Monday, January 29, 2007

Understanding the Subtleties: Fixed Pricing That Works & Fixed Pricing That Wont!

This post is to respond to a fellow practitioner who spent the time to write me an email asking about the finer point of fixed pricing. Here, I will explain how to execute on a fixed price model that will result in profits and explain the common flaws in establishing a fixed price.

ABC's of Profitable Fixed Pricing
1) Price based on VALUE TO THE CLIENT (NOT Value of the Deal)
2) Clearly Define the SCOPE of the engagement
3) Constantly manage SCOPE, and issue a change order if deal is outside the SCOPE
4) Set client expectations up front, communicate regularly, manage expectations throughout

To put these in context, I will first respond to the questions from the practitioner (thanks for allowing me to post them, BTW): The Practitioner Wrote me:

I gather that you do not have pre-determined flat fees that are one-size-fits-all, even if the work being done does not differ for different clients. This might be where I have made some mistakes although I do often base my fees on what I perceive to be the "value of the deal".

Answer: Right! one size DOES NOT fit all. It is a big misconception that fixed-pricing is the same as MENU PRICING. While menu pricing is a form of fixed pricing (low end work is sometimes done on a menu basis). the pricing theory Exemplar uses is Value Pricing, which is a fixed price that is based on the value of the transaction to the CUSTOMER. (Yes - determining perceived value is an art, not a science, so learn to think value value value. Your clients will thank you for giving a hoot!)

Practitioner Continued:
How much time is going to be spent at the negotiation stage of doing one of these deals is very unpredictable. How do you deal with a contingency like that? I have tried setting fees in stages -- for example, $X for review of the agreement and consultation with the client. An additional $X for preparation of mark-up, "first round negotiations" and consultation with the client. And so on. I try to price these up front and then give the option of one all-in fee which is less than the client would ultimately pay if he/she ended up purchasing everything in the smorgasbord approach.

Answer: Great Question! Time is unpredictable. First, it is less unpredictable if you manage scope. Assuming you did and time is still unpredictable, SO WHAT??????? Are you running your business to make a lot of money or are you running your business to have a consistent effective hourly rate? The point is that we run our business to be profitable. We DO NOT COUNT TIME, let alone bill for it. Why? Because at the end of the day all that matters is that our business is increasingly profitable and that we continue to take steps to increase profitability. If we ran our business to make sure that every hour spent had the same profit margin (effective rate) then we would be LESS profitable. So, if it is between $10Mil in profit or $8Mil and perfectly consistent margins on every 6-minute increment, which would you choose? (Thanks for letting me pick on you. . . now to my next point)

STAGING: Great! Staging is a good thing. If you are just starting to implement a fixed pricing model, staging a deal is a good way to go. Your all-inclusive option at a discount is counter-intuitive!! You say that you offer a discount for the one-price option? Why? If I were a client and you asked me what I would value more, COMPLETE CERTAINTY, or fixed pricing in stages, I would say COMPLETE CERTAINTY without question. I would pay a premium for peace of mind, wouldn't you? (Don't get me wrong, I know why you do it.. . . . there are compelling psychological factors at play in fixed-pricing). Here, your interests are aligned. The client attributes more value to the all-inclusive fixed price and you undertake more risk include everything, so you ought to be charging more.

NOW: I would like to address some common mistakes professionals make when implementing a fixed-price model OR common (yet unfounded) fears!

1) Pricing based on the value of the deal
Yes, you read that correctly. Remember, Value pricing is all about and only about delivering value to the client. So, while the value of the deal may be a relevant factor in determining the value you can add, it does not mean that the client values your services in direct proportion. Depending on the client, their needs, risk profile, cash flows, and time sensitivity the client may value your services substantially more or less than you think. There is only one right way to approach value pricing: Price it based on perceived value to the client.

TIP: You are NOT a commodity! The whole point of Exemplar's innovative approach is to CREATE VALUE by leveraging our unique talents, skills, and diversity as a firm . . . ultimately offering a product/service to the customer that cannot be obtained at any cost somewhere else! So, always ask yourself "How can I create value?"

2) Menu Pricing
This will only work if you want to be a low-cost provider. If so, enjoy the lack of intellectual challenge, low margins, and the feeling of fungibility! While you are commoditizing yourself, you might as well welcome customers by saying "Welcome to McDonald's, can I help you?" After a year of hard work, maybe you'll get a McRaise!

3) There is no way to fixed-price a litigation!
Really? What do you think this profession did for the 1,950 years before we starting billing by the hour? (Hourly billing started in the 50s). Do you think we all threw our hands up in the air and decided to just settle everything? The funny thing about this is that everyone who says it cannot be done have never even tried. Most do not want to spend non-billable time even thinking about how it could work! Those who have lost their shirt have done so not because of a problem with the model, but because they had NO CONCEPT of what it means to manage SCOPE or price on the VALUE to the client. If you don't want to do it right, don't do it at all! If you don't want to learn it, don't try it! Go read Ron Baker's book on Value Pricing for Professionals. "Take one of these and call me in the morning" and then you will begin to scratch the surface of what value pricing really is. (FUN FACT: Ron's book is awesome. How much more in production cost do you think it cost his to make that soft-covered book compared to others on Amazon? How much more TIME do you think it took the printer to print the darned thing? YEAH! NOT MUCH! That son of a gun VALUE PRICED the book!!! It is $149. I still bought it because I valued it. It was great and I did not regret it for a minute Are you beginning to get it? I think Ron and I will set up a bunch of vending machines in the dessert selling bottled water at $50/bottle.

4) Pricing based on an estimate of time multiplied by your hourly rate. I must say, this is just about the worse form of fixed pricing out there and is really only done by professionals who are too clueless to figure out how to do it right. It is no wonder why most people that do this get burned. Here are the most obvious reasons:

-- Clients are not stupid. They never wanted to buy your time to begin with. Do you think that if you put it in a can with a bow on it (and overprice it to be safe) that clients will want to buy it? If your clients are that dumb then they are dangerous. If you are crazy enough to think that's what they want then you deserve to lose your shirt! (Shirt-loss seems to be a theme in this blog)
-- The whole point of fixed pricing is to be able to add value with non-time-dependent value adds, such as additional skills/services, creative thinking, strategy, stress balls, etc!. Basing your price on time deprives you of the opportunity to get paid for adding value.
-- Now you are shifting the risk to yourself (of the project taking more time) and not reaping any reward. You already cap your profit margins by charging by the hour and now you are putting that at risk by "estimating" wrong. What are you thinking? Rather: Are you thinking??

Oooops, I just got a call from my publisher who told me that if I write any more it will be as long as a book. This only scratches the surface, but should provide some good guideposts for fixed pricing. Remember to practice your ABCs until next time:

1) Price based on VALUE TO THE CLIENT
2) Clearly Define the SCOPE of the engagement
3) Constantly manage SCOPE, and issue a change order if deal is outside the SCOPE
4) Set client expectations up front, communicate regularly, manage expectations throughout

1 comment:

Steve said...

Thanks for the passionate post Chris! Why don't you say what you think! :0) Just kidding. This was very helpful. Especially since I am the poster child for what NOT to do in setting a fixed fee. However--I am willing to change. I would be interested in knowing more about how you determine the value to a particular client. Thanks again. Steve