Profitability Through Pricing

In my last post entitled The Profitability Problem, I promised to discuss specific pricing strategies that can improve profitability.

I suggested integrating three approaches to achieve optimal profitability: evaluating the firm’s capacity by knowledge level, specializing in a limited number of practice areas (service or product oriented) and pricing strategically. But there is one other thing....

To be as profitable and successful as possible, no matter how you price--high or low, hourly or fixed by project--the first and most important thing to address is to assure consistent high-quality of service no matter what service is sold, no matter who is delivering it, no matter what price is asked.

These are the 3 Essential Behaviors:

• Positive attitudes all around
• Exceptional expectation management skills (this means creating them and then consistently meeting them)
• Communication whenever change, or the need for change, first becomes apparent if outside of anyone's established expectations

The above list regards INTERNAL behavior just as much as EXTERNAL behavior. This is known as role-modeling. Treat each other as you wish your clients to be treated. (The same principle applies to parenting. If you yell at your children, you shouldn't be surprised when they yell at others.)

(Near) perfect service is possible. It is defined by proper expectation management and, as such, is completely within your control. This doesn't mean you may never err. If you are managing expectations properly, you can promise that if and when you err (everyone is human, after all) the situation will be remedied immediately and completely, without assignment of blame or other uncomfortable moments for the customer. But I digress....

The above behaviors, alone, will set your organization apart in the eyes of those who work for you and with you. These are valuable behaviors that are hard to find in today's business world. I'm not saying that you can charge more if you do these things because, in fact, they are the foundational traits all businesses should be demonstrating, but we know how that goes...(this is why just a few select businesses, like Disney, are so admired).

So if you cannot necessarily price higher because you are doing these really important things, why do them? Do them to create loyalty and, ultimately, demand for your services. When demand is created (people competing for your limited resources) you can charge more and/or grow to meet that demand.

My first recommendation is to work toward becoming a shining example of the Three Essential Behaviors. At first, this will take a lot of effort and focus from everyone in your organization. Selling the idea to your colleagues shouldn't be hard--people need only listen to their instincts to know the behaviors are in the best interest of both the organization and the customer. Why delay? Start now.

If you don't work on the Three Essentials, you can still work on the following, but results will be limited. The effectiveness of the strategies below assume you are doing the Essentials pretty well.

Here are some specific pricing considerations that can be put into practice to boost profitability:

Managing Expectations Through FPAs & Change Orders
Managing expectations definitely goes beyond prices and billing but, let's face it, the biggest reason clients complain about bills is not price at all, it is the fact that they are surprised by the price. That is a very different complaint.

The surprise occurs because someone didn't properly set expectations by thoroughly explaining/defining the scope of the work and then communicating, clearly, in advance if and when that scope needed to change.

Most CPA firms already use fixed pricing for many services. Most law firms less don't yet, but some do...contingency cases, estate planning, and even a family law firm in AL that even did away with timesheets. FPAs are Fixed Price Agreements. This is the document used to convey what you will deliver to the customer (the scope of the work) and any foreseeable conditions that would result in a change of price.

Offering a range doesn't work. When the customer hears a range, they hear the low end. When you state the range, you mean the high end. This is a problem from the start. Just give the price.

For firms that already offer a fixed price, the big problem is with change orders. Firms know about them, and mean to use them, but are typically undisciplined about employing them. This is where profitability leaks from the firm like it would from a sieve.

I just talked with a partner who said it's hard to get staff to let them know when thing change in the field. This is unacceptable. It's a leadership problem because partners don't put enough emphasis on the importance of the change order.

The firm has to make it a priority to prevent scope creep. Your mechanic does NOT do extra work until authorized by you. Your carpenter certainly doesn't either. It is your professional responsibility--if you want to get paid--to discuss additional work with the buyer before you do it, or you are expected to eat the cost.

I believe it is inappropriate--even unethical--to bill a customer without their advance consent to do the work.

But firms do it all the time. And then partners are "surprised" when customers balk and the balking is incorrectly interpreted as a price issue. It is not a price issue, it is poor expectation management and it causes clients to leave.

Improve profitability by managing expectations through use of FPAs combined with diligent use of change orders. Teach team members how critical these are to customer service and the firm's success.

Timing and Talent Availability
Study the practice to learn wherein lies the greatest demand for timing and talent. This helps the firm identify “peak” times that can be priced higher as well as “off” times that can be priced somewhat lower until or unless demand increases for those times. This is just smart business.

Specialization and Complexity
The same goes for services. If you offer services that are in particularly high demand (perhaps there are limited numbers of providers) or if you serve industries that require greater-than-average knowledge, these can both drive up your price. So does the amount of risk to you in providing the service. Securities law, or public company audits are two examples of services that ought to be higher priced due to your exposure.

Oddly, the accounting profession has not stood together on pricing highly specialized work or higher risk work. Instead, providers compete against each other to drive pricing to ridiculously low levels. Take school district audits, for instance. Most would agree there aren't too many audits that provide greater risk of public backlash for even a minor oversight. Much on-going CPE is needed to perform this work. Yet these are some of the cheapest audits out there because the profession hasn't stood together to demand a price more in-line with the risk--instead CPAs perpetually underbid each other. Maybe it's time to change these backward situations?

The lowest priced services are those that can be found readily and which require the lowest skill levels to provide. The firm can do these things, but recognize that the price will be lowest for these services so either: 1) limit the number of these things and confine them to off-peak times and people who aren’t needed for higher priced services; 2) get really, really effective at doing these things so they can be done well and in high volume to be as profitable as possible; or 3) opt out of doing these things altogether and focus on higher level, higher priced work.

Multiple Service Tiers
Again, as discussed at the beginning of the post, the highest priced services are those provided to the most appreciative customers. Create loyalty and appreciation by being positive and delivering well against the expectations that you set.

That being said, all clients are not equal. Their needs differ, their natures differ, and so do their expectations. All services provided by your firm probably are not of equal value or worth—either in your eye or in the eye of the buyer.

The trick here is to be clear to the buyer, before they buy, about what level of service they will receive at which price. This is what Ron Baker and VeraSage calls the airplane model or the “adaptive capacity” model. If you picture your firm’s time and talent as the available seats on a plane, you can clearly see that you have limited seating to offer customers.

Your best customers will probably want to sit at the front of your plane, receiving first class service, able to reach you anytime, day or night. In fact, you would are willing to “reserve capacity” (or even bump another customer) to make sure you are able to meet their needs. These customers, probably your highest maintenance, should be willing to pay a premium for this level of service. If not, they may be perfectly happy in your business class.

Those who simply want bare-bones service, perhaps don’t seem to act upon or value the extra advice you give them, might be economy fare clients. Clearly, they shouldn’t receive the same level of service as your other customers. And the space for these customers should be limited to the times and talent you have available after seeing to the needs of those paying first and business class fares.

In most cases, whether you serve organizations or individuals, it is possible to look at many of your services and offer a gold/silver/bronze tier of service, priced accordingly. Focusing on pricing, and on making sure you have the right number of people in the right part of your plane – and that you have the correct people at the appropriate level to serve them – is the best way to increase profitability. It may even mean you have to let excess clients or employees go. Sometimes it means you would discontinue providing a certain service or serving a certain industry.

Summary
Some service or industry areas are clearly more profitable than others. Why would you sink profitability of the best areas into funding those that are losing money unless there is a clear strategic reason to do so?

You may notice that I didn't discuss "value added" services and it's not because I don't believe in adding value to a sale. One reason I don't go into this topic here is that there is just too much confusion about what value-added means...see my post Value Added Confusion.

The main reason, quite frankly, is that it's more important to get the basics--the Three Essential Behaviors--right before the firm spends energy on making up for service lapses by tacking a few bells & whistles onto the engagement. There is much more benefit to the client and the firm if the Essentials, capacity, specialization, and client tiers, are the focus of the firm.

For much, much more on pricing methods (and why and how to employ them) read Ron Baker.

My next post, at David Maister's suggestion in his comment to the last post, will be discussion of profitability through leverage or delegation, whichever you prefer to call it. I shall call it "work flow."