10 Common Pitfalls In Value-Based Pricing

After the invention of the microscope, which made possible the observation of the microorganisms that cause infection, it still took the medical profession almost 150 years to fully embrace germ theory. Sometimes, transformations can take a long time. Fortunately, this change in paradigm eventually produced a shift in practices. For the first time, surgeons started washing their hands, and sterilization practices changed in medical facilities around the world.

The transformation in pricing professional services also starts with a change in paradigm. We don’t sell — neither do our clients buy — time. Our clients buy solutions to business problems, and our practices must reflect that truth. Pricing practices in professional service firms are finally beginning to change. Progressive firms ranging from advertising agencies to law firms are doing many things right. But here, in our experience, are ten potential hazards that deserve our attention.

1. Calling it “value-based pricing.”

The first misjudgment we make is using the term “value-based” when referring to new pricing strategies. The issue with the word “value” is that it has two mutually opposed definitions: “value” as in Wal-Mart versus “value” as in Porsche. Also, many buyers of professional services are suspicious of the word “value” because it sounds mushy and subjective. Much better to use the term “solution-based.” What we’re really referring to is pricing based on the value to the customer — as in customer-based pricing.

Ultimately, we're just moving the professional services business into the world of modern pricing -- pricing as practiced by the rest of the business community. When we use a term like “value-based,” it sounds new and experimental, when actually it's just basic pricing as taught and utilized by all the organizations that are clients of professional service firms.

2. Changing your pricing without also changing your language.

It is said that all revolutions begin with language; all transformations are linguistic. Most professional firms are trapped in the bad habit of using the language of cost instead of the language of value.

At the top of this list is the word “cost,” as in “The cost of this program is …”. The correct term is “price.” Not cost or estimated cost, but “price.” And once we’ve committed to burying the billable hour, we should discontinue any references to hourly rates, utilization rates, time of staff, or estimated time.

3. Confusing value-based with outcome-based.

Many professional firms who endeavor to transform their revenue models are under the impression that “value-based” means “performance-based” — that the goal is to tie compensation directly to outcomes. While outcome-based pricing is a form of value-led pricing, it’s not how new pricing strategies should be defined. The essence of revenue model transformation is to charge for outputs (deliverables), not inputs (hours). The simplest pricing approach is a fixed price for fixed scope (where scope is defined as outputs, not inputs). But beyond that, firms can employ other progressive pricing strategies — what we call a “pricing stack” — including licensing of intellectual property, subscription-based pricing, etc.

4. Selling the same thing with a different price.

The point of progressive pricing strategies isn’t to charge more; it’s to charge differently. By implementing a diversified revenue model, the firm is able to achieve above-average margins. It’s the same principle that guides our personal investments. We build diversified portfolios knowing that a healthy mix of risk and reward results in a healthier year-end return than putting all our money into a single type of investment.

More to the point, we’re trying to move to a model where our clients are billed for what they’re actually buying: solutions, not services. This means reconstructing our offerings as solution sets, not the typical bullet-point lists of competencies and capabilities. The ultimate manifestation of a transformed revenue model is a suite of programs and “products” in place of services and competencies.

5. Pricing from the bottom up instead of the top down.

If you look behind the curtain of some firms who are attempting to move toward solution-based pricing, you’ll find they are still engaged in an old habit: calculating the price from the bottom up based on the cost to the firm instead of pricing from the top down based on the value to the customer. State-of-the-art pricing starts with WTP: Willingness to Pay. The answer to that question defines the price. We still look at cost, but only to determine whether we can deliver the output for the price at a cost that will return a fair profit.

6. Continuing to think of pricing as a finance function.

In most mature businesses, pricing is a function separate from finance. Major companies have a Chief Financial Officer, but they also have a Chief Pricing Officer, based on the acknowledgment that pricing is a skill set entirely separate from accounting.

Because most professional service firms have found themselves mired in cost-based pricing (charging for the cost of time), they mistakenly have regarded “pricing” as a finance function. But as referenced above, most other businesses regard pricing as a top-down process, where the first question is not “What is the cost to the firm?” but rather “What is the value to the customer?”

7. Counting on premium pricing without a premium positioning.

What’s scarce is valuable. If what you do is widely available from other firms, why would you expect your clients to pay your firm more?

Countless professional service firms continue to believe that the way to appeal to more clients is to offer more services; to do more things, in more categories, for more types of clients. This is the “full-service” approach, which is not a strategy but rather the absence of a strategy. No client is looking for a law firm with a “wide range of experience.” Instead, they’re looking for a firm with experience in their particular category, related to their specific problem.

The firms that earn the highest fees are those that know what they stand for; they solve a specific set of problems for a specific kind of client — the opposite of “A full-service firm serving a wide variety of industries.” Don’t confuse narrow with small. Starbucks is narrow (coffee, not a “full-service restaurant”) but they have stores on the street corners of every continent.

8. Offering a single, take-it-or-leave-it price.

When it comes to effective pricing strategy, there’s a foundational practice that almost every major marketer follows. In place of a single choice, we are always provided options. Not a single size of coffee, but small, medium, and large. Not a single cable plan, but premium, enhanced, and essential. Even your local car wash knows the power of options.

We can and should follow the same practice in professional services. Instead of one take-it-or-leave-it price, offer your client a choice of yes’s. In professional pricing circles, this is referred to as value engineering. Behavioral science experts call it choice architecture, based on the principle that buyers need context to make an informed decision about price. Most firms report that offering options has improved their sell-in rate by at least 40%.

9. Believing that new forms of pricing only apply to new clients.

When you center your business around the principles of a solution-based revenue model, you’ll discover that it’s not just a change in pricing strategies, but a holistic change in operations. Which means new pricing practices aren’t just for new business, but for existing clients as well. Eventually the goal is to convert every single one of your business relationships to a compensation model based on the value of outputs or outcomes instead of the cost of inputs. In our experience, even long-term legacy clients can be persuaded of the benefits of solution-based pricing, usually within a timeframe of 18-24 months.

10. Changing how you charge externally without also changing what you track internally.

A modern revenue model changes not just what you list on your invoices, but what you measure and manage inside your firm. The most critical change stems from how “scope” is defined. Scope is no longer related to hours spent but rather work delivered. Project managers are now focused on the percentage of project completion, not estimated versus actual hours. The only thing that matters is delivering what was promised, on time and on budget.

In place of “billability” and utilization, we’re focused on tracking what really matters: measures like revenue per employee, team velocity, marketplace results, and client satisfaction.

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First and foremost, a change in revenue model is a change in thinking. We first change our paradigm, and a change in practices follows. And just like learning a new sport, you’ll get better and better with practice.

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Tim Williams leads Ignition Consulting Group, an international consultancy that advises professional service firms in the areas of business strategy and revenue models. Tim is the author of several books, including "Positioning for Professionals: How Professional Knowledge Firms Can Differentiate Their Way to Success."

X: @TimWilliamsICG