Your Firm Should Establish a Pricing Cartel
VeraSage - 03/30/2006
By Ronald J. Baker
The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgment with which it is anywhere directed, or applied, seem to have been the effects of the division of labour.
––Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776
Despite present-day management gurus who claim to have discovered the concept of core competency, in reality it is a very old principle. Adam Smith’s famous example illustrated how a pin factory could produce up to forty-eight thousand pins in a day if it divided and specialized the labor in such a way as to assign a particular task to each worker, whereas perhaps not one pin a day could be manufactured if each person made a whole one on their own.
Smith demonstrated that the division and specialization of labor was a central cause of the wealth of nations; it is also the central cause of the success of a business. Not everyone can be good at everything.
Despite this knowledge, many CPA firm partners behave as if the firm is a household, where all of the chores have to be divided equally. Take a prime example: Pricing. It seems just because you are a partner you are responsible for pricing your engagements.
But ask yourself if a pilot of a commercial airliner also sets the airfares? Do the plant managers in General Motors set the sticker price of the cars they make? The answer, of course, is negative. Pricing is considered a function in the business world, delegated to an individual (or group) within the company who are responsible—and have final authority—for it.
Nonetheless, I have yet to encounter a CPA firm where the partners do not all believe they are quite competent at pricing, even though the evidence is overwhelming this is not the case. Furthermore, everyone in the firm already knows who the best and weakest pricers are, yet every partner is responsible for the function. This is not pricing on purpose, and it is a serious violation of the division and specialization of labor, not to mention a barrier to firm profitability. In golf, the lesser skilled players receive a handicap; with respect to poor performing pricers, the handicap is less profit in every partner’s pocket.
Pricing is far too important to the viability of the firm to be left to mediocre pricers. No other area—not cost-cutting, productivity increases, or rainmaking—can have as large an impact on profitability as does pricing. It is time for firms to recognize that if they are serious about pricing commensurate with the value they create they need to establish a core group of enthusiastic pricing students in order to make pricing a core competency within the firm.
Many partners will argue they already do this, by, for instance, discussing pricing amongst each other and bouncing different pricing scenarios off of one another. That is not enough—it is too informal and ad hoc. Successful businesses do not price in such manner. Pricing needs to become a function within the firm, delegated to a cartel who will develop an intellectual capital base of skills in this vitally important area, and act in the interest of the entire firm, not just each partner’s individual book of business.
Establishing the Cartel
Obviously we are not suggesting the firm organize a real cartel with other firms in order to set prices, which would be illegal. What we are suggesting is an internal cartel—often called a pricing committee, team, council, or board—that will have final authority to set prices in order to maximize profits for the entire firm, while also acting as an educational unit and resource in order to assist all members in capturing prices commensurate with value.
We recommend a group of between four, with no more than six, self-identified individuals who have demonstrated a competence in creating value for the firm’s clients, and capturing that value accordingly through price. It should not consist of all partners, but should have some managers and team members in order to spread the competency throughout all levels of the firm. Some firms have made one-half of the positions rotate, perhaps on a two or three year basis in order to bring in new blood and a new perspective.
The final determination of the committee’s membership should be made by the managing partner, who should begin by asking for volunteers, thereby self-identifying those team members with an interest in the art of pricing (volunteers not selected may be eligible for future terms).
We have seen two reactions from this selection process: relief and frustration.
Recognizing they are not the most aggressive pricers, they feel better knowing a committee will now assist them in setting a proper price. The other reaction is more difficult, as some partners will inevitably believe they should be on the committee but were passed over. We have witnessed the emotional reaction this creates, and it is not a pleasant spectacle.
Here is my response to those who whine and pout over not being chosen: Grow up. This is a business, not a household, and only those with demonstrable skills should be allowed to price, for the benefit of the entire partner group. This is a not a popularity contest, it is a skill set, and responsibility and final authority should be given to excellence, not status or seniority. It is the leader’s job to put individuals in positions that accentuate their strengths, not their weaknesses. NFL coaches are masters at this, and a firm’s leader should be as well.
Imagine when Jack Welch was CEO of General Electric and announced his Six Sigma initiative as a corporate-wide goal. If anyone on his executive team—or any other manager—thought it was a bad idea, what do you think his or her choices would have been? To ask the question is to answer it. Margaret Thatcher is fond of saying “Consensus is the negation of leadership,” and she is right. Leadership demands tough choices, and sometimes individuals have to be sacrificed for the good of the firm.
The Cartel’s Mission
Examples of mission statements for the pricing cartel are:
- To ensure [firm name] Prices on Purpose, according to the value received by the customer, not the hours spent.
- To make Pricing for Value a core competency within [firm name].
- To change the marketing culture within [firm name] to one that comprehends, creates, communicates, convinces, and captures the value of the services we provide to our customers.
Similar to a SWAT team—or the Green Berets—the cartel would meet as needed in order to assist firm members in setting prices above some specified minimum (routine work need not be submitted to the cartel, but it should be responsible for setting minimum firm-wide prices). Since the team would see pricing from a firm-wide perspective, they are in the best position to ensure that work is not priced below value. This may require someone from the committee to assist in the sales process with partners who may not be up to speed in pricing for value.
It will also slow the process of quoting prices, and although most partners treat this as a disadvantage, it is in fact an enormous advantage. Here’s why: the sooner the firm quotes a price, the lower it will be. Why? Because most likely you have not given enough thought, creativity, and innovation to the value proposition being offered to the customer. It is much better to step back and have four or six minds comes together to make sure the firm is offering the maximum value to the customer, and pricing accordingly. The pricing cartel will be obsessed with value, which is exactly where the focus needs to be when it comes to marketing—externally on customer value, not internally on process, labor hours, and costs.
The Cartel’s Functions
Establishing minimum prices for tax work, accounting, auditing, consulting, etc. A growing firm needs to set a cut-off price for all new customers, recognizing it should not take all comers. One of the most effective ways to pre-qualify low value customers is through minimum prices. These are, of course, increased annually.
Pareto Analysis and Grading Customers.
Baker’s Law: Bad customers drive out good ones.
Twenty percent of your customers generate eighty percent of your revenues. Should the firm “outplace” some of its customers in order to focus on providing more value-added services to better customers who are less price-sensitive and more valuable to the firm?
Develop the firm’s standard Fixed Price Agreement and Change Order. With a pricing cartel, all work is priced before it is done, period, just like every other business (would you fly on an airline that charged you $4 per minute?). A team member is not allowed to do anything on behalf of a customer without a signed FPA or Change Order. This ensures the firm is pricing when it has the leverage, and the customer will never be surprised by an invoice from the firm. It also eliminates write-downs and write-offs. When do you want to learn the customer doesn’t like your price, before or after you do the work?
Establish the firm’s 100% money back guarantee. Why should your customers bet on you if you won’t? Offer an unconditional service guarantee to all customers, thereby gaining a competitive differentiation, and an opportunity to command premium prices. You do this already, why not get some marketing advantage from it?
Select Key Performance Indicators for pricing. What percentage of FPAs are written above the firm’s minimum price; what percentage are rejected; track the percentage of reservation, hope-for and pump-fist prices the firm realizes on each engagement; how many Change Orders is the firm capturing. These KPIs go a long way to change the focus of the firm from internal processes and efforts to external results and value.
Post-mortem analysis. Every engagement under the authority of the cartel needs to be reviewed once the engagement is finished in order to assess what was learned, how adequate was the price, what was the value created, and how could the firm have priced it better. This process will, over time, build an intellectual capital base of skills that will turn pricing into a core competency.
Continuous teaching. Like the Green Berets, the pricing cartel is not just an effective group of pricing warriors; it is also a teaching organization, responsible for reading books, articles and other information on the art of pricing. Further, it continuously teaches every team member the importance of pricing for value. Tiger Wood’s father, Earl Woods, was a Green Beret. Witness the effect on Tiger’s self-esteem and commitment to excellence. Since pricing is a self-esteem issue—you have to believe you are worth it before your customer will—this is a trait the cartel can enhance by achieving pricing excellence and sharing success stories throughout the firm.
Not Final Thoughts
All partners have heard pricing objections from their customers, it is to be expected. After all, it is the customer’s job to push down prices. That said, it is the firm’s job to push back, and that is done most effectively by focusing on value, not capitulating on price. At the present time, it seems the only competency most firms have with respect to prices is lowering them.
The pricing cartel will be the group responsible for keeping the firm obsessed with value and wealth creation for the firm’s customers—the main purpose of any business. It is a group of professionals who see pricing as an enormous opportunity, not a limitation. It is a group that will force the firm to work smarter, not harder, since pricing is the single largest driver of profitability in a CPA firm. Like the division and specialization of labor, it is an old idea whose time has come.