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Customers will never tell you you’re too cheap

Making the transition to value-based pricing | Jon Manning in conversation with Anthony English

There are a lot of service professionals who are frustrated at pricing their services based on timesheets, but they’re not sure how to transition out of it into value-based pricing. What’s a safe way to get started?

So before I answer that question, let’s just define what we’re talking about here when we say “value-based pricing”. Just as “cost-plus pricing” is pricing on the basis of costs, value-based pricing is about pricing on the basis of value.

People listening to this interview (or reading the transcript) at this point are probably asking themselves “OK…I know what my costs are, but what’s my value? Surely that’s subjective and determined by my client?”.

That’s true. But the best way I’ve found to think about “value” is to consider three sources of economic value:

How do I increase my clients’ revenue?

How do I reduce my clients’ cost?

Or how do I minimise my clients’ risk?

Then express your price as a percentage of that economic value: I can save you $1mill in expenses and your investment in that savings is 2%

As you might have noticed there, a switch from cost-plus pricing to value-based pricing is one where we also switch focusing on our inputs (i.e. the hours we are working) to the customers’ outputs (i.e. the value provided).

So now we can talk about transitioning to a value-based pricing model. Here’s a couple of suggestions…

Firstly, condition customers in advance. Let them know of the forthcoming change(s) rather than using immediate, shock-and-awe tactics;

Offer clients a choice of pricing models. There’s no rule in business that says you can only offer one pricing model. Let the customer decide which one they prefer – hourly billing or value-based pricing.

Run two pricing models side by side, and offer the customer the cheapest of the two. You might do this just for a limited period of time (say 6 months while you transit to value-based pricing, after which time time-based / cost-plus pricing is discontinued)

And roll it out slowly rather than via a big bang approach. Start with small customers first. If you get it wrong, there’s less at risk.

Why do you think so many people are embarrassed to talk about pricing?

You know, it’s probably fair to say there are “pricing introverts” and “pricing extroverts”. Corporate Australia provides the best illustration of this, but there will be SMEs, and freelancers for that matter, that can be likewise classified.

Bunnings, Aldi, Tiger Air and Dan Murphy are all businesses we could call “pricing extroverts”. Their value proposition is centered on lowest prices…always, often accompanied by price-match or price-beat guarantees in support of this.

A “pricing introvert” would be any company that is trying to sell on value, rather than price. There’s an old adage that sums this up perfectly: If you have to ask the price of a Rolls Royce, you can’t afford it.

But there’s probably a bit more to it than that, often found amongst business owners and freelancers….

The first is confidence and having enough of it to stand your ground on what you’re worth in the market

For some, this confidence problem may be associated with the “endowment effect”, where we tend to place a higher value on things we own (houses, cars) than what others would pay for them

And finally, there is no such thing as THE perfect price. In the world of “pricing nirvana”, every client would have their own unique price representing their willingness to pay, but very few businesses have the knowledge and technology to, minimise the consumer surplus (as economists call it) and charge every client the perfect price.

Is there some kind of service professional who would be a better fit for value pricing? Is there a particular business size? Are some industries or services never going to change?

If you look hard enough, there probably isn’t a single business (of any size) or industry that couldn’t adopt value-based pricing if they put their mind to it. It’s certainly very well suited to B2B industries.

Are there some industries or services that are never going to change? Well, I never say never, but there are three industries that will probably hasten their demise if the DON’T shift to value-based pricing: the Legal, Accounting and Advertising industries.

What are the pitfalls in transitioning away from billing by the hour (or a day rate)? How do you protect your business from these?

Can I answer this with an example? A couple of years ago, a neighbour of mine asked me to help her with her husband’s pricing. We sat down and developed three management consulting packages for him, specifying exactly what he offered in each package, pricing them on the basis of value.

A couple of months later I bumped into him and asked him how his pricing was going. He said he’d doubled his revenue. But what he loved the most was that because he’d spec-ed out what was in the three packages, he knew exactly what he had to do. He got as much value out of the new packages as his clients did.

One of my business coaching students tripled his effective hourly rate and actually got busier, because he attracted better clients. Is that sort of thing common?

It’s certainly not uncommon. One of the things prices do is convey the quality of a product or service – you see a price of $9.99 (or a price ending in 99 cents), you know it sends a different message from a $100 (or other rounded) price point.

Conversely, price too cheap and customers / clients think you’re too cheap to be true and there must be something wrong with the product or service. So when your student has tripled their effective hourly rate (whatever that means), clients have thought “hey, this guy isn’t charging Mickey Mouse prices any more….he must be good”.

As a business coach for service professionals, I have to fight off the “too-good-to-be-true” skepticism. How do you price your own services when the ROI is sometimes unbelievable?

So here are my thoughts on this. Clients will never tell you you’re too cheap. But they will tell you you’re expensive. Lift your prices every so gently, from “unbelievably too-good-to-be-true”, to the point where clients start to talk to you about your pricing….unless, of course, you want to leave money on the table.

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