How much is an hour of your time worth?
As an employee I am engaged in a trade with my employer. The employer and I have an agreement, a mutual understanding that my time is worth a certain amount of money. As an employee I am in the business of trading my time for money.
The business engages in a different trade with clients. Rather than trading time for money, the company trades value for money.
Trading value for money
At the start-up company I work for pricing is determined by value provided. A client purchases one of our companies services for $xx,xxx. This price is representative of the value that the client is receiving.
If billed hourly the clients price would have only been $x,xxx.
If it takes our company 20 hours to produce or provide a service, and we charge an hourly rate of $100 our cost would have been $2000, and the clients price would end up closer to $5,000. That $5,000 figure is far below the price our company has determined based of value.
When trading value for money the client is generally unaware of the time associated with producing or providing their service. They tend to think it takes a considerable amount of effort, planning and organization to produce or provide their service. The client focuses solely on the value they receive from their purchase. If the client receives that value then everyone is happy.
Starbucks Coffee example
Think of Starbucks Coffee Company and their pricing scheme. A large latte has a price of $3.95. Consumers spend that much for a cup of coffee from Starbucks because of the value they feel they are receiving.
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Starbucks has mastered the idea of process (a topic I covered recently) and can produce your latte in under 5 minutes. The cost to make the latte is under $1, and Starbucks churns out hundreds of thousands of these coffee’s everyday. Amazing, right?
The employees at Starbucks agree to trade their time for money. Starbucks takes advantage of this by creating a simple enough process that the employees can create value. Then, Starbucks profits.
Why it works
Scaling a business in this fashion has two immediate and obvious benefits. First, with process in place a business can function with less employees. Second, with value based pricing the business ensures they are charging a high/justified amount to every customer.
Greater margins on every sale, and operating with a leaner staff is a perfect formula for long term success and sustained growth.
Read more about this subject on Patrick Mckenzie’s blog.