Pricing on Purpose
How to Implement Value Pricing in Your Firm, Part 3
In this third article of the three-part series, Ronald Baker discusses how to implement a value pricing model and the advantages this model presents over the hourly billing model. Again, the focus is on the value provided to the customer and communicating this to clients.
The Eight Steps Required for Pricing on Purpose¬†
If all patients were the same, medicine would be a science, not an art.
‚Äď‚ÄďSir William Osler, one of the fathers of modern medicine¬†
Have a conversation with your customer to determine their needs and wants in the forthcoming year. Ask them the questions in Exhibit 1. This is your opportunity to comprehend and communicate the value you can add, establishing the scope of value and then the scope of the work to be performed. ¬†Sometimes a member from the value council attends this meeting, especially if the partner is not a member of the council or is uncomfortable with pricing.
The information gleaned from Step One is then presented to the value council, where three options, at three levels of service, are established. Think of American Express‚Äô Green, Gold, and Platinum cards. Each is varied in price based upon the value and services they deliver. Firms should offer customers options, not a take-it-or-leave it single price. This allows the customer to convince herself of value, while revealing their individual price sensitivity. It also changes the mindset of the customer from ‚ÄúShould I work with this firm?‚ÄĚ to ‚ÄúHow should I work with this firm?‚ÄĚ This is a powerful change in attitude that differentiates your firm from the competition.
The value council then goes through the 20 questions to ask before establishing a price (Exhibit 2). Based upon the answers, the council then conjectures three internal prices for each level of service, based upon their assessment of the customer‚Äôs subjective value and price sensitivity.
- Reservation Price: Below this price, the firm would turn down the work. It must get this price. It will generate a normal profit.
- Hope-for Price: A firm should get this price more often than not. It will generate a supernormal profit.
- Pump-Fist Price: This is an aspiration price, when the firm is adding extraordinary value. It will generate a windfall profit.
Many firms use the following nine-box model:
From this brainstorming session, the pricing council then determines at which price the three options will be presented (obviously, not all nine prices are presented to the customer). The upper bound of these prices should be based upon the value being created, yet all will be lower than that value so as to ensure the customer also earns a profit.
For example, if you know the customer is highly price sensitive, you may only present the reservation price for all three options. However, if there are some services that are adding high marginal value, a hope for price may be quoted for the gold and platinum levels. If extraordinary value is being created, quote the pump-fist price.
This is where the art of pricing comes into play. ¬†It requires judgment, and the more the value council does it, the better they will get, since pricing is also a skill.
Firms that use this model report that it makes them ‚Äúcompete with itself.‚ÄĚ To receive a pump-fist price, the firm must conjure up ways to add extraordinary value. This is a worthwhile thought experiment, as the focus is on value, not time.
Many people ask, ‚ÄúHow can you ascertain value since it‚Äôs subjective and there‚Äôs no formula?‚ÄĚ The answer is: with a deep understanding of your customer‚Äôs value drivers, which requires a deep conversation with the customer. One way to never get to value is to continue to think and price based upon hours.
Present the options to the customer. Sometimes, a member of the value council would attend this presentation, especially if the partner in charge is not a member of the council or is uncomfortable discussing price.
The option selected by the customer is then codified into a fixed price agreement (FPA), such as the one in Exhibit 3. The firm can include as much detail as required as to the scope of work, customer responsibility to provide information, timelines for delivery of work, etc. Exhibit 4 explains each section of the FPA and the pricing principles it incorporates.
The firm would perform adequate project management on the scope of work, detailing who will perform the work, timelines for delivery to customer, and other planning details. See ‚ÄúProject Management for Accountants,‚ÄĚ by Ed Kless, published in the Journal of Accounting.
If the firm finds scope creep while performing the work, the customer is informed, given the option of how to proceed, and a change order will be issued if the firm is to perform any additional work. This policy also applies to any new services the firm provides within the year not specified in the FPA. Exhibit 5 contains a sample change order.
Since 1973, the U.S. Army has a policy of doing after action reviews (AAR), which take place after every mission. After assisting many firms in implementing AARs, we are convinced it is a practice that would have numerous salutary effects for firms, especially as it relates to the roles of the CVO and value council, helping them evolve pricing into a core competency. For a sample after action review the value council would perform after the value priced engagement has been completed, see Exhibit 6.
Do not skip any of these steps; all are necessary for developing a core competency in pricing. If these eight steps are followed on every major engagement, is there any doubt the firm will begin its journey to pricing on purpose?
Not Final Thoughts
No firm will ever be paid more than it thinks it is worth. There is nobility in earning what you are worth. Yet if a firm‚Äôs leaders do not think it creates more value for its customers than is reflected by hourly billing, how can customers be expected to understand a value proposition beyond hourly rates?
Hourly billing is, to borrow a medical term, an iatrogenic illness‚Äď‚Äďa disease induced inadvertently by a physician while providing treatment. This model is perpetuated because it is risk-adverse and simplistic, and the theory supporting it has been taught for multiple generations.
Yet hourly billing is nothing but a tradition, which is nothing more than the democracy of the dead. We will not be able to adopt value pricing if we continue to denominate everything into hours, thus remaining mired in the mentality that accountants sell time.
It is past time to change your conversations with customers from hours to value. Do this up front, before you begin any work. Appoint a CVO and establish a value council in your firm‚Äď‚Äďa group of intellectually curious leaders who will become, over time, experts in creating and capturing value. Your firm will become obsessed with value. Your customers will appreciate it, and they will not bother asking about hours. I guarantee it.
Let us, together, forge a new Declaration of Independence, and once and for all, free our profession from the tyranny of time. It is time to bury the billable hour and price on purpose. Will your firm be among the pioneers blazing the trail for others?
Ronald J. Baker is a frequent speaker, writer, and educator. His work takes him around the world. In addition, he has been an instructor with the California CPA Education Foundation since 1995 and has authored fifteen courses. Mr. Baker is also a prolific writer and thought leader; his most recent publication is Implementing Value Pricing: A Radical Business Model for Professional Firms (John Wiley & Sons, Inc.). Mr. Baker can be reached at (707) 769-0965 or by e-mail at firstname.lastname@example.org.
Exhibit 1: Questions to Ask the Customer
- What do you expect from us?
- What is your current pain?
- What keeps you awake at night?
- How do you see us helping you address these challenges and opportunities?
- What growth plans do you have?
- If price were not an issue, what role would you want us to play in your business?
- Do you expect capital needs? New financing?
- Do you anticipate any mergers, purchases, divestitures, recapitalizations, or reorganizations in the near future?
- We know you are investing in total quality service, as are we. What are the service standards you would like for us to provide you?
- How important is our service guarantee to you?
- How important is rapid response on accounting and tax questions? What do you consider rapid response?
- Why are you changing firms? What did you not like about your former firm that you do not want us to repeat?
- How did you enjoy working with your former firm?
- Do you envision any other changes in your needs?
- Are you concerned about any of your asset, liability, or income statement accounts to which we should pay particularly close attention?
- If we were to attend certain of your internal management meetings as observers, would you be comfortable with that?
- How do you suggest we best learn about your business so we can relate your operations to the financial information and so we can be more proactive in helping you maximize your business success?
- May our associates tour your facilities?
- What trade journals do you read? What seminars and trade shows do you regularly attend? Would it be possible for us to attend these with you?
- What is your budget for this type of service?
Exhibit 2: Twenty Questions the Value Council Should Ask Itself Before Establishing a Price
- What is the customer‚Äôs cost of not solving this problem or pursuing this opportunity in dollars?
- What is the economic benefit to the customer if they solve the problem or achieve this opportunity?
- With whom on the organization chart are we dealing?
- Who referred this customer to us? Why were we referred in the first place?
- Do they have any time sensitive deadlines for the completion of this project? Why do they need to do it now and not in six months?
- Who‚Äôs paying for the service? Are they spending other people‚Äôs money?
- Do we have any competitors? If so, who?
- What price information do we have about these competitors?
- How profitable is the customer‚Äôs company? How long have they been in business?
- Have they engaged with someone else prior to us to do similar work? Who was the prior firm and why are they changing?
- How sophisticated is the customer?
- Does customer add to the firm‚Äôs skills or markets?
- Do we like this customer?
- How do we help reduce the customer‚Äôs risk?
- At what price would this be so expensive the customer would not consider buying it?
- At what price would this be expensive, but the customer would most likely still buy it?
- At what price does this become inexpensive?
- At what price does this become so inexpensive the customer would question its value?
- What price would be the most acceptable price to pay?
- What costs can we afford to invest in at the target price and still earn an acceptable profit? At what price would we walk away? What price do we desire?
Exhibit 3: Sample Fixed Price Agreement
November 19, 2014
In order to document the understanding between us as to the scope of the work that ABC, CPAs will perform, we are entering into this Fixed Price Agreement with XYZ, Inc. To avoid any misunderstandings, this Agreement defines the services we will perform for you as well as your responsibilities under this Agreement.
2015 PROFESSIONAL SERVICES
ABC will perform the following services for XYZ during 2015:
- 2014 XYZ Corporation Tax Returns
- 2014 Financial Statement Review with PBCs to be provided by XYZ by March 15, 2015
- 2015 Tax Planning
- Unlimited Access in 2015*¬†
TOTAL 2015 PROFESSIONAL SERVICES¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬† $XXX
*Included in Unlimited Access are the following services to be provided by ABC to XYZ:
- Unlimited meetings, to discuss operations of XYZ, business matters, tax matters, and any other topic at the discretion of XYZ or its employees and/or agents.
- Unlimited phone support for XYZ personnel and/or independent contractors and agents regarding accounting assistance, tax issues, etc.
Because our Fixed Price Agreement provides ongoing access to the accounting, tax, and business advice you need on a fixed-price basis, you are not inhibited from seeking timely advice by the fear of a meter running endlessly. Our service is built around fixed pricing, as opposed to hourly rates, and offers you access to the accumulated wisdom of the firm through professionals with substantial experience, who can help enhance your company‚Äôs future and achieve its business objectives.
While the fixed price entitles your company to unlimited consultation with us, if your question or issue requires additional research and analysis beyond the consultation, that work will be subject to an additional price, payment terms, and scope to be agreed upon before the service is to be performed, and a change order will be issued to document this understanding.
Furthermore, the parties agree that if an unanticipated need arises (such as, but not limited to, an audit by a taxing agency, a financial statement audit or compilation required as part of a lender financing agreement, or any other exogenous service not anticipated in this agreement by the parties) that ABC hereby agrees to perform this additional work at a mutually agreed upon price. This service will be invoiced separately to XYZ utilizing a Change Order.¬†
Our work is guaranteed to the complete delight of the customer. If you are not completely satisfied with the services performed by ABC, we will, at the option of XYZ, either refund the price, or accept a portion of said price that reflects XYZ‚Äôs level of value received. Upon final payment of your invoice, we will judge you have been satisfied.
Furthermore, if you ever receive an invoice without first authorizing the service, payment terms, and price, you are not obligated to pay for that service.
The following payment terms are hereby agreed to between XYZ and ABC:
- January 31, 2015 ¬† ¬†$XX
- February 28, 2015 ¬† ¬†$XX
- March 31, 2015 ¬† $XX
- April 30, 2015¬† ¬†$XX
- May 31, 2015¬† ¬†$XX¬†¬†¬†¬†
- June 30, 2015¬† ¬†¬†$XX
- July 31, 2015¬† ¬†$XX¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†
- August 31, 2015¬† ¬†$XX
- September 30, 2015¬† ¬†$XX
- October 31, 2015¬† ¬†$XX
- November 30, 2015¬† ¬†$XX
- December 31, 2015¬† ¬†$XX
TOTAL 2015 PAYMENTS¬†¬†¬†¬†¬†¬†¬†¬† $XXX
To assure that our arrangement remains responsive to your needs, as well as fair to both parties, we will meet throughout 2015 and, if necessary, revise or adjust the scope of the services to be provided and/or the prices to be charged in light of mutual experience.¬†
Furthermore, it is understood that either party may terminate this Agreement at any time, for any reason, within 10 days of written notice to the other party.¬† It is understood that any unpaid services that are outstanding at the date of termination are to be paid in full within 10 days from the date of termination.
If you agree that the above adequately sets forth XYZ’s understanding of our mutual responsibilities, please authorize this Agreement and return it to our office. A copy is provided for your records.
We would like to take this opportunity to express our appreciation for the opportunity to serve you.
Very Truly Yours,
Allan Somnolent, Partner, ABC, CPAs
Agreed to and accepted:
¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬† ¬†¬†¬†¬†¬† ¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬† Date:
Customer, President, XYZ, Inc.
Exhibit 4: Explaining the Sample Fixed Price Agreement (FPA)
Date of the FPA
The FPA can be either for a calendar or fiscal year, depending on the customer. You may want to stagger your FPAs so the firm will not be rushed to draft new FPAs within one particular time of the year. I have seen multiple-year FPAs as well as perpetual FPAs that cover all the compliance work for the customer, leaving a second FPA to outline those services that change from year-to-year.
Professional Services Provided
Obviously, you will describe each service to be provided by your firm, and you may provide additional scope detail to the degree necessary to have no misunderstandings between you and the customer. This requires professional judgment. For example, with the audit service in the sample FPA you are specifying the customer provide PBC schedules by March 15, 2015. If the customer does not deliver by this date, the scope of the audit changes, and a change order should be issued.
This service is included in the bundled price to the customer and will break down the communication barrier that may arise if you charge for each meeting and phone call. The more you talk with a customer throughout the year, the better able you will be to provide additional value, especially before the customer enters into various transactions.
Do customers abuse this service? Overwhelmingly, the answer is ‚Äúno.‚ÄĚ Any customer who enters into an FPA with your firm is usually an ‚ÄúA‚ÄĚ or ‚ÄúB‚ÄĚ customer, and a high level of mutual trust, respect, and understanding already exists. If they do need to call you at home on Saturday evening at 11:00 p.m. it is usually for a very good reason (a death in the family, accident, etc.), and you want to talk to them. Any additional work that results from these contacts is priced separately, utilizing a change order. Also, if a customer did contact your firm excessively, you are obviously adding value, and can readjust your price accordingly for this access. If they are abusive, or unwilling to pay for your value, you should terminate them.
This clause offers many advantages. By specifying the services that you are aware of at the time of drafting the FPA, you are leaving many opportunities for providing additional services, and because customers are paying you for unlimited access, they are more likely to select you to provide those additional services, thereby effectively locking out the competition. Another advantage is, by their nature, change orders deal with marginal services that the customer wants, rather than what the customer needs (because the FPA has taken care of their basic compliance needs), and can command premium prices.
This policy reduces the risk to the customer of working with your firm as well as justifying a premium price. Why should the customer bet on your firm if you won‚Äôt? A service that is guaranteed is worth more than one that is not, so this clause will allow the firm to command a premium price over the competition.
This clause ensures that your firm sets the price when you have the leverage, which is before the engagement begins. A service needed is always worth more than a service that has been delivered. If there is no customer signed FPA or change order, no work will be performed‚Äď‚Äďperiod! This will inculcate the ‚Äúno surprises‚ÄĚ culture within your firm, something customers will value highly, providing an excellent competitive differentiation, and another opportunity for premium pricing.
The sample FPA shows 12 monthly payments, but this clause can be designed for quarterly payments, semiannual payments, or with a deposit made upon signing the FPA. For personal tax returns, many firms require payment up-front or upon delivery at the latest.
One value-added idea for business customers is to offer the customer the ability to structure the payment terms around their cyclical cash flow rather than the firm‚Äôs workflow (who knows this cycle better than their accountant?). Since the customer has input into these terms, it will negate payment resistance.
Revisions to the FPA
This is a good clause to add, especially for new customers, since it reduces the risk the customer is taking. It also ensures the firm will remain in communication with the customer and continuously solicit feedback on their level of satisfaction.
This clause also removes risk from the customer, lowering buyer‚Äôs remorse. By utilizing bundling and offering just one price for all the services in the FPA, the question arises about what to do if the customer terminates the relationship before all the services are performed. In that case, you will simply have to agree upon the value compared to the payments made, and one party will owe the other. The customer already has the option of paying whatever they believed the value to be due to the service guarantee, so don‚Äôt let this detail prevent you from bundling your services into one price.
The Words You Should Use
The word price is a better word than fee, since it conjures up no negative feelings, as is invoice rather than bill. The word agreement is preferable to the word contract, which conjures up images of disputes, lack of trust, courts, and lawsuits, while agreement has a much more positive connotation to the customer. The word authorize is preferable to sign for the same reasons, and puts the customer in control.
Exhibit 5: Sample Change Order
Date:¬†¬†¬†¬†¬†¬†¬†¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬† ¬†
Project Description and Scope of Services [and Estimated Completion Date, if appropriate]:
We believe it is our responsibility to exceed your expectations. This Change Order is being prepared because the above project was not anticipated in our original Fixed Price Agreement, dated xx/xx/xx. The price for the above project has been mutually agreed upon by XYZ and ABC, CPAs. It is our goal to ensure that XYZ is never surprised by the price for any ABC service, and therefore we have adopted the Change Order Policy.
The price above is due and payable upon completion of the project described [or, payable up front, if agreed upon, or in installments, etc., whatever you and the customer agree to].
If you agree with the above project description and the price, please authorize and date the Change Order below. A copy is enclosed for your records. Thank you for letting us serve you.
Allan Somnolent, Partner, ABC, CPAs
Agreed to and accepted:
Customer, President, XYZ
Exhibit 6: After Action Review To Be Completed by the Value Council/CVO After Each Major Engagement
|Did we add value for this customer?|
|How could we have added more value? Did we create unexpected value?|
|Did we capture value?|
|Could we have captured more value through a higher price?|
|If we were doing this type of FPA again, how would we do it?|
|What are the implications for product/service design?|
|Should we communicate the lessons on this FPA to our colleagues and how?|
|How could we have enhanced our customer‚Äôs perception of value?|
|What did we teach this customer?|
|What other needs does this customer have and are we addressing them?|
|Did this FPA enhance our relationship with this customer?|
|What impact has this FPA had on developing our customer‚Äôs trust in us?|
|How would you rate our customer‚Äôs price sensitivity before and after this job?|
|How has this FPA advanced us?|
|Did we have the right team on this FPA?|
|How high were the costs to serve?|
|What could we do better next time?|
|Do we need to update our customer complaint register?|
|How could we thank this customer for their business?|