Charting Value

One of my teachers told me to draw a picture to better understand a problem.  So this crude chart is my attempt at making an economic depiction of the value pricing proposition compared to the hourly billing model.  Your service generally has a set value to the client, which is the maximum price they are willing to pay for your work.  If your price is based on hours worked as shown by line P, then as your hours increase, your price increases according to the rate. 

So long as your total hours keep your price under the value line, you will easily collect what you bill, as the client knows they would have paid more and feel they have received your services at a discount to their value.  However, if your hours put you at a price point above the value line, the client will either pay grudgingly or attempt to negotiate back down to the value line.  If you are consistently over this value line, you will encounter haggling with clients who don’t want to pay your price.

If you are consistently under this value line, then you are always leaving money on the table that the client would have given to you if you had asked for it.  This scenario is why value pricing increases profitability.  The efficient service provider is punished in an hourly pricing model (same profit margin with less total revenue), but will be rewarded in a value based model with a higher profit margin and higher total revenue.

Good economics dictates that firms wish to maximize profit, not billable hours.  Be efficient, deliver great value, and make obscene profits by pricing for value.

Score one for value based pricing

A post on CPA Trendlines has really hit the nail on the head with regards to some of the most compelling arguments to abandon an hourly billing rate in favor of a value pricing model.  The key to maximizing your take from what the market place will bear for your services is to walk away from the cost plus model of hourly billing and decide what work you are willing to do at what price.  After that decision is made, you just need to find the clients who see the same value in your services that you do and have the willingness and capacity to pay for those services.

One of the comments on this article outlined several client ‘reactions’ to bills.  The only time reactions to bills are even an issue is when hourly billing is used and the amount of time required is a bit ambiguous, at least to the client.  The professional may have had a good estimate as to total cost up front, or at least sometime in the middle of the engagement (especially if special problems have arisen that cause more work on the project). 

Had cost been discussed in total up front and been set so long as all goes as planned, these reactions would never take place, because the client and the professional would be on the same page in the beginning, instead of finding out there are differences at the end.  Value based, fixed up front pricing can save a lot of headaches, heartaches, and wallet aches for both the client and the professional as engagements with clients who don’t understand your value will not begin in the first place.

A tip to micro-managers

My experience is in a public accounting firm, where the staff are considered to be professional employees. As such, I would think we should be beyond the point of severe micromanagement, but apparently we are not. I have recently been reminded of this as I have had a couple large projects on which I am not allowed to use all of the resources at my disposal.

The tool I wish to use is a certain software program that has been recently acquired by the firm, and in my opinion, its usage would increase efficiency and reduce errors.  I guess when you bill clients by the hour efficiency isn’t everything.