Wednesday, November 14, 2007

The Difference Between Value Pricing and Price Gouging: The Difference Between Apples and Oranges!

I find it rather interesting how many professionals confront the possibility of adopting a new pricing model. I find that many professionals make simple-minded mistakes when evaluating alternative models as if they are looking for reasons to rationalize why it won't work rather than actually using their BRAINS to think about how it DOES work. for instance, value pricing is based on the subjective theory of value, an economic theory which requires study and understanding. It is not one that is readily comparable to a cost-plus pricing model on a dollar for dollar basis. Many professionals have lost before they have begun when their limited thinking and binary analysis paralyzes intellectual curiosity at the expense of our great profession. Let me give you an example:

Most attorneys ask the following question: "Well. . . if value pricing is so great, tell me. . . does it end up costing the client more money or less money under that pricing model than it does under the billable hour?

The question itself demonstrates a dangerous level of ignorance about what Value Pricing really is about. The answer is BOTH. The problem with the question is that it does not seek understanding, but it is rather a trap door. You see, the professional is asking a question with only 2 acceptable answers already knowing how to rationalize the dismissal of the pricing theory NO MATTER THE RESPONSE. For instance:

LOWER: If I said it was lower the professional would dismiss the practice on the basis that they will make less money or be less profitable under the model so they will not do it. What they see is the risk of a new pricing model, the risk of error in estimating their time (which is incorrect because value pricing is NOT based on a time estimate], and a lack of financial motivation to change.

HIGHER: If I said the cost would be higher to the client, the professional would dismiss the model on the basis that they already know and feel like clients are getting SCREWED by the billable hour, and that it would be somehow unethical to charge MORE than they already do.

You see, professionals who ask the comparative question have already made up their mind. They are no seeking answers. They are seeking validation for a conclusion they have already made. For those professionals who do seek understanding of a better way and want to become educated on the model, I am hopeful and that you understand that the answer to the question is: BOTH. (Not higher nor lower, but BOTH] Here is why:

Cost-Plus pricing is pricing based on time. It ASSSUMES that all time is valued the same since it is priced the same. Such a silly model cuts directly against a universal principle of the LAWS of DIMINISHING RETURNS. Anyone with an iota of business sense understands this. So, what happens here is that there are times when a professional's pricing is grossly below what they are truly giving in value and also times when it is GROSSLY above the value. Look within yourself for a moment and you will discover the psychological proof of this:

1 - Sometimes you feel like to added much more value than you got paid for, don’t you? (This is because you know the value of the 25yrs of wisdom you just gave away in 15 minutes for only $15O was many thousands of dollars!]

2 - Sometimes as you are billing a million hours for a simple brief you also worry about whether the client really can afford or values all of the time you think is necessary to spend on a case. You wonder whether they will get pissed off or not pay . Somehow you know the client does not value you the way you price yourself!

You see, the cost-plus pricing practice of billing by the hour produces bad results for BOTH the client AND the professional because it is NOT based on VALUE. Sometimes you are getting ripped off and sometimes the client is getting ripped off. It is a value imbalance. And all imbalance produce undesirable results for one party or another.

Value Pricing is about pricing on the margin of perceived value and bringing into balance the transaction between the buyer and the seller. In that instance, you as a professional will feel valued because you are pricing correctly and the client will never go away feeling ripped off. This also aligns you with your client and provides an incentive to ADD VALUE to the client and actually care enough about them to discover what they value and creative ways to accomplish an outcome. You are more than a drone. You are not a commodity so stop pricing like one!

The moral of the story is that professionals need to truly understand the competing economic theories rather than use simple-minded tactics to compare and dismiss competing practices. Philosophers that shaped our world did so with thorough deliberation and thought, not with passing gestures of curiosity. I am shocked that I must challenge our professions to THINK . . . . but if we are serious about progress and positive change, we should try to get back to our roots of being a THINKING profession that considers timeless principals rather than droning on in 6-minute increments in a state of perpetual skepticism. It could change your life. It certainly has changed ours!


Anonymous said...

Chris, you seem to be hitting the right buttons in this column. Value Pricing is not easier than Cost plus billing. We too often want billing to be easier, since we are usually so bad at handling it. Not easier, but more fair to the client and the professional

Discussion with the client about value and fees, as part of learning the case, gets us closer to finding out what they value in the matter before us.

Compare that with the studies that a doctor that spends as little as 3 minutes more with a patient has a substantially lower likelihood of a complaint for malpractice, and we ought to be able to see the importance of talking about fees in a deliberate way.

Ted Waggoner

Christopher Marston said...

Hi Ted,

Thanks for the thought. Yes - The billable hour creates economic disincentives to have thorough disovery sessions with clients to get the value proposition right. This is a real problem, because by its very nature expectations cannot be set up front, and so they are adjusted during the project, much to the detriment of both parties. With value pricing, we are able to capture the value of our investment up-front because clients do truly value the time we spend making sure we are giving them exactly what they want.

The change to the new pricing model IS in and of itself an investment that requires professionals to take a long-term time horizon for determining it's value to the company. All too often professionals look only at immediate revenues to determine whether they think the model will work, when in fact there is likely to be a short-term reduction in revenues, but a significant long-term increase in enterprise value. You would find that the Net Present Value of making the change is positive. If only attorneys understood business. . . then we would be making these changes faster!

Christopher Marston