How to value price: Just do it!

I'm finding it incredibly difficult to keep up with all the chatter in blog on value pricing in the accounting, legal, advertising and IT worlds.Ed and I were discussing this incredible wave of interest in value pricing yesterday. It seems to be a confluence of events: a teetering economy, continuous challenge from customers looking to cut costs, firms trying to maintain margins, challenges in attracting and holding on to talented knowledge workers who don't want to define themselves by how many hours they bill, etc.Whatever it is, we love it, but continue to be amazed that people are still complaining that there's not enough "how to" instructions on implementation.Over at 3 Geeks and a Law Blog, Toby Brown—whom I've had the pleasure of speaking with—wrote this on his post, How to—Alternative Bill:

It appears that firms and clients are ready; they just need to figure How To. From my recent post on the Paradigm of Profitability, Jackie Hutter's comment included a great statement: "In truth, many lawyers are unable to function in a fixed price environment."In my opinion, this is the challenge. Sitting down and talking with clients about value and price may be a new thing for lawyers, but it is not a particularly daunting task. In contrast, changing the entire way a firm functions will be a monumental challenge. Law firms' entire structure is built on the billable hour. The way we intake business, the way we manage our knowledge, the way we hire and 'train' our people and most importantly the way we compensate our lawyers. The last point is especially important because "you get what you pay for."So my role as the KM Guy is becoming the How To Guy. And where this all comes to a head for me is deciding where to start. I have good idea of the various processes and systems involved, but I am struggling with the question of where to best attack this problem. It may well involve multiple points of attack, but I think choosing wisely will be very telling for success.

VeraSage readers know there's no better way to get flamed on this site than to ask "how to" questions before completely understanding the theory behind Value Pricing. Read the very last section of this post to understand why.As Ronald Reagan used to say:

They say the world has become too complex for simple answers. They are wrong. There are no easy answers, but there are simple answers.

I remain unclear on why sitting down with a customer to discuss value, define the success of your engagement, scope the work to be done, and put a price and payment terms on it is causing so much confusion.This is how every other business on the planet prices. When I began Value Pricing in my firm in 1989 I had no clue what I was doing. There were no books, no blogs, no nothing on "how to" do this.I simply dived into the pool and started swimming. I went under fast. I struggled, it was daunting, not at all easy. So what? Can you think of anything worth having that is easy? There is no such thing as a free competitive advantage—it takes work, risk, and investment.I remain unclear on why the size of the firm matters at all, though I will admit we have seen more smaller, and up-start, firms adopt this model than larger legacy firms. But smaller firms constantly tell us, "This would be easier in a larger firm, since they have more resources and have the ability to assume more risk." Oh well, everyone has an excuse about why they can't do it, as Ed Kless has so brilliantly chronicled.A few years ago, I had the great good fortune to have a drink with Bob Cross. Bob is a giant in the pricing world (and a former lawyer), having authored the best-selling book, Revenue Management, and implementing Yield Management pricing at Delta Airlines in the 1980s.After the airlines were de-regulated in the late 1970s—by those free market advocates Jimmy Carter and Ted Kennedy, incidentally—the airlines no longer could look to the Civil Aeronautics Board to set its airfares. They had to actually pay attention to supply and demand.Bob Cross tells the story in his book, but suffice to say, his investigations led him to conclude that Delta Airlines was leaving a substantial amount of money on the table with its use of a hybrid cost-plus and break-even pricing model.When I asked him how he did all this in such a short period of time, he basically said they just did it. I'm paraphrasing, but this is the essence of what he told me:

Our business model was broken, and we knew we had to change. We made every mistake in the book, sometimes not even knowing exactly what we were doing. It was trial and error. But all of our competitors were doing it, and we didn't want to fall behind.

It certainly didn't take the airlines decades to rid themselves of cost-plus pricing and adopt more optimal pricing strategies.*It's an interesting question why professions are so slow to change, which I've written about before, most recently here. Partly because they are hermetically sealed from ferocious competition; they are not innovators; and are shielded, by and large, from creative destruction.Answering the how toWe've actually answered this question, but I'm going to do it again in response to Tony and other who are still afraid, and/or over-analyzing, this change.Here are the things a firm must do to begin Value Pricing. Experiment with one customer, a new or old one, it doesn't matter.Offer them a fixed price for a specific scope of work. Communicate to them that you are making this change to offer them certainty in price, so they never will receive an invoice from your firm without first knowing the price, payment terms, and scope of work to be performed. Use the analogy of the auto mechanic and/or contractor.Since you'll still be maintaining timesheets, figure out how well or poorly you did with the fixed price after the work is performed. Perform a post-mortem, or what is known as an After Action Review. How could you do better next time? What lessons did you learn about the price compared to the value created for the customer?Stop worrying about not making your hourly rate on every single minute. This is a learning process.Pricing is an art, but it's also a skill. You will get better at it the more you do it, like tennis or golf. This is why we only want people in your firm to price who are good at it. Stop letting partners who suck at pricing do this critical function.If the scope changes, issue a Change Order. Go through the same process: communicate to the customer up-front before you perform the work. Set a price, payment terms, and scope of work.Don't let anyone in the firm perform work that the client hasn't agreed to, including price, terms and scope. If auto mechanics can do this, so can intelligent knowledge workers.Have the CVO and pricing cartel read every single link on this post and discuss among themselves.Have them read every book they can on pricing. You will find a list on my Shelfari bookshelf, click on the tag "value pricing" below the shelf.In other words, just do it. Stop analyzing, stop looking for a checklist, a formula, or detailed instructions like this was a piece of IKEA furniture—there aren't any.Value is subjective, it's like beauty, in the eye of the beholder. You must discuss this with the customer. If you don't, you'll end up discussing hours, efforts and activities, all things they really don't care about but will look at if you don't give them something else.I can assure you of this: One way not to implement Value Pricing is to continue to think about and discuss hours, utilization and realization. This is to remain mired in the mentality of Karl Marx's labor theory of value.Will your pricing be perfect? No. It never will be. Live with it. Pricing intellectual capital is one of the hardest things you'll ever do. So what?Even if you are able to capture 1% more of the value you create, it will have an enormous impact on your profitability. Eventually, you'll capture 5% incremental value, then 10%, etc.And consider this: how much are you leaving on the table right now with sub-optimal hourly rate billing? The problem is, this lost revenue doesn't show up anywhere on your financial statements, so it's off your radar screen completely. No one is even asking the question.Resources on "how to"Read blog, articles, and books written by firms that have made the transition. Learn from their successes, not just their failures. Here's a few places to start.VeraSage fellow Chris Marston's recent article in The Complete Lawyer. Chris is CEO of Exemplar Law Partners, which doesn't bill by the hour, nor does it have timesheets. He also has an excellent blog.Mark Chinn—a family law attorney in Mississippi who not only has stopped billing by the hour, he trashed timesheets—has written a great primer, Dumping the Billable Hour: One Lawyer's Experience, an e-book which you can buy for $15.Jay Shepherd, of Shepherd Law Group, has an excellent blog where he frequently writes about the insanity of the billable hour.Read RainToday's report, The One Piece of Advice You Need to Get the Price You Deserve.Read about four firms that have made the transition from my Journal of Accountancy November 2008 article.Read some case studies from our Trailblazer section at VeraSage. Don't just read about law firms, read about accounting, advertising and IT firms. They are mired in the billable hour too, and the issues are essentially the same.All of these resources are more than I ever had when I embarked on this journey in my firm twenty years ago. These are the "how to" answers.You may not like them, they may not be easy, but that doesn't mean they haven't been addressed.Seriously, just do it.* Please spare us the comments about how the airlines are not profitable. Yield Management is not the reason. In fact, airlines couldn't exist if they didn't engage in price discrimination, not to mention many other industries—from rental cars, cruise lines, sports teams, retailers, and hotels—engage in Yield Management and are quite profitable.