Back in September 2007, Rob Lewis of AccountingWeb in the UK wrote a provocative piece entitled “In defence of the billable hour!”
He stirred the hornets nest with that post; as a matter of fact, it’s still drawing comments as late as today, has been read 3,883 times and attracted 67 comments as I write this. In fact, now the comments have equated Value Pricing with religion. Though some of these comments are witty as hell, especially the one by Allan Mackie, I must say that Value Pricing is based on sound economic theory.
The technical name is price discrimination for those who want to research it further. This is a theory that goes back to the 1880s, but was really developed well by the 1920s. It has nothing to do with religion. Nor does trashing timesheets. This is based on empirical evidence, from firms that have done it. Not quite a religion.
In any event, Rob is back today with another post “Value pricing: a debate without end.” This one is less provocative and much more reasoned. It appears based, at least partly, on an interview I had with Rob after his last piece. I found Rob to be very intelligent, someone who asked penetrating, tough questions. It’s obvious to me that he is wrestling with this issue. Good. He should, as should all of us—I still struggle with it!
I actually liked this article by Rob. It’s already attracted four comments, the first being from VeraSage Senior Fellow Paul O’Byrne [I know, amazing, but that’s another story. I’ve posted a longer version of Paul’s comment in the comments section to this post]. Rob’s piece is balanced, well reasoned, logical and he does quote me accurately, which I’m grateful for.
I would like to clarify just a few points from his column. I will let others go further with this discussion, such as Eric Fetterolf—one of our Trailblazers—who has already commented. I’m sure there will be many others. This is certainly not the last word on this topic.
I like Rob’s opening question in the first paragraph: “Will value pricing remain on the sidelines, or is it about to enter the ascendancy?” It’s an excellent question, one we at VeraSage have pondered long and hard. Rob reported my view on how this is a new theory, and germ theory took the medical profession centuries to become widely accepted. There are many more examples. I wrote an article about it: The Diffusion of a New Idea.
A little further down Rob writes that I believe the accountancy profession should be “defined above all else by what it can charge for.” Well, that’s not quite right. We do say a business is defined by that for which it charges. But what it really means is the accounting profession should be judged based on its ability to create value, not just capture it with better pricing. Any organization, from a government hospital to a non-profit, is judged, ultimately, by the results it creates outside of its four walls, something Peter Drucker called the marketing concept.
Then Rob explains how the billable hour became common between the 1940s and 1960s, proving a new theory can diffuse relatively rapidly. True enough. There was enormous pressures and technological factors that led to the rapid diffusion of the billable hour. There was also no VeraSage Institutes questioning the economic theory behind such a change. A herd can move damn fast once it gets going.
But I would remind everyone that scientific truth isn’t determined by majority vote, or consensus. Science, like business, progresses based on dissent. The logic and economic theory behind the billable hour was always weak, and that doesn’t change just because a majority of a population does it. In fact, if you want to get technical, most of the business world does not price by the hour, so the minority is really the PKF sector that clings to the billable hour.
Rob then writes, “Pricing itself is a tricky and intricate activity,” noting the existence of professional pricers. Yes it is. So what? Does that mean firms shouldn’t do it? Or shouldn’t develop a core competency in doing it? Nearly all of the Fortune 1000 have pricing professionals, demonstrating the benefits outweigh the costs of investing more creativity and intellectual capital into this function. All we are saying is firms should do the same. Is it any different than benchmarking best—or perhaps, next—practices?
But here is where Rob loses me. Let me quote him:
It’s also an aspect of value pricing where the theory contradicts itself somewhat.
Value-pricing is supposed to create a market-led, client-focused competitive marketplace. It’s also supposed to boost your profits. And that is a big paradox.
‘Of course we’re professionals, but we’re also business people,” Baker argues, ‘and I don’t see anything unseemly about charging a price centered around the value you create. Sometimes that could very well mean a lower price.’
Really? Rather than invoicing your billable hours and charging, say, £1500 (which you believe they will happily pay), you value price, decide what your work is really worth to the client, and charge £1200. For most people, that would be a decision that flies in the face of normal economic behaviour. And the problem theoretically, of course, is that the market isn’t really making that decision: you are.
There’s no contradiction here with Value Pricing. Again, it’s classic price discrimination, and overwhelming empirical evidence proves it does add to profits. What price discrimination says is quite simple: With a downward sloping demand curve—which economists call having market power—if a business can then segment those customers who are willing and able to pay above the so-called equilibrium price, then the marginal revenue will add to profits [click on the supply and demand graph at the end of this post. What any business is looking for are customers in the shaded area, those willing and able to pay more than the equilibrium price. This is how price discrimination works in theory. There’s more to it than this, there are different degrees of price discrimination, but this is the essence of it. For those wanting a deeper explanation, see my Pricing on Purpose book].
In the real world, there are myriad examples of this being done: from airlines, hotels, rental car companies and cosmetics, to hardcover vs. paperback books, liquor, wine, beer Coke, etc. I document dozens of examples of this in my books. There are literally thousands.
There’s no contradiction in that theory with the real world. Something simple as your local Starbucks menu is an example of price discrimination in practice.
Rob then poses an example of £1200 vs. £1500 price and says the market isn’t making the decision, you are. But you’re not making the decision, the customer is, since they are given a price before you do the work. I would also add, markets don’t buy things, people do, and value is subjective. Accounting firms can meet with each and every one of their customers at a very low marginal cost, so it behooves them to determine the value of what they are doing for each customer.
If the airlines had the ability to interview you before your flight to determine if it was travel for business or leisure, they’d be able to customize a price based on the value of your trip. The problem is, the costs of doing that exceed the benefits, so they develop clever rules to segment customers—Saturday layovers, how close to departure are you purchasing your ticket, etc. But that’s not true in an accounting firm; they meet with each customer anyway, so the marginal costs of determining value are negligible.
Rob them writes that only firms that offer exceptional service and highly specialized knowledge are able to value price. He even writes: “But for the average firm, value pricing may not be the way to go. One issue could be that you end up charging clients wildly different sums for the same work.”
But why is value pricing not right for the average firm if the economics make sense? I guess I have more faith in the average firm than does Rob, because I see firms of all sizes and shapes that have adopted value pricing successfully.
Now the charging different prices for the same work is truly a straw man argument. Mark Lee has an excellent comment (#4) on the post that talks about the more common scenario. But let’s deal with this straw man head on.
If a firm does a large volume of tax work, say hundreds or thousands of returns, then many firms offer a menu price service: A sort of American Express Green, Gold, Platinum card offering. If all the customer needs is the minimum bundle, then prices will be the same across customers that select that bundle.
It’s when you get into the customers that require more than minimal compliance services where you customize a Fixed Price Agreement, and this is where no two customers are exactly the same. As I say, there are strategies that can deal with the charging different customers different prices issue, if you are willing to research them. For an example of a menu strategy from an Australian firm, see here.
Then Rob claims the billable hour prevents this problem. But does it? Two partners can charge radically different prices for the exact same work, depending on their level of self-esteem and who works on the jobs. People can lie on their timesheets. People can eat time. You can’t tell me the billable hour produces the exact same price for similar customers. Fixed prices are far more likely to do so.
Rob ends on a discussion of trashing timesheets, and says it’s a leap of faith. Really? There are 500+ firms that have done it, across all PKF sectors, from advertising agencies to IT firms. How can that be a leap of faith? They are not a good management tool, we have provided many replacements that actually enhance the value of a firm’s intellectual capital far more than timesheets.
All that said, I love Rob’s last sentence:
But surely the simplest way for most accountants to make sense out of value pricing is to forget about the pricing bit, and just concentrate on becoming more valuable?
Amen. A firm must first create more value if it wants to capture more value. This takes hard work. It takes creativity, innovation, and deep thinking. It’s why most firms have not made the shift to Value Pricing.
Rob, you answered your own question. If you’d like, we can arrange for you to interview any of our Fellows and talk with them in-depth about how they Value Price and operate firms without timesheets. I’d start with O’Byrne & Kennedy since they are in your backyard. I’d be more than happy to introduce you to others, or you can contact them yourself, under People on our Web site.
Thanks for furthering the discussion, Rob.