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Management
Four Realities of Value-Based Pricing
March 2006
The logic of value-based pricing for consulting work is sound. Why shouldn't consultants be paid based on the results of projects, rather than the number of hours they log on them? And to take the logic another step, if a consultant's work generates big savings for a client, shouldn't the consultant share in that windfall?
I think value-based pricing will take hold in the consulting business, so facing the realities of this approach now will prepare you for the changes ahead.
Reality #1: Clients care about the performance of their businesses-not yours.
Most clients are looking for tangible results, at the best price, when they hire a consultant. Of course, clients will pay a premium if they believe they can achieve faster, better or more permanent results with a higher-priced consulting firm.
But never lose sight of the fact that clients are interested in their results, not your profit margin or how much time you put into a proposal or a project.
Some clients will express enthusiasm for and negotiate a value-based fee with a consultant, only to get cold feet at the last minute and ask for a time and materials or fixed-fee proposal. Clients sometimes perceive less risk and lower cost with the hourly rate option, even when that does not reflect reality.
Keep your pricing options flexible even if a client shows a strong interest in value-based pricing. You'll avoid scrambling at the last minute to create a price for services.
Reality #2: Clients are reluctant to leave their comfort zone.
For decades, clients have used the simplicity of the hourly rate to help make decisions on choosing consultants. The hourly or fixed rate gives clients an apples-to-apples comparison-at least on price-of their alternatives.
Sure, the firm with the lowest hourly rate isn't always the winner, but clients like having a standard measuring stick. Consultants know that old habits die hard, and that the hourly rate or fixed-fee pricing won't go away quietly.
Many clients need a powerful incentive to budge them from old habits. After all, if a client can hire a consultant on a fixed-fee basis to help reduce manufacturing costs, for example, what would motivate that client to pay a value-based fee, which is likely to be higher?
The answer is reflected in just about everything you do, from marketing and selling to delivery. You need to rethink your marketing communication, sales approach, and your value proposition to effectively convert clients to a value-based billing approach.
You have to demonstrate a dramatic difference in measurable results as compared to the rest of the pack or your clients will head right back to their comfort zone-the hourly rate.
Let's say you believe a client's $10,000 investment in the customer service improvements you are proposing will result in an annual reduction of $3,600 in merchandise returns. Is that 36 percent return on investment (ROI) enough to justify a value-based price to the client? Maybe, but you'll have to test that ROI with the client as you're developing your proposal.
If you've come up with the right ROI, your sales cycle should be shortened immediately, plus you'll bypass the dreaded hourly rate. Expect substantial give and take, though, as you work with clients outside their comfort zone through the mechanics of value-based pricing.
Reality #3: You need to answer "yes" to six questions.
Is the anticipated result (ROI) of the project substantial enough for the client to clearly understand the advantages of a results-based fee arrangement?
In competitive situations, your value-based fee may be compared to lower priced, hourly proposals. Make sure there is a logical link between your fees and specific results, and emphasize your track record of achieving the ROI you are proposing.
Given the client's environment, is there at least a 75 percent certainty that the project team will achieve the proposed results?
Carefully consider how probable it is to achieve the results you're proposing. Often, success depends on team composition and organizational support, so be sure you have the right consultants and client team members, and the executive support you need to hit your target.
Are you willing to put part of your proposed fee at risk?
For most value-based billing arrangements, your fee will be based on a sliding scale, based on results. If your team exceeds expectations, your fees will be generous. If your team fails to meet the pre-determined performance benchmarks, part of your fee is at risk. The potential for sharing in the client's windfall carries risks.
Can you wait for expected results to materialize before you ask for full payment?
Clarify all payment details before you begin work. Focus on levels of payment, including timing of payments, and the potential impact of uncontrollable events. Executive shake-ups, mergers, and labor strife are just a few events that can derail the best planned payment schedule.
Does the client have the will to make the tough choices that a value-based project can demand?
In many value-based billing projects, organizations must make substantial changes to achieve the desired results within the proposed timeframe. You'll need to trust that your client has the will and the ability to make hard choices. That assurance is best known with existing clients. You'll need to perform extra due diligence on this issue regarding clients you have not worked with before.
Have you considered the project's best and worst case scenarios for you?
Before agreeing to a value-based billing arrangement, assess what impact the agreement could have on the short and long-term financial health of your business and on your relationship with the client.
Reality #4: Value is in the eye of the beholder.
Some consultants complain that the industry is beset with commodity pricing, stingy, clients, and endless price negotiations. It's true that many consultants in today's market are peddling the same services that do nothing to inspire clients to pay for results.
Don't expect clients to automatically see and understand the value you could provide to their businesses. Some will be focused only on the need to install a new system or solve a narrow problem.
You have to dig deep to change clients' mindset about projects and put the real value right in front of their eyes. Once you do that, and assuming your offering is better than that of your competitors, your value-based pricing proposal will find a receptive audience.