discounts I will outline, in part two, some tactics for dealing with discount-seeking clients.

Posted in Economics | Tagged | 1 Comment

Is Web Development A Commodity?

Posted on March 19, 2011 by Joseph Ryan Glover

There’s a great apocryphal anecdote about Picasso that has the famous painter eating in a restaurant and being interrupted by a rude patron who demands that Picasso draw something for him. Picasso obliges and scribbles a drawing on a napkin with a marker and makes to hand it to the patron but then says “That will be a million dollars”. The patron, dumbstruck says “but that only took you 60 seconds to draw!” to which Picasso replies “yes, but it took me 40 years to learn how to draw that in 60 seconds”. The rude patron’s mistake was that he failed to recognize the value of expertise because he assumed that Picasso’s service, his drawing, was a commodity.

What do we mean by commodity? Commodities are goods that are, to use an economic term, fungible, which means that the supplier of the commodity can be changed with little to no loss in the quality of the good. Coal, salt, copper and wheat are examples of commodities and some clients also believe that web development should be in that list. They are, of course, incorrect. Like any specialized skill there exists a wide range of expertise in web development from novice greenhorn on one end to veteran expert on the other. Why is this important? Because you will find many clients who, like the rude patron, focus exclusively on the time it takes to complete a web project and implicitly deny the importance of expertise to web development.

An example more relevant to the industry is found in a project I once worked on. The client contacted me with a big job that needed to go live in a week. Typically, a project of this size would take about four weeks to complete but I agreed to the tight deadline and called in my team. My associates and I delivered the work on time and submitted our invoice for $30,000, a fair price for the value delivered. The client pushed back on the price and said it was unreasonable for only a week’s worth of work and I had to explain to the client that it was only thanks to my teams experience and expertise that we were able to deliver their website within their unreasonable time frame. I mentioned that if we were a firm with less experience the job would have taken four weeks to complete and they would have missed their deadline. The client responded by saying that $30,000 was reasonable for four weeks worth of work but not for one.

Consider the logic in my client’s thinking. In their mind, a job performed over a longer time frame is worth more than the exact same job performed over a shorter time frame. This type of thinking is consistent with considering web development a commodity; a commodity that is sold by the hour. My client believed that web development hours are all equal and therefore an objective basis for determining a fair price. What they failed to take into account is expertise and how it invalidates the fungibility of web development hours. To them, an hour spent by a novice is the same as an hour spent by a veteran and they should be charged the same. This is obviously nonsense since the profession is accumulative and web development skills are learned over time. The inherent illogic of the position becomes clear when you consider that adopting the commodification mindset means that the better you get at your job the less you are paid to do it.

Further exasperating the issue are clients who flip-flop between treating web development as a commodity and a skilled profession. These are the clients that demand high quality work, implicitly recognizing that all web development is not the same — since there are evidently levels of quality — but who will also dispute our right to charge for the expertise required to deliver high quality work.

Why do clients do this? They do it because it serves their interest to demand expertise and not pay for it and they will continue to do this until they are called out on this behaviour. As professionals we need to be mindful of clients applying this tactic and assert our right to be compensated for our expertise. This means that if you have a client who acts like web development is a commodity, you need to educate them and if they refuse to be educated you need to ditch them. Most importantly you need to recognize when a client is adopting a commodity mindset and be ready to defend your prices with concrete examples of how your expertise led to the success of their project.

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The Dangers of Cost-Plus Pricing

Posted on March 12, 2011 by Joseph Ryan Glover

The most common way to price a job is to use the ‘cost-plus’ approach. As the name implies, the price that is charged is based on the costs associated with the work plus a little extra for profit. In the web world most project costs are wrapped up in the hourly rates that designers, developers and programmers charge and projects are priced out by estimating the number of hours needed by each worker. Unfortunately, cost-plus is a really poor way to price a project as it has some serious drawbacks.

The first drawback is that a pricing scheme that only considers internal costs will always arrive at the same number regardless of who the client is. Clients always have in their mind a dollar figure for a web job and that number can vary widely from client to client based on things like prior experience, how wealthy the client is or how the client values the work they need done. The danger of adopting a cost-plus pricing scheme that does not consider the client’s perspective is that it leaves money on the table in the form of lost profits that could have been had if the asking price was more in tune with client perceptions.

Of course, clients love to know hourly rates and time estimates because it gives them a leg up on you when it comes to negotiating price. If you reveal that you use cost-plus to determine prices every client will perform the simple math of multiplying hourly rate by estimated project hours to discover your cost and therefore the ‘true’ price of a project. When you use cost-plus to price projects you reveal to everyone your pricing strategy and eliminate any leverage you may have to negotiate a higher price because the client will become fixated on your cost and hold you to it under the guise of ‘fairness’ and ‘honesty’.

The alternative to cost-plus pricing is value-based pricing. As the name implies you stop looking at a job in terms of the cost and start considering it in terms of the value, specifically the financial value, that you generate for your client. This means that the first step in pricing a project is to ask “what financial value am I helping the client realize?” How you answer this question is more complicated than multiplying hourly rates by time estimates but when you do answer it you will have a basis for determining a fair asking price. Think of it this way: does it make sense to create a web app for a client that is going to make them millions of dollars and only charge them for the hours it took you to program? Value-based pricing helps you make sure that you never make someone else rich unless you make yourself rich at the same time.

Does cost still matter with value-based pricing? Yes, because it is always necessary to know the estimated cost of a project in order to ensure that you don’t price the work below cost. However, realize that these costs are an internal matter and not the business of your clients and should not be revealed to them. Some clients won’t like being denied access to your internal cost estimates, no matter how inappropriate it is for them to ask, and I have found that a diplomatic response that gets them thinking about value is to remind them that I’m not selling them my hours I’m selling them the solution to their problem. You may be surprised how effectively this small insight changes the conversation away from a focus on your costs and on to a focus on the value your provide.

Why, you may ask, if value-based pricing is so superior to cost-plus pricing is cost-plus pricing so common? It’s common because value-based pricing requires more work than cost-plus pricing because it requires that you identify and articulate the value you provide. In a future blog post I will further discuss value-based pricing and how to create your own ‘unique value proposition’.

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