How Fees Help Determine Client Perceptions of Value
Confessions of the Pricing Man, How Price Affects Everything
Financial experts often struggle with setting fees for their own services and expertise. It is easy to see how someone could have trouble with decisions involving hourly billing versus fixed fees, premium pricing, bundling, discounting, and adjusting for scope creep. The author in this article shares insight from Hermann Simon on the above considerations.
Financial experts often struggle with setting fees for their own services and expertise. It is easy to see how someone could have trouble with decisions involving hourly billing versus fixed fees, premium pricing, bundling, discounting, and adjusting for scope creep.
After a long career as a pricing consultant, Hermann Simon wrote: Confessions of the Pricing Man, How Price Affects Everything. In this book, he shares his experiences and insights that can help with the challenges of setting fees.
He begins by making clear that, whether we like it or not, adjusting our rates is the most effective way to generate higher profits. That leads to his next point, which is ‚Äúnever run a business in which you have no influence on the prices you charge.‚ÄĚ This is a critical issue when choosing an industry niche or an area of specialization.
Pricing power is the ability to raise rates. Simon says understanding how much pricing power we have is vital to managing a successful practice. He quotes Warren Buffet as saying, ‚Äúthe single most important business decision in evaluating a business is pricing power.‚ÄĚ
Mr. Simon makes it clear that we should not hesitate to raise our fees in accordance with the value we provide to generate more profit. It is not the business that earns an adequate profit that ‚Äúrips off‚ÄĚ society. Instead, the business that fails to do so is the one that hurts society in the long run.
However, Mr. Simon points out that too many people still believe that the best way to increase revenue quickly is to cut their rates. They eventually learn the hard way that that practice leads to price wars with devastating effects on profits.
In determining appropriate rates, the author says we should remember that the two most powerful intangible benefits people willingly pay for are convenience and peace of mind. So, while we may think we are producing documents full of words and numbers, we may really be helping clients reach more important priorities. Consider the value of that.
According to Simon, pricing is a powerful communication tool. The price itself becomes the primary indicator of quality. In professional services, higher prices signal status and therefore offer the buyer an additional level of psychological comfort. Therefore, he recommends offering absolutely no discounts if you believe that your expertise is worth your rate.
With respect to specialized professional services, the demand curve may have an upward (positive) slope. This means that a price increase can lead to more new clients. This is in part due to the way lower rates can prompt prospects to forego your firm due to concerns about quality. Many people act according to the motto ‚Äúyou get what you pay for‚ÄĚ and steer clear of low-priced professionals for their important matters.
Simon describes multiple studies in which people were tested about their response to differences in pricing. In one test, study participants received a pain reliever in packages showing different prices. One group saw a tag with a high price, and the other group saw a low price. Without exception, the participants in the high-price group claimed that the pain reliever was very effective. In the low-priced group, only half of the participants made that claim. For all of them, however, the pain reliever was a vitamin C placebo.
The less prospects know about the quality of the services and expertise available to them, the more strongly they are influenced by pricing. This is not to encourage anyone to overcharge simply because they can get away with it.
Although higher prices may signal higher quality, not everyone buys at the top of the price range. Simon describes a concept that he refers to as the ‚Äúmagic of the middle.‚ÄĚ This involves evaluating a price in relation to other prices. For example, a $10,000 fee quote can trigger widely different reactions, depending on whether it is the highest, lowest, or middle quote that they receive. Believing that all else is equal, prospects may gravitate toward a price in the middle of the range. This concept has been found to apply in various scenarios. For example, in restaurants, tests showed that most guests ordered wines with prices near the middle of the ranges on the wine lists. For this reason, some restaurants will add a couple of very expensive wines to their wine lists. They may never sell those very expensive bottles, but by adding them to the list, they move their previously highest-priced wines toward the middle and begin to sell more of them. The very high-priced bottles become ‚Äúanchors,‚ÄĚ making others on the list appear to be more reasonably priced.
Simon‚Äôs theory is that very high prices may scare off prospects who are concerned they may spend more than they need to. They do not want to later feel that they wasted money by spending more than necessary. On the other hand, the lowest prices may scare off prospects who are suspicious of the quality.
Despite our best efforts, some prospects see financial services as a commodity. However, there is still some fee flexibility because consumers willingly pay a broad range of prices for commodities. To verify this, look at the wide range of prices on bottled water in a grocery store. Or notice the wide range of prices on soft drinks at a hotel. The prices vary dramatically depending on whether the soft drink is purchased from a vending machine, through room service, in a gift shop, or in the hotel‚Äôs restaurant.
In closing, Simon reminds us to keep in mind that fee-setting is the most effective profit driver. For this reason, he believes that pricing should be in the forefront of our thought processes and final decisions should be made at the top of the firm.
Stephen D. Kirkland, CPA, CMC, CFF, is a compensation consultant for privately-owned companies and non-profit organizations. He serves as an expert witness in court cases involving potentially unreasonable compensation. View his website at www.ReasonableComp.biz.
Mr. Kirkland can be contacted at (803) 724-1414 or by e-mail to Stephen.Kirkland@AECG.biz.