A growing number of industry pricing experts are urging CPA firms to jettison the venerable billable hour and replace it with a fixed-pricing model, or even the more optimal model of “value pricing.” Few public accounting topics spark as much controversy as this one. Many firms have adopted value pricing in recent years, but others have been reluctant to do so. To give our members additional insight into this important topic, we sat down for a series of Q&A sessions with author and consultant Ron Baker, an unabashed value-pricing champion. These conversations give readers an in-depth look at the reasons a firm should consider switching to value pricing, and the nuts and bolts of how a switch might work. The following Q&A session, the second in the series, focuses on the ways firms can set prices and evaluate performance when using value pricing. The first item in the series, “Should You Dump the Billable Hour?” is available here.
What method do you suggest firms use when implementing value pricing?
Baker: The method I recommend is price-led costing, where a firm determines the value that it’s able to create based on the outcome that it’s able to provide for the customer. And it’s actually the value that determines the price, and then it’s the price that determines the cost. That’s why it’s called price-led costing because the price leads the cost, not the other way around, as in hourly billing where the cost is actually generating the price.
For example, if you diagram hourly billing, a form of cost-plus pricing, it would look like this:
Service → Cost → Price → Value → Customer
Now, look at how value pricing inverts the above chain by recognizing the economic fact that it is the customer who is the ultimate arbiter of value:
Customer → Value → Price → Cost → Service
I also suggest that firms establish a value council led by a chief value officer—a CVO—that sets prices. And I recommend that they adopt a policy of set price agreements that allows for change requests and change orders. That way, if something unexpected comes up and the scope of a job increases, the firm can send the client a change request detailing the changes and asking that the terms of their agreement be altered. If the client agrees to the request, then it becomes a change order.
What are the advantages to having a value council?
Baker: The value council turns pricing over to people who are going to be good at it and who enjoy it. Some CPAs get very excited about the topic of pricing. And there are others who hate it. I’ve encountered many CPAs who say, “I’m so glad we have a value council because now I don’t have to worry about pricing.” It also forms a kind of SWAT team in the firm. They assemble when they’re needed to set prices for a client. They are also an educational arm because they disseminate the after-action review records (I’ll have more to say about after-action reviews when we discuss measuring performance) and they celebrate successes.
Could a sole practitioner use the value council approach to pricing?
Baker: If you don’t have team members who can be your value council, find someone from outside to be your brain trust, such as your business mentor or your spouse. The theory behind this is that none of us are good at pricing ourselves. This is why authors and actors have agents. They don’t hire these people so they can give 15% of their revenue away to them. They hire these people because these people can negotiate better prices for them than they can do on their own. Most pricing mistakes happen because we underprice. We all need to be supported by somebody when it comes to pricing, someone who can say, “No, I’m not going to let you give yourself away.”
What characteristics should a CVO have?
Baker: Based on my experience with sitting CVOs in action, I’ve come up with an acronym called LACEY. The L stands for leadership: not necessarily a leadership position, but credibility within the firm and the ability to attract followers. The A stands for attitude: they have to have an attitude of abundance when it comes to pricing. They have to understand that you’re not ripping off the customer when you increase the price; if anything, it reflects the fact that you’ve increased the value and the profit to the customer. They also need to have the attitude that they’re there to protect the firm’s brand integrity and price integrity. And the C in LACEY stands for commitment. These people are committed to the pricing function. They’re committed to turning it into a core competency which means when they fail—and they will—they’ll learn from their mistakes. The E in LACEY stands for experimentation. They have to be willing to experiment, try new things, not be tied to any one dogmatic approach. And then the Y in LACEY—and this may be the most controversial one—is youth. I believe you need some young people on the value council who aren’t as tied to the religion of the billable hour as some of their older peers.
You believe that time sheets are a poor metric for judging performance. Why?
Baker: I do not believe time sheets predict the success of a CPA. A CPA could come up to you and say, “I billed 2,500 hours last year.” Are you going to automatically say that they are a great CPA? Does that tell you anything about their customer service attitude, their professionalism, their ability to mentor, or their personal skills and communication skills? All of these things have nothing to do with the time sheet, and yet it’s the one metric that we rely on so much.
What are some ways firms can measure performance without using time sheets?
Baker: One way is by using key predictive indicators, or KPIs. And one of my three favorite KPIs is turnaround time: When did we promise something to the customer, and when did we deliver? What I like about turnaround time is it’s something you can measure firmwide. Every time you assign a knowledge worker such as a CPA a task, even if it’s just auditing cash, you can put a deadline on it. You can track the percentage of work completed on time, and, that way you tend to spot problems a lot sooner than you can by looking at a time sheet after the fact.
Another favorite KPI of mine is the value gap. You make a list all of your clients, how much revenue you’re generating from each one, and how much you could be generating. There will be a gap between the potential and actual earnings. And then the question is how you close that gap in the coming period.
We’ve actually seen some firms work value gap into their partner compensation. That gets partners thinking up more ways to create value. They might think, “I know this client needs estate planning, so I’m going to set up a meeting with him and our estate planning expert.” Value gap is a very outward-focused KPI that we have seen drive more value creation for the customer and hence more pricing opportunities.
The third KPI I really like is high satisfaction days, or HSDs. It’s actually a term trademarked by the New Level Group out here in Napa, California. They said, “Why don’t we track the days that we have where you just pump your fist in the air and go, ‘Yes! This is why I became a CPA.’ ” All sorts of things can generate an HSD. Maybe you have a big break on a customer, or maybe you had a no-change audit with the IRS, or maybe a customer came in and gave you a gift or hugged you because you helped them through a difficult period. New Level first tracked HSDs with a computer application called a widget. When anyone had an HSD for whatever reason, they’d type in a couple of sentences about it, and the widget would ping everybody’s desktop. Now, as you can imagine, social media makes HSDs much easier to track.
I do believe HSDs are predictive. The CEO of the New Level Group learned three things from tracking HSDs, and the first was that the more HSDs he saw in a given period of time, the higher the morale of his team was. The second thing he learned was it’s a concrete way to measure that the firm was meeting its purpose—that it was walking its talk. And what’s most fascinating to me was that the more HSDs he saw in a given month, the higher next quarter’s profit was.
What are after-action reviews? Can you describe what they look like for CPAs and why some firms use them?
Baker: The after-action review, or AAR, was developed by the United States Army in the post-Vietnam War period. It consists of four simple questions you ask yourself after you complete a task. The first question is, “What was supposed to happen?” In other words, what were the objectives of this mission? What’s funny is that a lot of times people are very unclear on what the objectives were. And, if that’s the case, you’ve got a problem.
And then the second question is, “What actually happened?” There’s typically a gap between what you wanted to happen and what actually did. What positive and negative things came about because of this gap? And then the last questions are, “What have we learned?” and “What are we going to do better next time?” So, each time a new project or task comes up, you read through the AARs that relate to it, and what you learn will make you more efficient and effective the next time around.
If firms had a database of AARs that they were able to access for different projects, how much more effective would they be in getting new people up to speed, in transmitting knowledge that they have throughout the firm? Let’s face it, a lot of what goes on in professional firms is the reinvention of the wheel, because we’re not learning from our mistakes and our successes. And so the AAR is a way to disseminate that knowledge.
—Courtney L. Vien is an associate editor at the AICPA.