By Tim Williams
WHO’S IN CHARGE OF VALUE?
Who determined the price of the car you drive, the mobile phone you use, or the software systems you use? Which internal function inside these companies made the decision about what to charge for their products or services?
The answer, surprising as it might be to professional services executives, is NOT the finance department. The CFO of Tesla, Apple, or Salesforce does not make the pricing decision. In modern companies, pricing is determined by dedicated pricing professionals. The larger the company, the more likely they are to have a Chief Pricing Officer.
Unlike the head of finance, whose job is to determine and analyze costs to the company, the Chief Pricing Officer is responsible for determining and analyzing value to the customer. These are very different jobs with very different skill sets.
Top-down pricing vs. bottom-up costing
In place of the outmoded bottom-up costing approaches used by most agencies, contemporary client companies utilize top-down pricing. They understand that value is based on perceived utility to the customer, not the cost to the company. They direct their energies to determining the “willingness to pay” (WTP) for each of their products and services.
Many frameworks exist to help evaluate WTP, the most famous of which is van Westendorp’s price sensitivity meter, which asks the following four questions:
At what price would you consider the product to be so expensive that you would not consider buying it? (Too expensive)
At what price would you consider the product to be priced so low that you would feel the quality couldn’t be very good? (Too cheap)
At what price would you consider the product is starting to get expensive, so that it is not out of the question, but you would have to give some thought to buying it? (Expensive/High price)
At what price would you consider the product to be a bargain—a great buy for the money? (Inexpensive/Good value)
This is a very different exercise from counting company costs or applying formulas to determine hourly rates (salary + overhead). Cost accounting is a calculation, whereas pricing is a judgment.
Not the floor, but the ceiling
While finance professionals are mostly focused on the “floor” (the costs of providing a service), pricing professionals seek to determine the “ceiling” — a target price based on the value to the customer. As Tim Smith writes in Pricing Done Right, “Leading firms price according to the customer’s willingness to pay, not the firm’s costs to produce. They treat costs as a constraint with regards to pricing and a lower boundary on prices that the firm will accept. When it comes to pricing, they treat value as the goal.”
To effectively capture the value they create for their clients, professional firms like agencies must institutionalize pricing as a core competency — separate from the finance function. Not only does pricing involve a different skill set, but it also requires a different disposition and temperament. The best pricers are self-assured, can deal confidently with professional buyers, are persuasive presenters, and passionately defend the firm’s pricing integrity.
This is not to diminish the role of the finance group. Finance professionals perform an indispensable function, but their training centers on estimating costs whereas pricing professionals are trained in estimating value. The primary competency of the Chief Financial Officer is a thorough understanding of costs. The leading proficiency of the Chief Pricing Officer is a deep understanding of the customer.
The right tools for the right conversation
In preparing to have a pricing discussion, finance professionals invest their time in preparing detailed spreadsheets that present and defend the firm’s costs. That’s the wrong conversation to have with a buyer. Clients don’t buy your costs: they buy the outputs and outcomes that solve their problems and build their business.
Pricing professionals have the ability not only to set pricing based on value (using modern pricing methodologies) but to communicate that value in a way that builds client trust. Instead of playing a zero-sum game with professional buyers where each party fights for a larger slice of the pie, pricing professionals seek to “grow the pie” by aligning the interests of both the buyer and seller.
Some progressive law firms now have Chief Pricing Officers, or small teams referred to as pricing councils or value councils. Pricing professionals George Tacke and Madhavan Ramanujam propose the creation of a “monetization team” whose job includes:
- Developing customer segments based on needs, value, and willingness to pay.
- Packaging services based on these customer segments.
- Employing behavioral pricing principles in developing the revenue model.
- Developing the right value message.
This is clearly important work, and clearly not the province (or competency) of most finance departments. It’s time for professional firms to catch up with the rest of the business world and formalize the pricing job inside their organizations.