Not all Service-Based Revenue Models are Created Equal: How to Optimize Your Pricing and Business Model
Figuring out your pricing model is a critical component of structuring a profitable business. For service-based businesses, in particular, implementing a pricing structure that not only covers your expenses but helps you secure a healthy profit is challenging. While there are several variables that go into establishing a service-based pricing model, service-based businesses make most of their revenue by charging based on:
- time and materials;
- project fees or fixed-cost billing; and
- ongoing retainer agreements.
Below, I examine different service-based revenue models and how to optimize each model. Across these models, what’s arguably the most time-consuming and challenging factor from a finance and administration perspective is generating invoices for services charged in different ways. And while it may be tempting to stick to just one type of billing method for services, this could mean you deter customers. This is why it’s crucial to optimize your pricing and ensure that offering different billing options to your customers doesn’t impact your bottom line.
Time and Materials
Popular across the professional services and legal industry, charging for services based on time and materials is still a good way to charge for services that are difficult to quote at a fixed rate. Most companies that charge based on time and materials will charge for the number of hours worked and resources used to complete the work with the margin added.
A key advantage of billing for services based on time and materials is that scope creep is accounted for by billing for time worked, unlike fixed-cost or project fees. For clients who prefer to be billed based on time and materials, most will require a very detailed breakdown of how time and resources were invested in getting the work done. This is where it becomes especially important to ensure you have customized billing systems in your business.
To address billing for scope creep and ensure other payments don’t fall behind, companies need to consider how they’ll bill in these instances. In a situation where scope creep has gotten out of hand, it can be difficult to get bills paid on time. This is where it becomes especially important to ensure you have customized billing systems in your business, such as flexible billing.
With flexible billing, businesses can bill scope creep on a separate invoice under a separate project, if needed. This allows businesses to get paid on time based on the rates agreed at the start of the project, without letting scope creep slow these payments. For big projects, using flexible billing allows multiple invoices (covering the agreed-upon fees and scope creep) to be created under one project. The original SOW can get paid on time, while you come to an agreement with your client on the invoices to cover scope creep.
Project Fees or Fixed-Cost Billing
Project fees or fixed-cost billing sets the standard at the start of a project. All parties know what the deliverables are and how much the project will cost. Some clients opt for project fees over time and materials-based billing for services as it mitigates some of the risk associated with time and cost overruns. If, however, a project runs over time because a mistake is made by either party or major variations are needed, further discussions will be needed to determine who will cover those costs. Penalty clauses and out of scope clauses in contracts will usually provide all parties with direction on what needs to happen in these cases.
Ongoing Retainer Agreements
For a service-based business, working with clients on an ongoing retainer basis is excellent for cashflow and business stability. Working on a retainer basis usually occurs over a longer timeframe from a few months to many years. In these situations, you’ll end up establishing a strong relationship with your client and develop a deep understanding of their business.
One of the biggest advantages of working on an ongoing retainer basis is that you can plan your cash flow effectively and earmark future billables that can be invested back into your business. On the downside, nothing in business is guaranteed. When a client is reviewing costs in their business, your services may be one of the first to be cut. Keep making your clients your number one priority, however, and offer them flexibility based on how their business changes, and you’ll potentially be able to keep clients for life.
What about ad-hoc services?
As a service-based business, you may also provide ad-hoc services to clients. These services can be time-consuming to bill, which is why it’s important to think ahead about how much you’ll charge for ad-hoc services. With a customized and responsive billing system, you can easily add these services into your system to make billing your clients a breeze.
Which revenue model is best for service-based business?
The short answer — there’s no single revenue model that will work for all service-based businesses. In fact, most service-based businesses will opt to provide a couple or all of the billing options above to make sure they’re providing flexibility for clients while also contributing to growing profits. With that in mind, your most important consideration isn’t necessarily the billing method, but which billing method is suitable for each client to ensure they’re happy while continuing to grow your business.
Effectively Integrating Different Billing Methods into your Services-Based Business
If you run a service-based business with a variety of billing methods, BillingPlatform can help you make your billing processes more efficient for you and your customers. With BillingPlatform’s easy account customization features, you can structure a billing system that works now, while being able to adapt as your business grows and changes.
Figuring out how to effectively integrate different service-based billing methods into your business can be challenging. That’s why we created The Ultimate Glossary of Billing Terms. Not only does this white paper detail all the terminology that you need to know, but it covers how to adapt your billing practices as customers demand more flexibility. The white paper also details how to remain competitive in the digital economy and strategies to continue growing a successful business. You can download the glossary and learn more about billing methods for your business here.