A commodity-based service is priced to benefit the seller of a service; and a value-based service is priced to benefit the customer. It sounds a bit controversial, but a closer examination will reveal more.
Said another way, in order to be competitive, a company that has commodity based service offers that service at the cheapest price possible. They do this because price is the primary differentiator. This is the classic definition of a commodity.
Commodity-based services employ a cost plus pricing model, which means the workers and overhead comes at a cost, and they add profit on top of that cost. The total cost for that service is in the ballpark of other competing service. There are few differentiators across competitors, they are derived from similar attributes, and the product they offer is fairly well standardized.
Oh, there may be a few things a commodity service can do to differentiate from competitors, like offer a better quality service by earning certifications that attest to the level of quality, like CMM or ISO. They could specialize in a particular domain, or offer a one-stop shop that can augment your staff in any way you want. Essentially they are a body shop; you just pick the size and features.
There is pretty much only one thing a commodity-based service can do to maximize profit. They can lower costs, and the principle cost factor is people. So, they employ the lowest cost labor possible. This creates a dilemma, balancing the quality of the work force with a profit margin that sustains growth. There are other factors that can influence profit, but the cost of people is the primary one by far.
It’s plain to see that with a commodity based consulting model, pricing is focused on the needs of the consulting service, not on the customer. The charge is to deliver a commoditized service at the best price possible.
A value-based consultancy is the antithesis of the commodity-based service. Pricing is based solely on the delivery of value to the customer, either estimated or perceived. The difference is that margins are significantly higher than commodity-based pricing, and so are salaries, because of the need for a more highly skilled work force. A value-based consultancy that does their job well will be highly profitable and position itself for faster growth.
Consulting, by it’s very nature, is the act of providing expert knowledge and advice to a customer, presumably to help the customer make a business decision that benefits them. A price is negotiated for this service, and the settlement of that price is based on the value perceived.
So, in an ever increasingly competitive marketplace, the commodity-based consultancy often looks to differentiate itself by trying to be more like the value-based consultancy. So they’ll attempt to be more customer focused, bringing on a few more experienced consultants and taking on a few more ambitious client engagements, but they continue to price themselves like a commodity, as they don’t truly base pricing on the value they deliver. They revert back to what they know, and staff these projects with commoditized labor, and operate without any true adherence to the principles of value-based consulting.
The problem is the two business models are orthogonal; they are incompatible at the core. You simply can’t be good at both at the same time; one side of the equation must be subservient to the other, unless the company makes a logical separation.
So, what are the principles of value-based consulting and pricing?
First of all there’s the people. In a value-based consultancy it is important to have rock stars, peak performers, the most experienced and gifted employees you can find, cost is of little concern, you pay the highest prices to get the best. You’ll need them to deliver the kind of value your customer will pay for happily.
The next thing is you have to know your customer’s business and how to deliver real value. You must identify early on in the engagement key performance indicators (KPIs), because your pricing is going to depend on you explicitly showing the value you bring to the engagement.
So, this is the setup, following are the principles of how a value-based consultancy engages a customer and prices that engagement, based solely on the customer’s needs.
- Avoid all discussion of price until you thoroughly understand the customer’s goals. All pricing is going to be based on the customer’s ROI, so until you can make this case, a discussion of price will be of zero value.
- Price the service based on the relative value. If you help a client make $1 million with a solution, and you charge say 20 percent, or $200,000; that seems like a fair deal. But what if you provide the exact same advice to another client and they make $100 million on your solution? Well, you still charge 20 percent, or $20 million. And because you delivered it sooner than expected, regardless of the fact that you already had the solution from previous work, you provided even greater value for delivering it fast, so you are perfectly within your rights to charge a premium on top of that. It’s all based on relative value.
- Never compare your service to competitors. This is what commodity-based services do, and you are not one of them. If the customer wants the commodity, then refer them to a company that can supply what they want.
- Think different, think strategically. Build trust with a customer, sometimes you have to take on small projects first, until the customer feels good about working with you. But that doesn’t mean working at a discount; it just means you hold back the real value until you know their business better than the customer does. Or at least in the area where you can deliver value.
- Never offer discounts. If the client refuse to get off price, they say your too expensive, just remember, it’s not a price issue, they are saying it’s an unacceptable investment for the return they expect. You are showing them the wrong solution, so show them another, add something that will alter their perception. If they don’t think it’s affordable, then strip away features until it is, but never drop your price.
- Position your company as a premium service. Always be aware what your competitors are charging, this intelligence is critical. You don’t want to be perceived as cheap, that’s what you want the perception to be of your competitor. It’s a psychological thing. Do you really think a BMW is that much more expensive to build than a Toyota? That’s a big rhetorical NO! So, then be the BMW.
- Look for value-adds. The reason you hire senior people is so they can size up KPIs early on. This is the nut of the business, all pricing is going to be base lined on this measure, and you’re going to demonstrate it to your customer every step of the way. And always hold back something, a negotiating chip to redeem for bringing more value than was originally expected.
- Become a trusted advisor. You need to build and develop trust with your customer; otherwise some of the questions you’ll want to ask will seem off limits. But if the trust is there, if both parties understand the motives of the questions, you can really get down to what is important and what constitutes real value.
- Stretch it to the limit. Once you discover the customer’s objectives, their pain points, the things they find most value in; then you must drive them to the extent they are willing to take it. The customer may only have a budget to do so much, and they may not know what that gets them. So you need to understand how big the field is you’re playing in, where’s the sweet spot, and the goal lines. This is the yardstick everything else is based on.
- Know where you stand. Ask the question; has the client engaged anyone else, are they planning on engaging others for any other part of the project. And ask; why did they consider you for this portion and not for the portion the other consultant is doing. You need answers to all these questions so you can position the value you bring relative to others, so you can price the project with conviction.
- Keep a constant dialog going with your customer. Get to know other stakeholders in their organization, try to gain an understanding of the social and political dynamics and how that might affect what your proposing to your guy. Look for other opportunities with these extended relationships; explore them, don’t be timid, climb the ladder, but be careful you don’t step on land mines Sometimes politics are hidden behind a façade.