Four Realities of Value-Based Pricing

By Michael W. McLaughlin

Some years ago, I owned a home with a nasty construction defect. When a strong wind pushed rain against the front door, the water flooded inside and under the front entry, damaging the floor and leaking into the basement.

My search for help turned up four contractors. Three of them quoted an hourly rate without specifying how long or what it would take to complete the job—too many unknowns with water damage, they said.

The fourth contractor told me that the damage and cause could be repaired in one week or less at a specified price. He presented a stack of references from other clients with similar problems and he promised something his competitors didn’t: to fix the leak.

That contractor’s price was based on results, not time applied to the project. He made good on his promises, and it was worth every penny.

Pricing on results, or the value of results, makes sense for consultants too. Why shouldn’t clients pay you for what you help them achieve, rather than the number of hours you log? And to take the logic another step, if your work generates big savings for a client, shouldn’t you share in that windfall?

Value-based pricing is a sound strategy, but it can be trickier than it sounds. Make sure you consider the four realities below before you try this pricing method.

Reality #1: Clients don’t care about your business.

Most clients try to get the most, at the best price, when they hire a consultant—and they should. Of course, some clients will pay a premium if they believe they can achieve faster, better, or more permanent results with a higher-priced consulting firm.

But never lose sight of the fact that clients are interested in what they stand to gain for their businesses; they don’t care about your profit margin, how hard you have to work, or how much time you put into a proposal or a project. So don’t be tempted to share–or whine.

Some clients will express enthusiasm for and negotiate a value-based fee with you, only to get cold feet at the last minute and make you re-do your proposal on a time-and-materials or fixed-fee basis. They sometimes perceive less risk to their businesses and lower cost with the hourly rate option, even when that does not reflect reality.

Keep your pricing options flexible even if a client shows a strong interest in value-based pricing. You’ll avoid scrambling at the last minute to create a price for services.

Reality #2: Clients are reluctant to leave their comfort zone.

For decades clients have used the simplicity of the hourly rate to help them choose consultants. The hourly or fixed rate gives them an apples-to-apples comparison—at least on price—of their alternatives.

Sure, the firm with the lowest hourly rate isn’t always the winner, but clients like having a standard measuring stick. Consultants know that old habits die hard, and that the hourly rate or fixed-fee pricing won’t go away quietly.

Many clients need a powerful incentive to budge them from old habits. After all, if they can hire a consultant on a fixed-fee basis to help reduce manufacturing costs, for example, what would motivate them to pay a value-based fee, which is likely to be higher?

The answer should be reflected in everything you do, from marketing and selling to delivery. You need to rethink your marketing communication, sales approach, and your value proposition to effectively convert clients to a value-based billing approach.

You have to demonstrate a dramatic difference in measurable results as compared to the rest of the pack or your clients will head right back to their comfort zone—the hourly rate.

Let’s say you believe a client’s $10,000 investment in the customer service improvements you are proposing will result in an annual reduction of $3,600 in merchandise returns—a 36 percent return on investment (ROI). Is that enough to justify a value-based price to the client? Maybe, but you’ll have to test that ROI with the client as you’re developing your proposal.

If you’ve come up with the correct ROI, you have an opportunity to shorten your sales cycle and bypass the hourly rate. Expect substantial give and take, though, as you work with clients outside their comfort zone through the mechanics of value-based pricing.

Reality #3: You need to answer “yes” to six questions.

Is the ROI of the project substantial enough for the client to clearly understand the advantages of a results-based fee arrangement?

In competitive situations, your value-based fee may be compared to lower priced, hourly proposals. Make sure there is a logical link between your fees and the specific value you plan to provide, and emphasize your track record of achieving the ROI you are proposing.

Given the client’s environment, is there at least a 75 percent certainty that the project team will achieve the proposed results?

Carefully consider how probable it is that you will deliver the value you’re promising. Often, success depends on team composition and organizational support, so be sure you have the right consultants and client team members, and the executive support you need to hit your target.

Are you willing to put some of your proposed fee at risk?

For most value-based billing arrangements, your fee will be based on a sliding scale, depending on results. If your team exceeds expectations, your fee will be on the high end of the scale. If your team fails to meet the predetermined performance benchmarks, you may forfeit part of your fee. The potential for sharing in the client’s windfall is not without risk.

Can you wait for expected results to materialize before you ask for full payment?

Clarify all payment details before you begin work. Focus on levels of payment, including timing of payments, and the potential impact of uncontrollable events. Executive shake-ups, mergers, and labor strife are just a few events that can derail the best planned payment schedule.

Does the client have the will to make the tough choices that a value-based project can demand?

In many value-based billing projects, organizations must make substantial changes to achieve the desired results within the proposed timeframe. You’ll need to trust that your client has the will and the ability to make hard choices. That assurance is best known with existing clients. You’ll need to perform extra due diligence on this issue regarding clients you have not worked with before.

Have you considered the project’s best and worst case scenarios for you?

Before agreeing to a value-based billing arrangement, assess what impact the agreement could have on the short and long-term financial health of your business and on your relationship with the client.  

Reality #4: Value is in the eye of the beholder.

Some consultants complain that the industry is beset with commodity pricing, stingy, clients, and endless price negotiations. It’s true that many consultants in today’s market are peddling the same services that do nothing to inspire clients to pay for results.

Don’t expect clients to automatically see and understand the value you could provide. Some will be focused only on the need to install a new system or solve a narrow problem.

You have to change clients’ mindset about pricing by putting the real value right in front of their eyes. Once you do that, and assuming your offering is better than that of your competitors, your value-based pricing proposal will find a receptive audience.