Why Your Firm Needs to Offer Fixed Prices
VeraSage - 03/30/2006
by Ronald J. Baker, Founder VeraSage Institute
Pricing is the moment of truth––all of marketing comes to focus in the pricing decision.
–Raymond Corey, Industrial Marketing: Cases and Concepts, 1962
In the last article we explained why hourly billing is the incorrect theory of value, and why The Firm of the Future will price its services based upon external value provided, not internal efforts generated. One of the most successful methods adopted to implement Value Pricing is the Fixed Price Agreement (FPA). Essentially, this requires meeting with each of your customers to determine the services they need and want over a given time period.
It is important to keep in mind any FPA drafted between your firm and a customer is the result of a conversation. This is your chance to provide the customer with a customized list of services to meet their specific needs and wants, to offer a fixed price for those services, specify the payment terms, the scope of services to be provided, and any other level of agreement reached. Thus, no two FPAs should look alike––they should be as unique and individual as your customers. The more customized it is, the higher will be its perceived value.
ADVANTAGES OF THE FPA
Pre-qualifies the customer. Discovering the customer’s perception of value––before your firm commits any resources––is a better strategy than finding out after the service has been performed the customer has a lower value perception than you do, no matter how you price your services. Discussing price up-front puts these issues on the table, and in the long run will save countless hours and back-end costs in pricing disputes, write-offs, collection issues, and other problems that could have been avoided had there been better communication at the beginning of the engagement.
Opportunity to cross-sell. By brainstorming with the customer regarding future goals and aspirations, you will inevitably learn of many opportunities to cross-sell your firm’s services. You cannot expect to automatically receive additional work from the customer––you have to earn it, by demonstrating your firm is a better alternative than the competition. Empirical evidence proves with an FPA relationship you will be more successful in obtaining additional work by focusing on value.
Value Pricing gains “ego investment” from the customer. All of us want to be in control; this is basic human nature. By giving customers a sense of ownership over your firm’s services, offering them choices, and customizing your delivery to meet their needs, you will get their “ego investment.” Once people make a commitment, by and large, they will behave in a manner which is consistent with their vow.
Quoting fixed prices projects confidence and experience. Being able to quote a fixed price before the service is performed shows the customer your firm is experienced and confident in its ability to perform, a trait valued by the customer, even if subjectively. Imagine an airline not quoting airfares before the flight, but instead charging by the minute. How would you feel? Would you begin wondering if the pilot will deliberately slow down? Would it lower your confidence in the airline? The argument the profession can’t provide fixed prices, up-front, is specious. Every other business has to do it, and we are subject to the same laws of economics, consumer and price psychology as everybody else. If you cannot quote a price before performing the work, perhaps you don’t know enough about the nature of the work and shouldn’t be doing it in the first place. Change Orders are designed to cover any scope creep, or unforeseen circumstances, which may occur (and will be explored in the next article).
Increases a customer’s switching costs. The more services you perform for the customer, the more you know about a customer, the more expensive it will be for the customer to defect. Creating a partnership with your customer links your destiny and prosperity.
Forces your firm to be effective. By offering fixed prices, you must delegate the work to those in your firm who can perform it most efficaciously, and not let surgeons pierce ears. It also forces you to review every procedure, work review level, etc., and ensure each task adds value to the customer.
Overcomes buyer’s emotions. Price resistance (sticker shock), price anxiety (buyer’s remorse) and payment resistance (not paying the invoice) will all diminish by utilizing FPAs. By discussing value, price and terms up front, you will diminish the negative impact of these emotions on the customer, not to mention your firm’s profitability.
The firm maintains the pricing leverage. A service that is needed is worth more than a service that has been delivered. If this is true––and it is––then why do firms insist on pricing their services after they’ve been delivered? Because they don’t know down to the last six-minute increment how much time is going to be spent. This is precisely the problem with the labor theory of value––since no customer buys hours, they don’t care how much time is spent. They only care about the value provided relative to the price charged. And they want to make that decision before they buy, just like you do when you buy anything as a customer. By pricing your services before you begin, you will obtain a higher price since you are removing the risk of the transaction from the buyer. You will also have the opportunity to educate the customer as to the value you are providing (if they don’t agree with your price) or withdraw from the engagement completely.
Prices can be increased each year. When was the last time you raised your hourly rate? Do you believe there is a concomitant increase in value to any one customer? I can assure you your customers don’t view the world that way. However, when you have customized services and pricing for each customer, it is easier to increase the price annually.
Provides a competitive differentiation. Since each price is customized, the perceived value of your firm increases. In contrast, by using hourly billing, you are simply treating all customers the same, which is not a prescription for success in today’s marketplace. Customers prefer fixed prices, up-front, and will continue to gravitate to those firms willing to offer them.
Obviously this is not an exhaustive list of the advantages of Value Pricing, just some of the most important ones.
FINAL THOUGHTS
Firms around the world have successfully implemented the Fixed Price Agreement and have seen many salutary effects as a result. They are cross-selling more services, obtaining a larger percentage of the customer’s wallet, able to extract a premium price since they are bundling services into one FPA, and offering a service and price guarantee that lowers the customer’s risk even further. Also, they are speeding up accounts receivable collection since the payment terms are agreed to up-front, and many of them are reporting negative WIP in some areas of their practice. Moreover, Change Orders are being utilized to capture the additional wants of the customer, and combined with innovative pricing strategies (such as the “TIP” clause) firms are reporting some windfall profits indeed. One partner I know received a “TIP” of over $1 million for work he would have valued at $180,000 utilizing the outdated hourly billing method. This illustrates the pernicious effects of being mired in the mentality that we sell time.
The future is here, it is just unevenly distributed. The Firm of the Future will offer fixed prices, up-front, for every service it provides, just like every other business. Firm leaders will remove the artificial ceiling they have placed over their firm’s head by the antiquated hourly rate billing method. As a result, they will finally begin to get paid what their customers already believe they
are worth.
© Ronald J. Baker 2004
This is Part II of a four part series on The Firm of the Future. Next month, Ron will provide some ideas on implementing Change Orders and other innovative pricing strategies.