Implementing Value Pricing: A Radical Business Model for Professional Firms — Book Summary
In 2010, Ronald J. Baker wrote the book “Implementing Value Pricing: A Radical Business Model for Professional Firms”. The book is targeted at service firms (i.e., agencies and/or individuals who provide services, not products), particularly focused on accounting firm examples due to the experience of the author, who owns an accounting firm.
The core argument of the book can be summarized as follows: “service firms must replace hourly billing with value-based, fixed pricing.” In every other industry, pricing is fixed and based on the perceived value of the customer, who knows exactly what they will pay before making a purchase. Hourly billing is only used in service offerings and is full of unaligned incentives, tension, and lack of clarity for the customer, who will only find out what they will truly pay at the end of the project, instead of the beginning.
According to Ronald J. Baker, a business model is “how your firm creates value for customers, and how you monetize that value.” And service firms need to focus on profitability, rather than gross revenues—because their goal is to play the game in the long run, not merely growth for the sake of it. This is similar to the argument of Paul Jarvis in the book Company of One. To maximize profitability, firms need to focus on efficaciousness rather than efficiency. Efficaciousness is the power of producing a desired outcome for the customer and taking responsibility (and risk) for that. Efficiency means doing things right and minimizing time in order to handle more work volume. The former can be a true source of competitive advantage, according to the author.
“Therefore, value pricing can be defined as the maximum amount a given customer is willing to pay for a particular service, before the work begins.”
Fundamentals of value creation
Profitability comes from offering a service that is “so good it can’t be ignored”, as Cal Newport would put it in his book. Fundamentally, that is business: creating superior value for your customer. Customers do not care about how much time you spend on doing the work, or your internal cost. Ultimately, they care about the results they can achieve through your service. And that is what you price, as a service firm.
In The Strategy and Tactics of Pricing (Thomas Nagle and Reed Holden, 2002:164), the authors define the five Cs of pricing:
Comprehend value to customers
Create value for customers
Communicate the value you create
Convince customers they must pay for value
Capture value with strategic pricing based on value, not costs and efforts
Price psychology is composed of two elements: price leverage, and price emotions. The former refers to the upper and lower price limits in the mind of the customer. The latter are the emotions that a customer experiences during the purchase process: price resistance (the feeling of not wanting to pay for the offering), payment resistance (the feeling of resistance toward making the payment), and price anxiety. To avoid these hindrances, Ronald J. Baker suggests you remove value from your offering when the customer asks for a lower price. Price is a proxy of value, and offerings should be adjusted accordingly.
Hourly billing vs. value pricing
Hourly billing is retroactive. Customers are only involved when paying the bill, which is not a good time to discover they do not agree with your price if that happens. According to Roland J. Baker, value can only be measured proactively, not retroactively. Consequently, he proposes seven elements that replace timesheets and hourly billing:
Price-led costing: pricing based on value, not internal costs of labor/time.
Value council and chief value office (CVO): a dedicated committee or individual in charge of setting up value-based prices for your customers following the mental models and processes outlined in this book.
Fixed price agreements and change orders: signed agreements outlining the scope of the project, prices, and what happens when the client requests a deliverable outside of the fixed price agreement (change requests/orders).
Project management: the effective practice of managing expectations, communicating with the client, and delivering the work as outlined in the fixed price agreement, with high quality and on time.
Key predictive indicators—firm-wide: these are KPIs focused on performance, output instead of input, and value instead of internal costs. Examples include “customer loyalty”, “innovation revenue”, and “turnaround time”.
Key predictive indicators—for knowledge workers: output-based measures of performance for people in your team. According to the author (who cites Peter Drucker (2002)), “knowledge work can only be designed by the knowledge worker, not for the worker”.
After action reviews
The 8 steps to implementing value pricing
According to Ronald J. Baker, value is “the maximum amount a given customer is willing to pay for a particular service, before the work begins” (2010).
The eight steps to implementing value pricing are:
Conversation: asking strategic questions to your customers to understand how much they value your service, and how you can help with that.
Pricing the customer: questions for the value council. The value council can ask some questions to understand the price psychology of the customer (van Westendorp, 1976). The questions are:
At what price would this service be so expensive the customer would not consider buying it?
At what price would the service be expensive, but the customer would still buy it?
At what price would the service be perceived as inexpensive?
At what price does the service become so inexpensive the customer would question its value?
What price would be the most acceptable price to pay?
What costs can we afford to invest in at the target price and still earn an acceptable profit?
At what price would the firm walk away from this customer (Reservation Price)? What is the firm’s Hope For price? Pump Fist price?
Developing and pricing options
Presenting options to the customer
Customer selection codified into the Fixed Price Agreement (FPA)
Proper project management. According to the author, the elements of a great scope statement include objectives, constraints, project structure, role definition, project team definition, assumptions, deliverables, scope details, project change control, future projects, and approval.
Scope creep, and change orders
Pricing After Action Reviews
