Pricing services for consultancies: why value pricing rarely works.
It’s not about the pricing, pricing, pricing….
There’s a lot of nonsense written about pricing which is based on zero evidence. The general advice from ‘gurus’ appears to be (i) raise your prices (ii) use value-based pricing. As we shall see, this is usually bad advice.
Pricing isn’t that important. Margins are central. Revenue is half the story of margins (along with costs), and pricing is an important part of revenue (along with services and sales). The most important question isn’t ‘what are your prices?’. The most important questions are ‘WHAT you are pricing? and, ‘for WHOM?’. Outstanding pricing strategy in the wrong niche with the wrong clients will always lose a poor-pricing strategy in the right niche with the right clients. Are you in the right niche? How do you know? How good are your clients? How do you know? If you’re in the right niche, with the right clients, then what are you selling? If it’s just time (yours or someone else’s) then that is generally sub-optimal. Your revenue will be much stronger and more predictable if you have recurring, passive revenue based on software, membership networks, video courses, benchmarking or retainers.
Generally, consultancies overestimate the importance of cost to their buyers. Frederiksen et al. (2013: 60) found that more than 50% of sellers say price is among the key drivers in a buyer’s decision, but only 28% of buyers rate price that highly. Even more so, in a survey of over 3,000 client executives, only 6% ranked price the most important factor when buying consulting services – on average, it was the 9th most important attribute. You may say, ‘well I’m sure buyers say that, but….’, however, in my experience, and certainly with those firms who grew successfully, value, innovation, and impact were all rated as more important than price. Indeed, as we will see later, there are good reasons for explicitly not competing on price (unless procurement is involved).
The limits of T&M
So, let’s assume you’re in a good niche, selling to good clients, and have a strong stable of services and products. How do you price your consulting services?
Although time & materials is the most common way of pricing consulting projects, generally it produces sub-optimal revenue:
- Clients don’t like it. They don’t like the uncertainty of not knowing what the final cost would be. Indeed, research shows that clients would actually much prefer a higher fixed price than a variable lower price. There is even a psychological condition for this called the Taxi Meter effect: the anxiety associated with unknown but ever-increasing costs.
- T&M doesn’t maximise your potential revenue as it does not take into the amount the client would pay based upon the value of solving the problem, the presence of competition, and the relationship you have with the client.
- T&M doesn’t encourage you to be efficient or to innovate. If you are being paid a fixed cost, or on the value delivered there is a huge incentive for you to innovate to improve the value to the client or to do things quicker. Without this incentive you are likely to stay doing what you have been doing for some time.
- T&M means you can be easily compared with the competition and commodified. Procurement or the client director can easily say ‘competitor X charges 80% of your day rate, can you match it?
In terms of moving away from time and materials pricing, if a client insists, a good tactic is to offer it but to make it so expensive so to discourage the client, but if they insist, then you do very well out of it anyway.
Gurus often argue that value-based pricing is the ideal solution for the average consultancy or sole-trader.
However, what they fail to note is that value-based pricing is not always suitable, either because it is too hard to measure, the preferences of the client are for something else, or because there are other consultancies who can offer the client better value. Value-based pricing can be useful if success is easily measured, if you are one of the top consultancies in this area, and if the client will allow it. For these reasons, value pricing used in only 15% of consulting projects.
Project & value based pricing
For most consultancies, mastering project based pricing (a variant of fixed pricing) will be superior to any other approach. It has several advantages:
- It is attractive to clients because it is fixed and therefore easier to budget for and associated with less anxiety.
- It encourages the consultancy to increase their margins through innovation and greater efficiency
- It encourages the consultancy to think of services as products which are comparable
- It enables deliverables to be reduced to fit budgets during negotiations
Yet, fixed pricing is a craft which improves with practice. It requires you to go back through previous projects to see what reasonable prices are and then be quite precise about the various deliverables and stages involved with the project. It also means that you need to have silver, gold and platinum options with these so that when a client asks you to reduce prices you can shift the value of the deliverables. This doesn’t mean that the deliverable isn’t done, but, for example, a more junior response is used, training is done at the client’s site instead of off-site, or delivery is virtual instead of face-to-face. Developing a clear view of these options is crucial to well managed project pricing.
In addition, when clients are insistent on the same value for a lower price, it is useful to prepare ‘swaps’: items that you need that can be swapped for price discounts. For example, when a client asks for a ten percent discount, you might reply ‘I can’t do ten percent, but I can do five percent if you’re happy to provide me with a good referral or a place on the preferred supplier list’. The swap can be anything that you would find useful that the client can provide, and you should have these ready in advance in case the negotiation is done live.
An alternative to project or fixed pricing is value pricing, where the fee is related to the financial value of the project (typically between 10-40% depending on the project and clients). However, although this form of pricing is on the rise, it has plateaued at around 15% of projects. This is because for it to work well it requires:
- The value to be unambiguously measured through agreed KPIs
- The value to be measurable in financial terms
- An agreeable client and strong trust levels
- Your consultancy to be the most competitive in terms of value delivered
- A level of skill with both the buyer and the consultant in using this form of pricing
Project and value pricing are skills that are developed with practice, and will allow you to negotiate more effectively, attract more clients, and achieve higher margins. However, strong prices are pointless without partner skills to achieve margins from them. Three things are crucial here: training in pricing and negotiation (too many partners discount excessively in order to win); a detailed understanding of what the project actually costing the firm (so that pricing and negotiation does not hit the big margin contributors), and strong project management skills that ensure costs on the project are minimised.
Finally, I should reiterate that your first focus for strong pricing should always be delivering great client value, which is continuously improved. Whilst you must develop your own strategies to maximise profitability, your direction should be informed by conversations with your client about the best way to incentivise their and your teams to create the best outcomes. The only sustainable pricing strategy is based on your continual increase in the value of your work, and the client’s perception of that. A knowledge system which improves your firm’s expertise, impact, and value, as well as a marketing strategy that is entirely focused on quality and value, will allow you to drive higher prices regardless of how they are calculated and avoid conversations about day rates. This will allow you to create higher margins, to hire and train better staff, to create a virtuous cycle of value. You want to be forever better, not forever cheaper.
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