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PRACTICE MANAGEMENT

Pricing on Purpose: How to Implement Value Pricing in Your Firm

 

By RONALD J. BAKER
JUNE 2009
Pricing on Purpose

A business is defined by the value it creates for its customers. Your price speaks volumes about your value proposition, more so than any other component of your firm’s marketing. The business world pricing revolution began in the 1980s, when many of the Fortune 500 companies began to employ professional pricers, and organizations such as the Professional Pricing Society were founded to assist companies in achieving excellence in pricing for value. Yet many CPA firms are still defined by “hourly rates.” The CPA profession has taken its collective intelligence, experience, judgment, education, wisdom, knowledge, and intellectual capital and commoditized them into a one-dimensional hourly rate. This article illustrates that pricing by the hour is the wrong way to measure the value created for the client.

 

THEORIES OF VALUE

Professionals undervalue their services because they are operating under the labor theory of value, which posits that the value of a service is determined by the amount of labor used in its production. Conversely, professionals who subscribe to the subjective theory of value believe that the services they offer are only valuable to the extent that there is a potential buyer desiring them. Value is in the eye of the beholder. For any transaction to take place, both the buyer and the seller must profit from the exchange and receive more value—in their subjective perception—than what they are giving up.

 

Today, thousands of firms price their services according to the external value created—as perceived and determined by the client—rather than internal costs incurred in generating those services. (For a summary of the advantages of value pricing, see Exhibit 1, below.) Changing the pricing culture in your firm will not be easy. It requires confronting the inherent challenges involved with pricing—all of which take hard work, commitment, leadership, creativity, innovation, and dedication of resources to continuing education.

 


Exhibit 1: Advantages of Value Pricing

  • Value pricing comports with the laws of economics and consumer psychology, aligning the interests of the firm with those of the client.
  • It manages, clarifies and offers the firm the ability to exceed the client’s expectations.
  • It prequalifies the client to ensure they are a good fit for the firm.
  • It provides the opportunity to cross-sell additional services.
  • It allows you to gain “ego investment” from the client.
  • It improves communication.
  • It projects confidence and experience, as opposed to being unable to inform the client upfront of a price as with hourly billing; or offering a range of prices, which is done more for the benefit of the firm than the client.
  • It increases a client’s switching costs, increasing their loyalty and long-term profitability.
  • It forces the firm to be effective in project management and to get the work done within the time promised to the client.
  • It overcomes the client’s pricing emotions and maximizes the firm’s price leverage.
  • It incentivizes the client to complain—through triggering the service guarantee—giving the firm a second chance to win back the client, and prevents similar problems from happening with other clients in the future.
  • Fixed-price agreement (FPA) prices can be increased each year, even if there are no changes in services. It is much easier to increase the price of a customized FPA rather than increasing your hourly rate by $10 per hour.
  • It provides a competitive differentiation for your firm when you offer clients certainty in price and less risk of dealing with you.
  • It specifies conditions for change orders that are usually value-added services that can command a premium price.
  • It uses price bundling, allowing the client to focus on the totality of the firm’s value proposition rather than the price of each service.

 

 

VALUE PRICING VS. VALUE BILLING

Value is defined in economic terms as: The maximum amount that a consumer would be willing to pay for an item. Therefore, value pricing can be defined as the maximum amount a given client is willing to pay for a particular service, before the work begins. This is not to suggest we can capture 100% of maximum value, but rather that we have the potential to access some of it with strategic pricing. (Also see "Price Psychology".)

 

This definition contradicts the popular term value billing. The difference is value pricing is always done before the work begins, whereas value billing is usually marking up—or more frequently, marking down—the invoice to the client after the work has been performed.

 

A cardinal rule on behalf of clients in firms that value price is: no surprises. Just as no auto mechanic performs work not pre-authorized by the customer, these firms only provide services after price, payment terms and scope have been predetermined and agreed to by the client. This creates a better client experience, with fewer write-downs and write-offs, lower collection and financing costs, and greater client loyalty—not to mention superior profitability for the firm.

 

TRANSITIONING FROM HOURLY BILLING TO VALUE PRICING

Not all pricers in a CPA firm are created equal. Firms should establish a pricing council and appoint a chief value officer (CVO) in order to centralize the pricing function and make it a core competency within the organization. Pricing is too important to the profitability and health of a firm to accept anything less than excellence in this vitally important skill.

 

If you diagram hourly billing, a form of cost-plus pricing, it would look like this:

 

Service  Cost  Price  Value  Client

 

Value pricing inverts the above chain by recognizing the economic fact that the client is the ultimate arbiter of value:

 

Client  Value  Price  Cost  Service

 

Thus, value pricing turns the order of cost-plus pricing inside out. Goods and services do not magically become more valuable as they move through the factory and have costs allocated to them by cost accountants. Firms that value price do not ask, “What prices do we need to cover our costs and earn a profit?” Rather, they ask, “What costs can we afford to incur on this project given the price obtainable from the client and still earn an adequate profit?” Costs in a CPA firm are largely fixed, but pricing is a policy. In most CPA firms, services are priced based on the costs incurred and not the value created. These firms have ample data on their costs, hours, activities, efforts and other inputs, but a paucity of information on the value they create for clients.

 

In firms that use value pricing, costs only determine if a service should be provided, and in what quantities. Costs do not play a role in determining external value to the customer, or setting prices (except as a minimum).Value pricing reverses what is now an artificial ceiling on firm income, inverting the ceiling into a floor.

 

THE EIGHT STEPS REQUIRED FOR PRICING ON PURPOSE

Follow these eight steps on every major engagement, and your firm will be on its way to pricing on purpose:

 

STEP 1

Have a conversation with your client to determine their needs and wants in the forthcoming year. Ask them the questions in Exhibit 2 (below). 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 pricing council attends this meeting, especially if the partner is not a member of the pricing council, or is uncomfortable with pricing.

 


Exhibit 2: Questions to Ask the Client

  • What do you expect from us, and how do you see us helping you address 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 us to provide?
  • 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 enjoy about your former firm? What did you not like about your former firm that you do not want us to repeat?
  • Are you concerned about any of your asset, liability or income statement accounts to which we should pay particularly close attention?
  • 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?
  • What is your budget for this type of service?


 

STEP 2

The information gleaned from Step 1 is then presented to the pricing council, where three options, at three levels of service, are established. For example, American Express’ Green, Gold and Platinum cards vary in price based upon the value and services they deliver. Firms should offer clients options, not a take-it-or-leave-it single price. This allows the client to convince himself or herself of value. It also reveals the client’s individual price sensitivity, which the firm can use in future pricing. It helps the firm answer the question: Did we leave money on the table? If there isn’t trepidation about the price, then the prices may be too low.

 

STEP 3

The pricing council then goes through the 20 questions to ask before establishing a price (see Exhibit 3 below). Based upon the answers, the council then conjectures three internal prices for each level of service, based upon their assessment of the client’s subjective value and price sensitivity. In tough economic times, this three-tier pricing model is a great opportunity for firms to offer less expensive options for struggling clients. When times get better, many clients will often choose to upgrade their services.

  1. Reservation price. Below this price, the firm would turn down the work. It must get this price. It will generate a normal profit.
  2. Hope for price. A firm should get this price more often than not. It will generate a supernormal profit.
  3. 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:

 

Reservation  

Hope For  

Pump Fist

Platinum

$C

$B

$A

Gold

$N

$M

$L

Green

$Z

$Y

$X

 

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 client). The upper bound of these prices should be based upon the value being created, yet all will be lower than that value to ensure the client earns more value than the price they paid.

 

For example, if you know the client is highly price sensitive, you may only present the reservation price for all three options. However, if there are some services that are adding 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, but the more the pricing council does it, the better the members will get, since pricing is also a skill.

 

Firms that use this model report that it makes a firm “compete with itself.” To receive a pump fist price, the firm must conjure up ways to add extraordinary value. This is a worthwhile thought experiment that focuses on value, not time.

 

Many people ask how to ascertain value since it’s subjective and there’s no formula. The answer is with a deep understanding of your client’s value drivers, which requires a deep conversation with the client.

 


Exhibit 3: 20 Questions the Pricing Council Should Ask Itself Before Establishing a Price

  1. What is the client’s cost of not solving this problem in dollars?
  2. What is the economic benefit to the client if they solve the problem?
  3. With whom on the organizational chart are we dealing?
  4. Who referred this customer to us? Why were we referred in the first place?
  5. 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?
  6. Who’s paying for the service? Are they spending other people’s money?
  7. Do we have any competitors? If so, who?
  8. What price information do we have about these competitors?
  9. How profitable is the client’s company? How long have they been in business?
  10. Have they engaged with someone else prior to us to do similar work? Who was the prior firm, and why are they changing?
  11. How sophisticated is the client?
  12. Does the client add to the firm’s skills or markets?
  13. Do we like this client?
  14. How do we help reduce the client’s risk?
  15. At what price would this be so expensive the client would not consider buying it?
  16. At what price would this be expensive, but the client would most likely still buy it?
  17. At what price does this become inexpensive?
  18. At what price does this become so inexpensive the client would question its value?
  19. What price would be the most acceptable price to pay?
  20. 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?

 

 

STEP 4

Present the options to the client. A member of the pricing council should attend this presentation, especially if the partner in charge is not a member of the pricing council or is uncomfortable discussing price.

 

STEP 5

The option selected by the client is then codified into a fixed-price agreement (FPA). The firm can include as much detail as required as to the scope of work, client responsibility to provide information, timelines for delivery of work, etc.

 

STEP 6

The firm would perform adequate project management on the scope of work, detailing who will perform the work, timelines for delivery to the client, and other planning details.

 

STEP 7

If the firm finds scope creep while performing the work, the client 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.

 

STEP 8

The U.S. Army has a policy of performing 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 benefits for firms, especially as it relates to the roles of the CVO and pricing council, helping them evolve pricing into a core competency.

 

CONCLUSION

There is nobility in earning what you are worth. Yet if a firm’s leaders do not think it creates more value for its clients than is reflected by hourly billing, clients may never understand a value proposition beyond hourly rates.

 

Hourly billing is a risk-averse and simplistic tradition that has been taught for multiple generations. Your firm will be unable to adopt value pricing if it continues to denominate everything in hours, thus remaining mired in the mentality that you sell time.

 

Now is the time to change your conversations with clients from hours to value.

 

Do this upfront, before you begin any work. Appoint a CVO and establish a pricing council—a group of intellectually curious leaders who will become, over time, experts in creating and capturing value.

 

Your firm will become obsessed with value. Your clients will appreciate it, and they will not bother asking about hours. I guarantee it. Make your firm one of the pioneers that is blazing the trail for others by burying the billable hour and pricing on purpose.

 

Web-Exclusive Exhibits:

Exhibit 4: Disadvantages of Hourly Billing

Exhibit 5: The Five Cs of Value

Exhibit 6: Pricing Council and CVO Purpose and Criteria

Exhibit 7: Sample Fixed-Price Agreement

Exhibit 8: Explaining the Sample Fixed-Price Agreement

Exhibit 9: Sample Change Order

Exhibit 10: After Action Review

Exhibit 11: A Lesson in Value Pricing Ice Cream: From an Accountant

 

 


EXECUTIVE SUMMARY

 

  Change the pricing culture in your firm from one that “sells time” to a value pricing firm that prices services according to the external value created for the client rather than the internal costs incurred to generate the services.

 

  Value pricing means the maximum amount a given client is willing to pay for a particular service before the CPA begins the work.

 

  Value pricing creates a better overall client experience because it improves communication between the firm and the client, offers certainty in pricing, and creates a service guarantee that allows the firm the chance to win back the client in the event of a problem.

 

  To transition from hourly billing to value pricing establish a pricing council in your firm to centralize the pricing function and make it a core competency within the organization.

 

Ronald J. Baker is the founder of VeraSage Institute. His e-mail address is ron@verasage.com.

 

 


AICPA RESOURCES

JofA article

The Firm of the Future,” Nov. 08, page 68

 

Publications

  • Bill What You’re Worth (#090479)
  • The Firm of the Future: A Guide for Accountants, Lawyers, and Other Professional Services, by Paul Dunn and Ronald J. Baker, John Wiley & Sons Inc., 2003 (#WI264245P0300D)

 

Webcast

“Bill Reeb’s Trusted Business Advisor Webcast: Pricing Your Advisory Work and Engagement Tips” (#TBA90729)

 

For more information or to place an order, go to www.cpa2biz.com or call the Institute at 888-777-7077.

 

Private Companies Practice Section

The Private Companies Practice Section (PCPS) is a voluntary firm membership section for CPAs that provides member firms with targeted practice management tools and resources, as well as a strong, collective voice within the CPA profession. Visit the PCPS Firm Practice Center at www.aicpa.org/PCPS. The PCPS Pricing Your Services page has related archived Web forums, articles and publications at pcps.aicpa.org/Resources/Fee+Pressure+Pricing.

 

 

OTHER RESOURCES

  • The Strategy and Tactics of Pricing: A Guide to Growing More Profitably, 4th edition, Thomas T. Nagle and John E. Hogan, Prentice-Hall, 2006
  • Pricing on Purpose: Creating and Capturing Value, Ronald J. Baker, John Wiley & Sons Inc., 2006
  • Measure What Matters to Customers: Using Key Predictive Indicators, Ronald J. Baker, John Wiley & Sons Inc., 2006
  • Mind Over Matter: Why Intellectual Capital is the Chief Source of Wealth, Ronald J. Baker, John Wiley & Sons Inc., 2007
  • Burying the Billable Hour, Ronald J. Baker, The Association of Chartered Certified Accountants, 2001. Visit www.verasage.com to download a free PDF copy.

 

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