Sunday, May 06, 2007

Pricing Misconception #2: The Difference Between Cost-Based Pricing and Price-Lead Costing

In this post I would like to talk about another big misconception that many attorneys have about using a fixed-priced model. The largest one has to do with understanding how, exactly, we arrive at a price. Many attorneys think that the trick to setting a price has to do with estimating how long it will take to do a job. That is entirely incorrect. There are numerous reasons why this practice will not work:

1) It assumes you know
2) In a multi-person organization it does no consider the differences in costs associated with using different human and other resources
3) It assumes that you cannot get it done faster or achieve the outcome more creatively
4) It is inherently task oriented because you are attempting to estimate the time to complete tasks -- this is backwards because the client is not coming to you to buy "tasks," the client is buying an outcome. You cannot estimate the time of an outcome. . . so STOP TRYING!!
5) Once you estimate time in order to price, you are less likely to be resourceful and think about how you can accomplish the outcome in less time
6) All of this brain twisting is inward-facing. . . it is all about you. . . if you don't charge by the hour then you have to retrain-your-brain to understand that clients really don't care what you do with every hour of your day. They want results.

I could go on forever, but to put it simply these are examples of Cost-Based Pricing. It is a LOSING proposition to price based on cost. The client does NOT CARE how much it costs you to do work. They care how much they VALUE the work you do. I know your ego is already big, so stop thinking about yourself and start thinking about VALUE TO THE CLIENT!

Studies of the most profitable companies in America show that they price based on the value of the good or service to the client, NOT based on cost plus a margin. Anyone who thinks it cannot be done has simply no done their homework. . . . most attorneys do not know how to comprehend value because they spend their entire careers looking inward at how much "time" they take and what "tasks" they do to justify their rates. Value pricing looks only at the client. unlike the most profitable companies who operate on a Value Pricing model (this does not mean cheap, it is the name of the pricing theory), attorneys have the luxury of meeting one-on-one with each customer and ask questions to determine how much it is worth to each of them. With this, attorneys (and accountants) can do a much better job of determining a price based on value than other businesses.

How are we profitable by pricing based on value?

1) We work with the client to define the SCOPE of the work, defined in outcomes NOT in tasks
2) We use project management skills to have the appropriate human resources doing work at the right level

So, If you lose money on a Value-Price model, you are most likely doing so because:
1) You defined the scope too broadly, or your proposal is task-heavy
2) You did not manage the SCOPE and are now doing work that the client did not originally want without getting paid for it!
3) Poor Project Management Skills: This is a huge problem. Now, instead of thinking of yourself as the person who does all of the work, you need to think about how to get it does cost-effectively. Profitability is improved in our model through balancing cost-efficiency with winning results every time.

There are several books written only on the topic of project management so I will not attempt to summarize them in a blog. The point is that there is a lot more to being profitable in a fixed price model than meets the eye. If you are curious how to pull it off, you really need to do your homework. Understand Project Management, delegation, Scoping for outcome, managing scope, and understanding and communicating value. If you understand these you will be well on your way to success in a value-priced model. Give it a try: It will change your life and your clients will thank you!

Questions: Post a comment and we'll discuss!

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