The second article presenting a case for Value Based Pricing
In our first article, we explored some of the basic concepts around pricing according to the value delivered and concluded that an adviser can influence the clients perception of value through focusing on ‘outcomes’ rather than ‘deliverables’.
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“Value, like beauty, it is in the eye of the beholder”
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It seems that the debate around the most effective way to charge clients is spreading across all “advice” industries with the legal profession now under attack around the way they charge clients. The criticism they are facing is that charging clients based on time or billable hours actually rewards inefficiency with higher remuneration having no direct link to the value delivered to the client.
If you are delivering significant value to a client, then why not be paid it? If you don’t believe that, the client won’t either.
How do we put a price on value?
Oscar Wild once wrote, “A cynic is one who knows the price of everything and the value of nothing.”
There is no scientific method to determine a price based on value as value, like beauty, it is in the eye of the beholder. Value based pricing is therefore more an art than science.
It is not enough to price based upon a client’s willingness and ability to pay. We must increase that willingness by constantly communicating the value of the offering. Nagle and Holden in “The Strategy and Tactics of Pricing”* presented their five Cs of value.
- Comprehend what drives sustainable value for clients
- Create value for clients
- Communicate the value that you create
- Convince clients that they must pay for value received
- Capture value with appropriate price metrics
Therefore, it is imperative that you are able to clearly demonstrate or quantify the value that you are providing.
It is easier to demonstrate quantifiable or tangible value such as an amount of tax saved or an increase in asset value. The difficulty is in quantifying the intangible or qualitative benefits such as an earlier retirement date, the trust in a relationship, the ‘sleep at night factor’ or the satisfaction that you can make your lifestyle choices. Although you should not have to justify your price to your client, you do need to be able to clearly demonstrate the value or the outcomes they will experience as a result of taking your advice.
There is also no moral obligation to charge two clients the same for similar advice. Firstly, the advice will never be identical and secondly, the perceived value to each client will always differ.
[tweet_box design=”default” float=”none”]Your duty is to demonstrate and justify the value, not the price.
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A great example of value-based pricing is in the way that surgeons charge for medical procedures such as cosmetic surgery. The cost of the surgery reflects the value of the procedure to the patient and compensates the surgeon for their knowledge, skill and experience. The cost is not determined by the actual time the surgeon spends in the operating theatre.
How would you demonstrate the value you are delivering to your client?
Let us explore how conceptually you could demonstrate the value you will deliver to a client. Please note, that there are many other factors that may influence the price that is finally presented to a client. These influences may include geographic location, competitive pressure, target market, the experience level of advisers and the depth of the advice offering. In the context of this discussion we are purely looking at one concept for quantifying the value delivered through advice.
In using value as the determinant for setting your price, the first consideration is to identify the tangible measurable value for which there is some degree of certainty given agreement on a number of conservative assumptions. The measurable value may comprise of a change in the client’s asset position due to a number of factors and any one-off identifiable savings.
»the improved asset position of the client due to the implementation of a number of strategies such as:
• Increased savings from more effective budgeting or better cash flow management
• tax savings from more effective tax planning and portfolio restructuring
• increased income received from positively geared investment properties
• interest savings from debt restructuring and implementation of debt management strategies
• increased asset base because of removal of adviser commissions previously deducted from investment accounts
» one-off tax savings through a specific component of advice
You would need to be clear with the client about the assumptions that are used in measuring these outcomes.
Step One: Identify the tangible benefits
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Value component;;;Position if continues as is;;;Overall position after advice is implemented;;;Value;nn;
Intangible benefits{;n}eg. peace of mind,{;n}security, freedom {;n}to choose, comfort etc…;; ;;;;;;$70,000;nn;
TOTAL tangible {;n}+ intangible benefits;;; ;;; ;;;$420,000;nn;
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This now gives a dollar value of improvement to the clients position of $420,000.
Step Three: Determine your price to deliver such value
You may decide fair compensation to deliver this value is, say, 20% of the total. Therefore your price is 20% of $420,000 which is $84,000.
Step Four: Determine the payment schedule
It would be rather difficult to charge a client $84,000 in year one, however you may choose to charge a client 15% of this value in the first year and then amortise the remainder over the next period at 5% per annum.
This would give you a fee in year one of: 15% x $84,000 $12,600
and a fee for each subsequent year of : 5% x $84,000 $4,200pa
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Value component;;;Position if continues as is;;;Overall position{;n}advice is actioned;;;Raw Value;;;Maximum Value{;n}delivered (@ 20%);nn;
Asset Position in 5 years;;;$500,000;;;$750,000;;;$250,000;;; ;nn;
Tax saving year one;;; ;;;$100,000;;;$100,000;;; ;nn;
Intangible benefits {;n}eg. peace of mind, {;n}security, freedom to {;n}choose, comfort etc…;; ;;; ;;;$70,000;;;;nn;
Maximum Value;;; ;;; ;;;$420,000;;;$84,000;nn;
;;; ;;; ;;; ;;; ;nn;
Value fee year 1 (15%);;; ;;; ;;; ;;;$4,200pa;nn;
Value fee year 2+ (5%);;; ;;; ;;; ;;; ;nn;
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The key to this approach is to work backwards from the ultimate client value, through your contribution to the delivery of this value and then determine the resultant price. Not the other way around. This gives you one example of how you could demonstrate and present the value you are delivering to a client.
As I mentioned before, value based pricing is an ‘art’, not a ‘science’ therefore this methodology is a guide only as to how you could demonstrate value until you are more comfortable moving away from the ‘science’ and more towards the ‘art’. The key to this is to be flexible, confident and most importantly focus on the perceived value being delivered to the client not on justifying your fee.
At the end of the day, the key outcome of value based pricing is that the client is delivered value at a fair price and you are fairly compensated for the delivery of that value.
“If you can’t articulate your own value, you can’t very well suggest value based fees. Look in the mirror and practice on the toughest buyer of all. The first sale is to yourself.”**
References
** Weiss Alan “Value Based Fees – How to Charge – and Get – What You’re Worth” (2002)
* Nagle, Thomas., and Reed K. Holden. “The Strategy and Tactics of Pricing: A Guide to Profitable Decision Making” Third Edition (2002)
