Value Based Pricing
Could your business be charging 30% more than it is now, without losing the clients you want to retain?
Optimise the pricing of your business’ products and services, and you leverage the most significant positive impact on both profitability and cashflow. Pricing has the potential to improve, or destroy, the financial health and performance of a business. Get it wrong and either the business will fail, or your people will have to work incredibly hard for little return.
Is it time to pivot the financial performance of your business, ensuring value is retained and built, enabling growth and scale? Thus creating significant shareholder and stakeholder value.
For decades the core component of determining pricing in the majority of businesses delivering the expertise and creativity of their people to their clients (the service sector), has been the hours required to deliver the work at an ‘appropriate’ hourly or daily rate.
This is one example of Input Based Pricing. Similar to cost+ in a manufacturing environment; and businesses in the services sector who truly understand the changing dynamics around their detailed cost model are in the minority, in my opinion. So why have businesses used ‘Hours X £Rate’ for so long? Reasons include; others do it that way, the perceived availability of competitor ratecards for ease of benchmarking, the feasibility of creating a model ensuring costs are covered, and the pressure from client procurement teams to homogenise a model from which they believe they can identify opportunities to reduce total cost to their business.
What are the downsides to this model?
Numerous! To identify a few:
Pricing can be commoditised and become a race to the bottom
It potentially rewards slow delivery; and penalises faster thinkers, creators & executors of the services provided
It focuses on the input, not the output, or (critically) the value added to the client
There is no direct link between cost and benefit to the client
In negotiations with procurement there is often a single, myopic, focus on the ratecard without consideration of the quality, or speed of output, or any other differentiator
The time invested in completing timesheets is significant and frustrates employees
The accuracy of timesheet completion is questionable; gaming the system is often prevalent
Negative surprises, likely to impact the ongoing relationship with the client, often occur when it is too late for either business to do anything about them, without at least one of you taking on pain.
So what should businesses be considering instead?
Step 1: Move from Cost Based Pricing to Output Based Pricing
Step 2: Move from Output Based Pricing to Value Based Pricing
Step 1 requires an understanding of the services and products your business provides to your clients. How are they described and positioned? Can they be differentiated from each other and from the competition? How does that product differentiation impact client and sector differentiation? Do you currently have alternative pricing methods - how are these used internally and perceived externally? Do different services have different competitor sets? How clear, reliable and measurable are scopes of work around deliverables for each product / service provided?
This approach encourages the identification of a clear road map, defined by the business, and understood by the client. Examples of this type of pricing could include:
Project fees for alternative services provided
Menu based fees for defined services and deliverables
Step fees for multiple output deliveries
Risk based pricing for measurable over and under delivery
Step 1 will need fleshing out even if the decision is to jump straight to Step 2, and move from Cost Based to Value Based pricing.
Step 2 looks at the impact of the services provided on the value add to the client.
What differentiates your services; your people; your deliverables?
How do / could the differentiators impact pricing?
What value does your business provide to each of your clients? What sized problems are you solving?
When you pitch to new clients, how do you describe and define the benefit of working with your business?
What is motivating your existing clients to work with you and pay for your services?
How does that motivation change project by project, or service by service?
How do you segment your clients? Who are the clients your business is able to deliver most benefit and generate most value for?
This requires a level of intraspection; an understanding of the services your business provides, how they differentiate to alternatives in the marketplace, the value they bring to your spectrum of clients, and the willingness your clients may possess to pay more for that value you are bringing to the relationship. Is the business seen as a partner - one that thinks for, or at least thinks with, the client?
Ensuring the pricing fits into the Marketing Mix of a business is critical to ensure the perception is consistent and delivered on (e.g. quality, expertise, availability, speed, problem solving, performance, brand image etc). Pricing is relational. Internally it needs to fit with the strategy of the business (ultimately delivering sustainable competitive advantage); externally it focuses on the connection to the client and its key stakeholders. In the short term there may be an argument to consider dialling down the pricing on a service clients value less, and increase the pricing in the areas clients are willing to pay more. Over time, value delivered to clients should grow. Shouldn't the pricing of those services reflect this?
Clients will be looking at the cost-benefit of their activities. Thinking with, or for, the client in a value based approach helps them with the assessment of the prioritisation and appropriate investment levels, and your business to clearly identify the value drivers. This route may elicit what clients are willing to pay. It will ensure the client understands why they are working with your business and the pain of extracting those roots may create.
Clients will usually be willing to pay more for the services provided, IF they add significantly more value, and generate a higher ROI, than the alternative. For example, Client X has the option of paying £10 for a solution that delivers estimated returns of £50 to the business; or £20 for a solution that delivers returns £250. Once the risk profiles, likely accuracy of the return estimate, and available budget are assessed, the client is in a position to make that choice. Even if the client selects the cheaper solution, the partnership will only be enhanced through the discussion and focus around Value Add, recognition of the client’s pain points, and the availability of choice.
Do you want to explore Value Based Pricing?
Value Add can be looked at in numerous ways including, but not limited to; revenue growth, market share, client protection, cost savings, product improvement, accelerated IP development, value of time savings, speed to market, and customer perception. Assessing and measuring these dynamics within a relationship which has the depth, trust, transparency and willingness, could be a useful start point. Working and thinking with clients can bring other benefits, but in this specific instance, could create a win-win for both your business and your client.
Also, looking at this through a lens of market competition will provide a useful additional perspective.
o Who are the next best alternatives for your client for this particular service?
o How does the quality, speed, impact and perception of your services in this area objectively compare?
o How would your competitors price a typical service deliverable you are looking to grow going forward?
o Can you estimate comparable value-adds (cost - benefits) to your target client market of the relative service deliverables?
o How can you develop, improve and evolve the value add you provide to your clients, both existing and desired, at a faster rate than your competitors?
Beware not to 'copy' competitors pricing as their services will differ, the clients' perceptions will differ, and their cost infrastructure (and thus profitability) will differ. They may also be on a very different strategic pathway.
Another route to consider would be to look at pricing new services, or new clients, in this new way, retaining current pricing methodologies to historic services for existing clients. Transitioning more of the business to the new approach over time. This can only be achieved if there is sufficient differentiation across services or across clients.
A business will always need a strong understanding of its cost and cashflow model, particularly in a constantly changing environment. And ensuring a pricing model is able to deliver an acceptable fully costed margin, over an appropriate time horizon, will ensure a business not only survives, but also thrives. If revenue is 'vanity', profit is 'sanity' and cashflow the 'reality'; then they also serve as the 'food', 'water', and 'oxygen' respectively of your living and evolving business.
It is certainly true that reliable and accurate Value Based Pricing is difficult. It is a journey, a process to examine and determine. But the ROI to your business through the value, depth and longevity of client relationships could be significantly enhanced.
A combination of bold Business Leadership & insightful Finance Leadership could reap significant dividends for your business, and drive value for your clients.
As Charles Darwin once said ‘It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is the most adaptable to change’.
Worth thinking about?
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