One of the most frequent questions I get at seminars and speeches is whether or not I support "value billing."
Usually, the questioner is asking whether services can and should be priced on some basis other than the hourly rate cost that it took to produce the service.
We are all familiar with the perverse incentives that hourly or daily pricing systems create: if the provider gets more efficient and finds a way to do the work with less time, then the provider gets paid less for the job.
This is an ancient problem. There's an old, traditional song in my music collection, sung by Paul Robeson, called "The Cobbler's Song". One verse goes like this:
The stouter I cobble, the less I earn
For the soles ne'er crack, not the uppers turn.
The stouter I cobble, the less my pay.
But work can only be done one way.
The best source on value pricing is Ron Baker's book The Professionals Guide to Value Pricing.
However, I think many people who analyse this situation get it completely wrong. They want to call it value pricing because they think that if they create more value for the client, they should be paid more.
Wrong! We like in a capitalist, free exchange society. In such an economy price is not set by what things cost to make, nor the scale of the benefits delivered to the client.
Instead, prices are set by scarcity -- the relative supply and demand for the service provided. Water has more inherent benefit than diamonds, but diamonds cost more because of an artificially managed supply and demand imbalance.
If you save your client a million dollars through your tax advice (for example), that doesn't mean you deserve a high percent of those savings -- IF MANY OTHER TAX ADVISORS WOULD ALSO HAVE ACHIEVED THAT BENEFIT.
You get paid a lot when your client believes you deliver a level of value that cannot be (or is not being) delivered by other possible providers.
For each of thus, then, whether we are individuals or large firms, our challenge is "How do I make myself special, in ways that clients value?" It's not primarily a pricing problem, but a combination of ensuring that I DO become more valuable in my clients' eyes, and then have a method of pricing which captures that.
For over ten years, I have practiced a particularly "clean" form of this. I set my fee by the number of days I work for the client (at particularly high daily rate) but I give every client an unconditional satisfaction guarantee.
Every bill I send out, without exception, has these precise words: "If you are anything less than completely satisfied, then pay me only what you think the work was worth."
Note that it doesn't say "call me to discuss payment." It says "Pay me what you think I was worth." The obligation is now on me to serve the client in such as a way that he or she can really see the value provided.
The amount they pay is now based not on my cost to deliver, not the amount of the benefit they received, but whether or not THEY believe I was sufficiently special to deserve a premium fee.
There's no secret trick to value billing -- just figure out a way to be more valuable. If you are, you'll get paid more.
24 comments:
Richard, I love the (Cobbler's) verse.
My father was a tailor and I remember the pride he took in his work -- fortunately, with people gaining (or losing) weight -- he had repeat business.
What is the customer measuring -- the solution and its value to their business or the amount of effort (usually equivalent only to "face time" -- time we are with the customer).
whether that time is spent hand holding, gathering information or framing/ presenting a solution.
Perhaps this is the starting point for the value billing discussion.
Perhaps an orthogonal view to the value billing for services in certain domains is hourly rate vs. fixed cost.
In my consulting domain there are issues between fixed cost and hourly billing rate -- not identical to "value billing" but similar.
The question is who owns the risk for hours (resources).
With fixed cost, if my team can provide/ complete a solution in less time then planned is it gravy?
What if we lose time because, for example, the client is a few days late in reviewing/ approving something.
Or if, with limited knowledge going in, I underestimate the level of effort needed.
If I go hourly, then the risk (obviously) is on my customer.
Another partially related issue is "giving away the store".
A specific example, in the mid-1970's when I was doing foreign exchange forcasting my billable rate was a heady $2,000 per day.
The reason -- primarily to keep someone from, in effect, getting our forecasts via consulting rather than purchasing our subscription services.
NO -- I seldom got per diem work (the rate was good for my ego) -- and then only with existing forecast clients.
This speaks to setting some minimums -- should you offer straight per diem consulting -- or only a minimum 3-day or 1-week package (of well defined services) ... another topic, "solution packages".
Richard,
While I agree with some of your thoughts on this subject, I believe you are incorrect on some of the economics.
First, value is NOT based on scarcity.
If that were true people would be willing to pay millions of dollars for my son's artwork that hangs in my office.
They are one of a kind!
Value is, rather, based on the subjectivity of the buyer.
My sons drawings are of infinite value to me, but not to anyone else other than family members.
That being said you are right in essence.
Any purchase decision is based on the belief by the purchaser that the value exceeds the price to be paid.
I think we are in agreement on this point, known to economists as the subject theory of value.
Professionals do, in fact, need to a much better job at differentiating themselves.
In addition, I do not dispute that pricing based on either the hour or the day is certainly viable in terms of making money, it is just suboptimal.
What most professions do when setting a rate is figure their cost and multiply it my their desired profit margin.
In other words, they price based on cost.
This in turn creates friction in the sales cycle because rather than discussing the value to be provided, the professional ends up (in most cases) trying to justify their price (and hence cost).
I am not suggesting that you do this in your work, just that this is the way that most professional do.
The conversation needs to focus on the value to be provided.
For further reading I suggest, Mahan Khalsa's extraordinary book, Let's Get Real or Let's Not Play.
Lastly, regardless of the pricing method, I shout HERE-HERE to anyone who offers a 100% satisfaction guarantee.
To borrow a title from a book I once read, it is the only truly professional way to do it.
I sometimes wonder if "value billing" isn't a construct built by and for professionals, masquerading as being driven by client demand?
No doubt clients have been expressing concern about value for a while; value pricing has been offered as a solution for maybe two decades now, at least in my experience.
But what problem is it solving?
I think it's an inadequate response to a more fundamental issue, the lack of trust between professional and client.
With the exception of a few clients who already know more than their consultants about the technical issue at hand, most clients are willing to defer technicaly to the consultant -- but want some form of insurance against incompetence of unethical behaviour.
Their natural response is to seek a downside guarantee.
Professionals, seeing a technical solution rather than the underlying human problem, have counter-offered a solution built around greater upside.
They are trying to quantify an essentially emotional issue, turning it into classic risk management formulations.
Richard's solution is elegant: a flat-out guarantee, that directly addresses the client's emotional concerns and doesn't get lost in the inevitable measurement difficulties that cause most value-pricing to founder.
Other solutions will do too, as long as they recognise that you can't analyse your way out of what's essentially an emotional issue.
Edward -- I mispoke.
I didn't mean to say that VALUE is determined by scarcity.
My whole point is that PRICES are determined by (relative) scarcity -- the balance of supply and demand -- and value doesn't really enter into it in any meaningful way.
Whether or not you command a high price does not depend on whether your client views you as valuable, but on whether he or she views you as special in some way (which is what I think Charlie is also saying).
As a concept, Value pricing misses the point about how markets work.
Richard, Excellent post.
You offer two very practical solutions to the problem: 1) a day rate; 2) guarantee.
I'd like your opinion on another possible solution -- one that serves a similar function as the guarantee and addresses the emotional issue Charles notes in his comment: should consultants offer a base cost for a project (think half your day rate) and tie the remaining pay to either outcomes (objectives met, and therefore, the remaining amount paid plus bonus) OR an investment in the business (e.g., I'll defer half my rate on this job, but you, Mr. Client, agree to pay me 1% of revenue generated because of my work over the next two years).
In essence, sharing risk and proving your guarantee.
What do you think?
Richard --
I really like what you're saying here.
I've never thought charging by the hour made sense for either the agency or the client.
I like the guarantee idea very much.
It raises the bar for everyone.
I'd like to know how many clients have paid you above your invoice?
I'm sure for many clients you were certainly worth it.
Richard -- With all due respect.
You are wrong on this (or perhaps we saying the same thing two different ways).
Value (or the customer's perception thereof) is the only thing that matters!
Perhaps my definition of value and your definition of specialness are actually the same.
If we define value/ specialness as "the quality (positive or negative) that renders something desirable".
We are in agreement.
In addition, your last sentence concerns me.
First, it seems that you have fallen for the fallacy that value pricing = price gouging or that value pricing is always a high(er) price.
This is not the case.
Value pricing just means to those who espouse it that price is determined by value, rather than price being determined by cost, which is what most, not all (you are an exception) professionals do.
In other words, most professsionals believe that cost drives price and price drives value.
This is clearly true because most hourly rates are based on some multiplier of the people costs.
Yes?
In value pricing, we must first understand value (in your words specialness) than we can determine price.
This is in fact what you have done in your work.
You have made yourself special in the client's eyes.
My second concern is your belief in markets determing price.
This is patently false.
Otherwise, there would be nobody who would buy bottled water since they can in most cases get it for free from some other source.
In addition, how would you explain the success of the iPod.
When it was released there were 50 other products on the "market" that played mp3s.
You would say it was the specialness of the iPod that made it more valueable right?
Therefore, it was not the market that determined anything.
The so-called market had determined that mp3 players were priced at about $200.
Jobs priced the iPod at $500, I bet he is sure glad he did not follow the "market".
While I can not recall the exact quote, I believe it is Stanley Marcus who said, "A market never came into my store to buy anything, but a lot of customers sure did".
Jeff, your variant of my pricing scheme (a base rate plus a kicker based on satisfaction or performance) is one that I also wrote about in TRUE PROFESSIONALISM.
I would only caution that I am nervous about pricing schems that are based on specific, quantitative peformance targets -- they lead the provider to focus too heavily on those things for which he or she gets paid, rather than the true interests of the client.
For example, there are consulting firms who are paid on the basis of cost savings they achieve for their clients, and they slash and burn the clients' payroll just to be sure they meet the targets.
Not good!
I prefer to base regards on satisfaction -- it means you have to do a more thorough, comprehensive job.
Leo, I once got paid even more than my normal obscene, heart-attack level fee.
I had been doing a consulting job trying to get all the troops to line up behind management's strategy, and figured that a good tactic to get everone to but in would be to refer to the top managment team as "tolerant wimps".
I said things like "If only those guys would stop acting like tolerant wimps, this could be a great place. How many of you want them to start acting as if they had standards?"
In this way, I "stampeded" the crowd into voting for management's plans.
When I sent in my bill, I received a reply which said that management were unhappy that I kept calling them tolerant wimps and were discounting my bill by 10 percent.
But they were so pleased with the outcome that they were giving me a 25 percent bonus.
I accepted!
Ed, maybe we are saying something very similar.
People will pay more if they think you are providing something they cannot easily get from others.
OK?
Do we agree on that?
All I'm trying to establish with continuing to argue this point is that I think obtaining high prices has very little to do with the way you structure your prices (it's not about mechanics) and it does have everthing to do with actually being special.
I am very nervous about those who argue that it's all "perceptions" -- in the businesses I know (professional businesses) it's about reality.
Not image, not packaging, not perceptions.
The only decent and sensible pricing strategy (like iPod) is to set a high (non-commodity) price then work like hell to deserve it.
I like the post quite a bit, but I'm surprised that no one has commented on the first thing that came to my mind on the guarantee -- those customers who will take the opportunity to stiff you on good work simply because of the opportunity via the guarantee.
Scott -- it has never, ever happened to me.
And if it did, I'd apply that old slogan "Fool me once, shame on you. Fool me twice, shame on me".
I don't work for cheats or people I don't trust.
And if it ever happened by mistake, I wouldn't be tempted to change the pricing policy to accomodate it!
A pricing policy designed to accomodate SOBs sounds like a disaster to me.
Great post, great comments from all.
Anyone who's not read Ron Baker's book is missing something really important.
Highly recommended.
He was doing value pricing before most of the rest of us had any idea what it was.
The comments about scarcity and differentiation are dead-on.
They are two sides of the same coin.
Strategy is about being different, and differentiation, according to Porter, is about "perceived uniqueness".
At the end of the day, though, one has to perform.
Perceptions will get you in the door, but reality is what rings the cash register.
Charlie's comments about trust are dead-on.
In our shop, we try to price most of our work on a fixed-fee basis.
That eliminates client worry about a ticking meter over which they have neither knowledge nor control, and it makes us really scope the work before we price it.
A couple of times back-when, I ended up working for what felt like 10 cents an hour.
In both situations, I was so hungry that I was too eager and didn't do enough due diligence.
Hasn't happened since, though.
In my view, marketing is an essential aspect of differentiation, esp. in professional services, which, by their intangible nature, are much harder to differentiate than, say, an automobile, a kitchen appliance, or a watch.
We strongly believe that website, logo, tag line, and approach to the work should ALL be tied directly and closely to our firm's uniqueness, which is that we marry strategy concepts to valuation in private equity and deliver enhanced value as a direct result.
Since we had our one-woman ad agency redo all our marketing stuff redone in the last year, our revenues have risen > 70%.
Our hourly rates (for those few occasions when we have no choice but to work by the hour [because we have no control over our time] are up 21%.
I could raise them another 20-30%, but don't feel right about doing that ... yet.
But if I keep working as hard as I've been working in the last couple of months, they'll go up again before New Year's.
We're not doing anything differently from the way we did it before -- it just LOOKS different to the outside world.
Marketing matters.
Richard: your solution is elegant: offering a guarantee is great.
However, it still does not solve the "problem" of what to charge, if you want to do so by value pricing.
Once you quote a daily rate, you will be "stuck" on that, no matter what value you provide.
If the perceived value is less than your rates, you'll get less based on your guarantee.
If it's more, you will not get more (only 1 exception in all the time you've offered your guarantuee).
Sometimes it is possible to get paid based on achieved results.
Which is what I prefer, it gives clarity to both the client and me.
I often ask them what it would be worth to them to have the issue solved, and base my fees on that.
Or I propose: this is the value I see, and I want x% of it.
What do you see?
Another approach I sometimes use is ask the client what THEY would charge ME if the roles were reversed, and why.
Which gives great insight in what is true for them.
It all comes down for me to create a win-win for both the client and me.
Based on a trusting relationship (they trust me, I trust them).
If that's not possible, then I won't do the job.
Anyone else using value pricing, and what are your experiences?
I'm surprised that no one has brought up Alan Weiss, perhaps because he competes with Richard Wood to some extent.
(?)
I have learned a lot from both gentlemen, who I view as complimentary resources.
Weiss has written extensively on "value based pricing".
His two rules (from the 3rd ed of Million Dollar Consulting, p. 172):
1. Base fees on the client's perceived value of your assistance.
2. Ask for them.
Richard's comments about being special in some way mesh with Weiss' notion of value and "market gravity".
But Weiss goes farther with his second rule by advocating asking for higher fees and not being afraid to turn down business.
Tough to do, but I have found his advice to be personally rewarding -- both financially and in terms of doing ever-more challenging, interesting work.
Of course, your mileage may vary.
Adam
Hi Richard,
Thank you for mentioning my book.
I was inspired by your post to write one on our Blog about The Economics of Value.
Though the post is a bit technical, I thought it important to clarify the origin of value and prices in markets.
Keep up the great work, I love your Blog.
Sincerely,
Ron Baker
I don't like the billable hour at all, and want to buy in to the concept of value pricing.
But several things make me wary.
First, all of the blogs that I see are authored by consultants, and to some extent lawyers, who endorse value pricing.
Where are the clients and the customers who support this model?
I just read an article at law.com about small firm employment lawyers who charge lower rates than their big firm colleagues.
One of the clients quoted in the article said that he liked that the rates were so reasonable.
I have always been told that small firms should not compete on price, yet here, in this article, a major corporate client was raving about the savings he was getting from a small firm lawyer.
Second, how do you figure out how to "value price"?
The examples about bottled water and Macs are not very helpful; one reason, I suspect that they are priced more is to reflect the added cost of packaging or manufacturing.
But when Macs first came out, was Apple earning a higher profit margin on them than lower priced MP3 companies?
But for professionals, how do we value price?
Do we pull a number out of the air?
Do we start with the base fee of what others charge and bump it up by 30 percent?
Do you dialogue with the client about setting value, or set it yourself and offer a money back guarantee?
Third, the business with the money back guarantee is really something of a red herring.
If you properly screen clients, you're not going to attract people who will have you do work and not pay for it, unless it is utter garbage.
Perhaps they'll cut the fee by 10 or 30 percent, but no one is going to forego payment.
I'd like to see some statistics on how often people actually exercise these "money back guarantees" when it comes to a service oriented industry.
Lots to react to here.
A few quick comments:
a) Adam, I like Alan Weiss' stuff a lot, too -- and am happy to recommend it.
(I wish I could write as many books as he does!)
You may have noticed that we do, in fact, recommend the same things -- ask for high fees and turn away business.
b) Ron, I read your economics analysis and while I think your work is terrific, I still miss in your analysis the existence of competitors.
You may not believe in the existence of markets, but surely you must acknowledge the impact of competitors on how you go about pricing.
I don't see that receiving prominence in your work, yet it's crucial for many.
Pricing is NOT just two-way negotiation between client and provider -- it's a complex multi-player game.
We stand shoulder-to-shoulder in saying pricing is NOT about costs, but we are not yet in complete sympathy about how it is best done.
c) Carolyn, You have a long, documented history of being against billable hours, not least because of the perverse INTERNAL behaviour it leads to.
For the same reason, that's why I cannot agree that the guarantee is a red herring -- it's whole purpose is to force us, the providers, to be so good that we obtain bargaining and market power (ie when we're that good, people pay us what we ask for).
I am being boring by repeating my point, but I still maintain that the secret to being able to ask for high fees (which I do and which I recommend) is working very hard at being able to do things that others cannot.
I don't believe the secret to getting superior (nay, superb) fees is in the pricing system.
Indeed, I think that's a distraction from the real issue that makes clients want to pay you more.
There is one issue that I don't think we've covered, and perhaps it's because, one could argue, it's just a restatement in reverse of the basic argument for "value pricing" and all those related elements.
Nevertheless, I think it's important because, at least in my case, it ended up empirically supporting my justification for higher pricing.
I'm talking, of course, about the Service Guarantee.
The reason I adopted it in the first place was because it seemed like the service provider was, in fact, "Putting his/ her money where his/ her mouth was".
It was more than just words ... it was an up front promise, that described the back end.
As such, it gave the offering even greater value ... phrases like "value added" are spinning through my head.
One other issue I want to discuss.
I think when you set your Value Added (or whatever) pricing schedule, you make the assumption that 5 percent of your customers will "try on" your service agreement, some just to try it, some because they're very "trying people" anyway, and some just because they're jerks.
What do you care?
You don't.
You adjust the costs of the tryers and jerks into your pricing formula.
My jerk level has been surprisingly low, according to the statistics (most research says between 2 1/2 and 4 percent), but even a little less than 2 percent of my love muffin clients have been a challenge.
However, as I still say, I've never had to refund money secondary to my guarantee, so, overall, I think the guarantee works.
Finally, re Carolyn's analyses, I suppose it's possible that a Guaranteed Guarantee might not work for some Law Clients (i.e. Satisfaction Guaranteed to a client who loses the case and has to pay fines, go to jail, sit on death row, etc)., but I still think there's some utility in making the effort.
Besides, based on the way receptionists behave these days, the profession has LIGHT YEARS to go before it needs to worry about High Quality Service Levels.
Warm Regards,
James.
I'm the author of Million Dollar Consulting and Value Based Fees, among others.
This particular thread was related to me by a colleague.
Value is not only created by scarcity.
It is created by the worth of the relationship.
Trusting relationships with buyers create higher fees.
The longer you take to develop strong relationships, the faster you are able to create high-worth and high-fee projects.
Scarcity is true for commodities, but not for services.
I may offer the same services as much larger firms, but I beat the competition every time because I'm able to generate a much more trusting relationship with the buyer.
Richard,
You've suggested that higher fees are created by scarcity, and Alan Weiss suggested that trusting relationships create higher fees.
In a sense you're both right, but some of your examples and comments seem to miss your main point (i.e., that "value" is always a subjective determination by the client).
I think the problem is the way you sometimes use the word "value".
Value is not the monetary benefit or utilitarian result you produce for the client.
For example, as a driver, I value getting from point A to B (i.e., transportation is the utilitarian result of driving).
But, I also place a high value on the experience of driving a car that delivers other things I want.
That's why I drive and am willing to pay for a BMW instead of a Geo.
Properly defined, "value" includes the nature of your relationship with the client or as you put being "special" in some way.
Steven, I'm certainly not disagreeing with your point, or Alan Weiss.
(After all I have written extensively about being a trusted advisor).
Where the ideas come together, I think, is that the value in the experience you describe will still only get translated into a premium fee if the recipient thinks you are one of only a few who can provide that experience.
If he or she thinks the experience is valuable but many can and will provid it, then you're not going to get paid any more.
Isn't that what we're all saying?
Richard, thanks for your response.
Yes, I agree and think we're trying to say the same thing.
If you position yourself to deliver a commodity service, then you can't charge premium fees.
It's an equilibrium, so the flip side is also true.
If you charge commodity fees, you'll eventually deliver commodity services (which is the reason many law firms have to auction their services by responding to RFPs).
Those who are stuck in the hourly fee paradigm (selling time as commodity) have very little incentive to improve and deliver more value.
As a result, there are plenty of opportunities for others to offer unique value and charge appropriately for it.
Late into the discussion, I've been reading through this post and the responses.
There are a lot of thoughts and opinions in there, but the main point of disagreement seems to be whether or not price is proportional to scarcity, with the counter being put forward that price is instead proportional to the value provided to the customer.
For my own benefit, I wanted to try to summarise the discussion, because I thought it was a valuable one, and I wanted share my conclusions with you all.
First -- it seems to me that price IS proportional to scarcity, as long as you take into account the demand part of the equation.
That is, for a given (non zero) level of demand, a scarce product or service will always command a higher price than a plentiful one.
The argument that a child's painting would have infinite value because of its scarcity falls over when demand is considered.
If there is zero demand for a scarce product, then it possesses zero value.
(Incidentally, I thought the original painting example was a little weakened by the observation that the parent would put infinite value on it!)
Equally, just because you have a truly unique product with some (non-zero) demand, it doesn't automatically mean it has infinite value.
Value is the COMBINATION of scarcity of supply AND intensity of demand.
Richard mentions this briefly in his comments, but I don't think anyone really picked up on it.
The counter argument, that pricing should be based on value to the customer alone seems to me only academically useful.
In the real world, consultants price their services using a mixture of cost-led and value-led algorithms, and clients almost always talk to more than one person.
Given two fixed price quotes from equal consultants, clients will tend to pick the cheaper one rather than, for some reason, preferring one that is based on a percentage of the value delivered.
The argument in favour of value-pricing seems to generally be that fees will be higher (i.e. that's why consultants should use it).
Therefore, cost-led quotes will generally be cheaper, and value-based quotes will be overlooked in favour of the cheaper, cost-led quote.
Only in the rare instance in which you are the only person talking to the client -- from enquiry through to delivery -- and the outcome is quantifiable, or everyone is using value-pricing, can the pure value-pricing model possibly be relevant.
And so we come to a second differentiator -- trust.
No two consultants are equal in all respects.
It therefore follows that a consultant that is more trusted will be able to charge higher fees than a competitor that is equal in all other respects.
Adding a satisfaction guarantee can only enhance trust.
As with so many things, the answer likely lies somewhere in the middle of a cost-led approach and a value-based approach.
By all means price your services as high as you dare, work to earn trust and innovate to deserve the rate, but surely there is also logic in being aware of the value that you are providing to clients and ensuring that you are always adding more value than you take in fees.
Thanks for the summary Tim.
Does that mean that the equation is:
Scarcity of Supply x Intensity of Demand x Trust in Relationship = Price / Value
E.g. If I want a builder to do some work on my house it work as follows:
Supply -- Number of good builders available?
Not many = higher price / value to me that I find any builder at all
Demand -- How badly do I want it done?
Now = higher price / value to me that it is done soon
Trust -- How much do I trust the builder to do a good job?
Greater the trust = more I am willing to pay / greater the value to me of confidence that a good job will be done.
Therefore switching it around, as a builder what I need to do is demonstrate that I have skills and specialisms that are in short supply, intensify the buyers demand to get the job done by creating a compelling vision of what a successful outcome will look like, and last but by no means develop a strong relationship of trust with the client based on my character, interpersonal skills and ability to demonstrate a strong track record of good work and happy clients.
If I as a builder deliver on all these three things I can charge a premium price because the client appreciates the value I deliver and is prepared to pay for it.
Thanks for keeping this going, guys.
Tim, I like your summary, too.
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