Determining Value-Based Fees for Software Projects - Part 4

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A couple of weeks later, Mark was really finding his feet with value-based pricing and sent me details of a conversation he'd had with a COO he'd formerly worked for.  Mark mentioned that he considered this person as a mentor, and that he values his feedback very much.  Mark was curious to discover my 'pricing-by-value' view on the responses he'd received.  Mark's words are in black, the COO's in red and mine are in blue.

1) Isn't the goal to get directly to the economic decision maker, and not some purchasing manager, HR rep, or other intermediary?

[the goal is to provide a Value Added Service, which results in a fee paid.... but you do not get to the VAS nor the fee unless you "work" the decision maker]

{Not sure that he's disagreeing with you here.  The ultimate goal is to provide VALUE, and get paid a profitable fee for doing so.  And the route to this goal is via Alan Weiss's "Economic Decision Maker".

I'm becoming more and more sceptical though about the idea of "value added" anything.  This just sounds to me too much like the deliverer can say what's of value, which of course they can't.  Only the recipient can decide if the offering is of value, to them, at this time.}

I tend to think of fairness letters as applicable to securities and commodities, not professional services.

[Fairness letters ARE used in financial transactions but it is an example of a consulting endeavor that is a gate to moving forward.....Environmental Consultants hold Clients hostage sometimes due to the fact that you cannot proceed without their consent.   Another example is certification groups (ISO 9000) that requires the use of a Consultant whether you are already doing it yourself or not.]

{I'm not really clear what a "Fairness Letter" is.  Wikipedia has no definition!  Elsewhere I find "A letter or opinion prepared by a financial advisor, pricing advisor or similarly qualified person opining on the fairness of the price paid".

In that case I would agree with you.  In the provision of professional services, if the Economic Decision Maker does not have the wit to be able to determine for themselves that the price is fair, they should not be in their position.  Businesses cannot afford the luxury of going to an outside, so-called expert, for their opinion on every price quoted.  The whole of commerce would break down!

I wonder why it's needed in securities and commodities either!  Is it not just a case of widespread CYA? - If you're not familiar with this abbreviation, it stands for "Cover Your Ass"!!}

If you're providing value to the Client, then why shouldn't you be compensated based on the Client's perception of the value of your contribution and not your time, regardless of some third party's notion of "fairness"?

[actually, typically the fee is directly proportional to the value..... 1) my fee is say $250/hr... the value someone receives from 1 hour of my time is worth 2.5 times the Consultant who is getting 100/hr....or I hope it is.... 2) Some Consultants (including me, which I did at *******) get equity along with their fee.   Lower fee for a piece of the action.  Others charge a fee as a percent of increase profit, turns, revenue, cost reductions, etc.   Fees do not have to be hourly.... in coding sometimes we used fixed price for components as an example]

{This guy should win prizes for shooting himself in the foot!  His fee is "directly proportional to value" yet is based on $250 per hour?  Not only that, he maintains he is 2½ times as valuable as someone else who charges $100 per hour?  And then "or I hope it is"?!!!!!  I rest my case.  The guy doesn't understand the first thing about value-based billing, and this illustrates it perfectly!

Receiving equity or a percentage is a recipe for payment not for, but after the results.  This means it is in the Consultant's interest to have a control on things until the equity or percentage is delivered.  This is either an ongoing project or a retainer environment.  In either case it needs to be charged for, so the original - not "lower" fee should prevail.  The Consultant should be telling the Client, "My fee is x, but if you want me to take equity or a percentage of the results, I'll be charging you extra for the privilege!}

2) The only one a Consultant should be worrying about staying in favor with is the economic buyer of his services - the one who can sign the check - no?

[You have to be careful with that one.... its a good idea to have exposure above your contact as you could find out that he is out of favor and my endorsing his idea you may be limiting your future in the account....... Like me with ********.... I was hired by him, but I had to tell *** and **** that ******** was the problem.]

{I think I'm with the COO on this.  The Economic Decision Maker might be your prime contact but you need to cultivate other relationships too.}

Expanding your role is about providing continually increasing value to the Client, not just showing up and assuming authority.  I am not sure that's what you were implying though.

[1) agree with expanding value creates expanded engagements...2) most Consultants actually shy away from "assuming authority" as it can run aftront(sic) of the employees and then you cannot take the "successes are mine and failures are yours" approach....ie... it either works, and if it doesnt' they did not implement it in the way you had recommended. 3) many Consultants I have worked with on the management side are all about increasing THEIR billing.. and focus too much on that.]

{As I said previously, I don't think you can provide value.  I think you can do things and achieve things which are valuable.  So, via subtleties of English, I think you will expand your role by demonstrating your capability to provide what is perceived to be valuable, and helping the Client to understand more of what will be of value to them and their business.  This certainly does not stem from merely "turning up".

I don't think "assuming authority" will work.  Even if the Client is timid, non-assertive, and lacking business acumen, will you not achieve greater buy-in (and become more irreplaceable) by allowing the world to see that the Client had a large, if not the greater share in making these achievements happen?

Who would want to take a "successes are mine and failures are yours" approach?  Again I feel a "successes are yours; failures are ours to both take responsibility for and to learn from" is a better policy.  If the ideas were not implemented correctly, this HAS to be the Consultant's fault!  I am confused with the COO's stance on his last point here.  Does he mean "billing" as the "lights on Broadway" type of billing or as the ability to invoice for fees?  Never mind, in either case I would contend that those Consultants should get educated about what delivering value and pricing accordingly means.}

3) I think of this as a self-esteem issue - I certainly suffer from this!

[Most Consultants are over confident and have a high degree of self worth....how else could you charge someone for telling them (many times) what they already know.......]   You have to be confidant stepping up to the plate.... even when you have to go research for the answers, but you exhibit integrity and confidence.... I think you would do well at this....]

{Let's assume that this naïve viewpoint is the COO's generalisation on all the poorly behaving Consultants.

My take is this.  1/. You have to be confident in your own abilities, and have sufficient integrity to admit when you don't know.  2/. It would be gross arrogance if you never doubted your own abilities.  3/. I believe every Consultant goes the through "Oh, my God.  I've got the assignment.  What shall I do?" moments.  4/. If the Client already knows something, telling them again isn't of value, so you shouldn't charge for it.  5/. Building a network of associates and strategic alliance partners helps.  Having the ability to say truthfully, "I don't know, but I know a man who will know" is a great comfort.  And leading on from this, the ability to say "Let's see what is the most pressing issue you face and then find an expert to work with you on that" is great too.  Knowing you can never unearth a problem you can't help the Client solve is a hugely comfortable place to be!}

Not sure I can relate to your case in point - perhaps if some CEO hired you to concoct some pleasant looking findings to satisfy his board of directors...not exactly ethical and not really the kind of work I'd want.

[Its all shades of grey..... only machine language is binary.... there will be times in management consulting where you have to work within the system to satisfy the parties even if you think a different method/tack would be better, but it might be to upsetting to the organization.... ]

{I agree with you Mark.  As soon as this becomes apparent, grab whatever fees you can, walk away and explain why you're never coming back.  Working this way even once will so stain your reputation you may never get rid of it.}

4) I don't think it's possible to be a very successful Consultant and have low self-esteem.  The potential Client will see it coming a mile away and will never trust you.  I myself am a natural introvert and often confuse self-esteem with arrogance...something I'm working on.

[Agree..... Humble confidence.... not arrogance and never lead with your chin...   You will be fine at this.... always listen and show patience...not necessarily my strong suit, but I learned.]

{I concur with the COO here.  Two things about confidence.  Firstly confidence comes with practise, not contemplation.  Get out there, try it, and learn from the experience.  Why do actors rehearse?  So it becomes second nature.  The ancient Greeks didn't think this way, at least not with the sciences.  They abhorred experiment.  For them contemplation and not observation could solve everything, and look where that left us.  Up to the time of Copernicus to get rid of a geo-centric universe!

Secondly, lack of confidence can often come from the little voice in your head, telling you either that you can't do it or what will go wrong, or what will happen when it does go wrong.  And it's hard to displace these "Mother Hens".  It's often easier to substitute rather than eliminate.  For example, I had one Client who was hesitant about everything.  We got it down to her parents warning her not to stand out from the crowd, and she couldn't get rid of this.  After I suggested replacing it with the thought that no-one would ever come to her shop unless she was different, she instantly was able to move forward.}

5) This comes from using a time-based billing model from accounting.  Many lawyers have abandoned the time-based billing in favor for value-based fees (i.e. contingency).  If you consider yourself a commodity offering, you will ultimately negotiate on an hourly fee, which becomes a race to the bottom and a lose-lose for both Client and Consultant.  You can certainly negotiate the fee - just negotiate the level of value proposed and have the Client choose Option 1, 2, or 3...a choice of "yeses" as Alan Weiss would say!

[actually more consulting is done on a T&M basis than on a structured fee..... Fixed Price for fixed work or results are hard from a contractual  standpoint.  Yes lawyers do it, but usually only after they have a certain book of business to support their operation.   As stated I do some things where I get a ½ to 1 percent fee on top of my hourly.  I also always work against an estimate (e.g. I think this will take about 80 hours) but in my line of work they are always adding and changing the scope... SOW's Statement of Work ie SCOPE is important in all assignments BUT, if you go the Fixed route they are tantamount.

Oh and if they want to hire someone for less... then OK... it's the same with the furniture I build..... you can find one for less, but it won't be the same......You don't really compete down to a lower common denominator........ that is not who you want to work for......]

{Even if more work is done as T&M, this doesn't make it better!  Why is "Fixed Price for fixed work or results" hard contractually?  You can define the scope of the project, the metrics which will allow anyone to say whether or not the goals have been achieved, the elapsed time and the fee.  What more do you need in order to draft a contract?

What does "only after they have a certain book of business to support their operation" mean?  Does it mean they build up enough experience to know what to charge every time?  Or does it mean they have built up enough cash reserves that if they lose money, they can ride it?  If the former, this is not value based at all!  It's one size fits all!  And they could be perpetually undercharging!

And if the latter, they are not worthy of the name 'businessman' if they continually trade at a loss!

I agree with the COO's idea of estimating his costs, but he doesn't 'cost' at the same rate as he 'charges'.  In implementing Value Based billing you need to know your walk-away point, but a gut feel is accurate enough.

"in my line of work they are always adding and changing the scope" just says the COO is not being tough enough in preventing 'scope creep'.  On a fixed scope, fixed fee project, if the changes are within the agreed scope, they get done.  If they aren't, that's a new, chargeable project.  The choice for the Client is then whether to call a temporary halt to the current project whilst the second is completed, or to continue with the original project until it is finished and then embark on the new one.

I believe the COO is correct in his assertion that only he can do what he does, in the way that he does it.  The Client may well try once to turn you into a commodity so they can enter you into a price-war.  Don't allow them to.  Remind them of your uniquenesses.  Why me?  Why now?  Why this way?

And finally, if it doesn't look a bargain investment to the Client and a hugely profitable reward for you, walk away!  No-one, not even a start-up can be that hard up for business that they'd sell their soul to the devil!}

Still more to come!

Determining Value-Based Fees for Software Projects - Part 2

Register now for my 'Pricing By Value' Workshop in Cambridge, England on September 29th.

The mystery correspondent was of course Florida-based Mark Richman of http://www.empiresoftware.net/

Mark went on to ask me:-

"While I understand the concept behind value-based fees, I'm still trying to wrap my head around how to apply them to what I consider highly commoditized services. That is not to say I devalue my own worth, but I do recognize that there is an upper bound to what someone is willing to pay for a service, regardless of ROI - price elasticity of demand.

"At what point am I delivering a valuable service, expertise, information, guidance, and coaching, and at what point am I simply laboring to produce a relatively undifferentiated good (i.e. a presentation website)? I tend to think I do much more of the latter, unfortunately. Certainly, I can rattle off a unique value proposition to a prospect, but many will have shopped around before they talk to me and already have an expectation of what they will pay.

"This brings me to my next hurdle. Assuming I have somehow navigated past the prospect's early push to hear a price quoted, I find that I get nervous asking for more money than I think is "fair" (whatever that means). Is it a lack of self esteem, or a sense of ethics run amok?"

I cover all of the dozen or so points he raised in my Workshop (and more!), so again, I replied to him in detail, tackling his points one at a time.

"what I consider highly commoditized services"

"It really doesn't matter what you consider! The client's perception is the only thing that counts!

"You are unique and provide a unique service, so it is only by your own lack of 'Sales Conversation' skill that a client could be allowed to retain that impression of "highly commoditized". If they do retain it, this just means you haven't done your selling job well enough!"

"not to say I devalue my own worth"

"It's not yours to devalue (although you could blow it completely!), and it's not your worth that matters! It's the client's perception of the worth of having their problem fixed that matters, coupled with your personal value to the client. This is where the 'Value Conversation' needs to be heading. As I said previously this can take quite a large chunk of your sales conversation, and mustn't be truncated."

"there is an upper bound to what someone is willing to pay for a service, regardless of ROI"

"There is an upper bound, but based almost exclusively on ROI! Having enabled the client to articulate for themselves the true value of having their problem fixed, your fee will be seen as an investment on which they expect that return.

"A ROI of 20 to 1 sounds mightily attractive! 10 to 1 is still pretty good. Many consultants say they'll make a client at least three times their fee, but I think this is not desperately attractive. Less than 3 to 1 is certainly not a brilliant investment, even though it does make money. We are trying here to get a reaction of "That's a bargain!", so go for a high ROI."

"price elasticity of demand"

"Re-read Alan Weiss's Value-Based Fees - particularly the 'Supply-and-demand illogic' section of chapter 2 (in my edition) on ''The lunacy of time-and-materials models'. Alan explains brilliantly why the economists' theories that apply to commodity markets don't apply to non-commodity markets such as you providing your services. "

"At what point am I delivering a valuable service etc"

"Easy! When the client believes you are!"

or "laboring to produce a relatively undifferentiated good"

"Easy again. Only when you allow them to think this way!"

"I tend to think I do much more of the latter"

"At the risk of sounding repetitive, it's not about what you think! It's about what the client perceives and believes."

"I can rattle off a unique value proposition to a prospect"

"Do I sound like Elvis Presley continually saying "one more time" to the band? The client is the one who determines value! You have to allow the client sufficient time to reach this conclusion (generally with your guidance via your questions, but certainly not putting words into their mouth) for themselves, so 'rattling off' is almost by definition not going to work. And your proposition comes almost at the end of the sales conversation - it's where that entire conversation has been heading all along - it's not even at the end of the value conversation. Re-read the rest of 'Value-Based Fees'!"

"already have an expectation of what they will pay"

"This is natural, but will be based on their perceived remedy to their perceived pain, turned into a commodity, and put out for the world to bid the lowest price for! If you hear "that's too expensive" this really translates as "I haven't understood enough of the value of having my problem fixed in this way to see this as a bargain investment in order to achieve that return."

"You need to get them to understand for themselves what is their fundamental problem; their 'underlying disease' that is causing the 'symptoms' or pains that they are experiencing. Once they understand, they can articulate it to themselves, and then to you, and then you can understand also!
A useful question is "What keeps you awake at nights?" I doubt the answer is lack of a website! Lack of profitable sales, maybe! You have to ask other value seeking questions first though."

"somehow navigated past the prospect's early push to hear a price quoted"

"Well done for identifying this one. Client questions about your daily rate are designed (even if subconsciously on the client's behalf) to identify you as a supplier of commodities, and thus be suitable material for forcing into a price war.

"There is only one way to get rid of the daily rate question and that is to say "I don't have one!" And mean it! If you're not charging for your time, why do you even need one in your head?

"It would be wrong to leave your answer there however. You need to continue along the lines of "I'm quite prepared to quote my fee, at the appropriate time, later, but at the moment I don't know enough about your issues to do so. Please can we start/return to talking about the problems that are bugging you right now?"

"I get nervous asking for more money than I think is "fair" (whatever that means)"

"Firstly you have to accept that backing winners at odds of 10 to 1, even 20 to 1, is more than 'fair'! Secondly, everyone gets nervous when they see how they've been undercharging in the past. [They've also been under-delighting, which is why they've been under-charging!]

"I know I was no exception, particularly in moving from "I'll invoice you at the end of the project" to "My standard terms are 50% before I start and 50% after four weeks". Stating that my fee was five or ten thousand pounds instead of the two thousand I would have asked previously was less of an issue for me, but all of us have different types of nervousness."

"Is it a lack of self esteem, or a sense of ethics run amok"

"Almost certainly it's a lack of self confidence! The good news is there are simple techniques for gaining confidence at this.

"As we've implied already, the toughest sell is to yourself. One technique that works for many people is to think of the highest fee you've ever been able to charge, multiply it by five, and then look in the mirror and tell the face you see there "My fee is x thousand dollars". Keep doing this until you can do it with a perfectly straight face and no hint of embarrassment.

"Confidence comes from practise, not further contemplation. If you can say it to yourself, you'll be fine in front of clients. And it gets easier every time.

"Do the value-based thing properly and effectively you're telling the client 'I know a horse that is absolutely guaranteed to win, but you can still place your bet at odds of 20 to 1.'"

I concluded by asking Mark, what is there to be embarrassed about in that?

More to come soon ...

The Death Of Time-Based Billing

Please consider this.

Far too many businesses operate a policy of 'cost-led pricing', whether this is the cost of materials or the notional cost of their time. This is the accountancy view and is held to be mainstream, and it pervades thinking at all levels of most businesses. The alternative, economists' view of 'price-led costing' is thought to be heresy.

Value-based pricing theories are largely ignored by Business Schools and MBA courses! But the only thing any business can charge for is the derived value as perceived by the customer, so why persist with ego-centric pricing policies?

It is perfectly ethical to charge different customers different prices for different value received.

Customers who are charged according to value received are highly delighted customers. Customers who are quoted and charged a fixed price are highly delighted customers. Customers who are charged according to value are high paying customers! Prospects who are quoted according to value are highly likely to become customers.

But you need to address more than just your pricing. You need to conduct a 'value conversation'; you need to ensure your prospects understand fully what purchasing from you involves; you need to make your proposal around value based pricing; and you need to gain the prospect's agreement to your suggestions. In short, you need to address the entire 'sales conversation', but it all starts with establishing the value to the customer of the results of their purchase. It has absolutely nothing whatever to do with your raw material costs, hours 'worked', overheads, lifestyle ambitions or accounting practices!

Win-win means just that! It means that the customer believes they are getting high value for a very reasonable investment, and the supplier believes they are being well rewarded for whatever they are supplying. If either belief is missing, the result is not win-win.

I presume you would like most of your sales conversations to end with "That's a bargain! How soon can you deliver?" whilst at the same time earning a highly profitable price/fee. Value based pricing or pricing by value, call it what you will, is the technique that will enable you to achieve this sort of win-win outcome.

David

Learn more about these techniques and how to apply them in your business by booking your place on my 'Pricing By Value' Workshop which runs in Cambridge on July 7th