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Professional Services - On Prices and Pricing Policy
Dear Ndarala Colleagues
One of the challenges that we all face is to decide just how to price for our services. A second and related challenge is to find the best way of ensuring both that we do provide value and that the client recognises that value. This report outlines some of my recent thinking and experiments in these areas focusing on what I am calling, for want of a better phrase, value based pricing.
Private versus Public Sectors
The approach works better in the private sector. The rules and rigidities associated with public sector jobs make it very difficult to adopt value pricing. I have still to work out a solution here, if indeed one can be found. In the absence of this, I fear that our public sector clients are just going to have to accept that over time, and on average, the real value they gain from their contracts will be less than it would be if they could adopt value based pricing.
In thinking about value based pricing, we need to start with the way we normally set our prices.
Each of us has only so much time in a twelve month period, essentially 1760 hours on the basis of a 40 hour week with holidays. Of this time, some has to be devoted to marketing, some to admin, some to professional development, and the rest to production. We usually handle this by setting a charge target, the proportion of time that we can devote to charge.
On the basis of 60 per cent charge and 1760 hours, we have around 1056 hours available to charge. If we then add our target personal income plus operating costs and divide this into 1056, we have the amount we have to earn per hour. In turn, this sets our charge rate.
To illustrate by example. Say our target pre-tax income is $120,000, that we operate from home (this reduces costs), and that our normal operating costs are round $200 per week or $10,400. So now we have to gross $130,400. On the basis of 1056 hours, this equates to a charge rate of $124 per hour. So this becomes our normal charge rate.
When we come to quote on a job we then use this rate. If it's a fixed price job, we hold our finger up in the air and work out what we think is a reasonable price and then adjust time or charge rate accordingly. If it's a small client, we may again adjust the rate.
Problem with Normal Pricing
The key problem with the normal pricing approach is that it usually does not take into account the real value of the job to the client. Our focus is on the time involved in doing the job. If real value is factored in, the price that should be charged may be higher or lower than that generated via the normal approach.
Calculating Real Value
Calculation of real value is far from easy. Sometimes numbers can be attached. At other times, the results can only be described in qualitative terms. But in all cases, the starting point is to try to get the client to articulate just what they expect to achieve from the job. Often the client can only express this in very general terms. I want a strategic plan, for example. Our challenge then is to assist the client to extend this via questioning.
Relating Price to Value
Once we have teased out the value the client expects to achieve from the assignment, the next task is to relate price to that value.
Where value can only be expressed in general qualitative terms, then the most sensible approach may be to follow traditional pricing approaches. At least in these cases, the overall approach to the assignment is still likely to be better than before because of the analytical approach adopted.
Where value can be expressed in quantitative terms, then it is possible to look at quoting a price expressed in terms of the expected value. This may be a straight success fee, a higher or lower basic charge rate, or a melded fee combining base fee with some form of success bouns.
Let me take an example to illustrate my point. In a recent assignment, I gave the client a choice. They could pay me in the normal way based on time ($185 per hour). Alernatively, I could increase my rate to $220. They could then pay me at the $220 rate less a 25 per cent discount. In this case, they would pay me immediately $165, a $20 per hour saving. The remaining 25 per cent would be paid if and only if the assignment achieved the expected outcomes over a twelve month period.
This type of approach will normally work if and only if you have a high degree of confidence in implementation. Even then, however, there can be exceptions.
In a recent case I offered an immediate discount with later bonus even though I knew that the exact way the client was defining success made it unlikely that the target returns could be achieved. Here I was dealing with sceptics within the client who doubted that the thing could work anyway. I was pretty sure that it could, so I needed something to demonstrate confidence. By betting my own fees in the way that I did, I guaranteed that the proposal would be taken seriously. I also ended up guaranteeing future work in that my membership of the review panel oversighting the project meant at least six days charge through to year end. This also put me in a position to help drive implementation.
Whatever method is adopted must be carefully documented to avoid later problems. Here I have adopted an approach that will only work with private sector clients that you trust. In essence, I say to the client you make the judgements, you pay me if and only if you think we have met target. This gets rid of a lot of the agro. If the client does not pay me even though we have achieved target, then I know that that client is not worth retaining.
Learning to Say No
An important issue in achieving value pricing is learning to say no.
I guess that we all have a tendency to grab the job even where we are not sure about it. This has to be resisted.
In 2000 a colleague and I were walking through the University of New South Wales on our way to a meeting. A prospective client rang on the mobile. When the conversation finished I commented, somewhat to my colleagues surprise, that I hoped we would not get the job. This reflected my gut judgement that the client was likely to be more trouble than it was worth. That is, that it would be unable to recognise value.
This judgement proved to be correct. As we always do, we invested in that first job. We also pointed to a number of things that the client needed to do. This advice was not well received. Even though we were subsequently promised more work, this was blocked by management. So we wrote the client off. Then, two years later, we were asked to run a planning workshop. I agreed with some reluctance. When I had not heard anything re details a few days before the workshop, I approached the client only to find that the assignment had been cancelled without notice to us. Life is too short to put up with this type of crap, so the client in question is now on a permanent black list.
The point of this story is that client work in general and value pricing in particular depends upon selection of the right client. Often we think that the client selects us. That is certainly true on one dimension. But it is equally true that we should select our clients. That is, we should go with those clients where we have the best chance of achieving positive results.
All for now.
Note on copyright
This material is copyright Ndarala 2003. It may be copied and used subject to due acknowledgement. If you wish to reproduce it or include it on your web site, then please include the following words at the end of the text: "This material is drawn from the Ndarala (www.ndarala.com) series on Managing the Professional Services Firm, is copyright Ndarala 2003 and is reproduced under license. If you wish to copy it, please include this acknowledgment."
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