Warren Buffett, CEO of Berkshire Hathaway, once said:
“The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business.”
The above statement perfectly illustrates the power of pricing. That is, how setting and being able to get the right price for your business offerings can mean increased profits for your accounting firm. Pricing certainly is a factor that has the power to boost or hamper the operating margins of your firm.
According to Mckinsey, effective pricing strategies can result in a 2 to 7 percent increase in Return on Sales (ROS). Were ROS is nothing but the amount of profit being generated on every Rupee of sales.
Other factors like reduction in fixed and variable cost or incremental sales revenue also influence the operating profits of a firm. But it is price as a factor that drives your firm’s profitability to a greater extent.
Despite the fact that price has such a big influence on your margins, you as a business owner are unable to demand the right price for your business offerings.
In fact, many times you are compelled to take the price offered by the buyers. This is on account of your low cost competitors, knowledgeable buyers or their experienced procurement teams who have the tact to work out ground breaking deals.
As said, you can certainly work on areas like cost reduction to maintain your profitability. But, having the right pricing strategy can have a positive long standing impact on your firm’s profitability.
Unleashing The True Power of Pricing
In order to realize the true power of pricing, it is necessary that you understand what is the worth of your business offering in the eyes of your customers. In other words, how much value do your customers place on the business offering that you offer to them.
Further, how does your business offering compare with the products or services offered by your competitors. This approach of pricing your products or services is called Value Based Pricing.
Accounting industry is getting inclined towards including value added services in addition to the core services of the industry such as taxation and auditing. As a result, accounting firms are able to distinguish their services from their competitors and are able to shift towards a value based pricing approach.
This article talks about the concept of value based pricing, its key benefits and how accountants can apply the same to their accounting firms.
What is Value Based Pricing?
Value based pricing is a pricing strategy by which you are able to set prices based on your customer’s perception of the benefits of your product or service. This method takes into account the value your customers attach to the benefits they derive against the price they are willing to pay for your product or service.
Such a pricing strategy is customer centric. Thus, it requires a complete shift from the cost based pricing approach. Under cost based approach, you fix the price based on the cost of your inputs such as time, labour etc and then add your margin.
Value based pricing is not about what you think your business offerings are worthy of. Rather, it’s your customer who determines the worth of your business offerings and whether he is willing to pay a premium price for the same.
How does Value Pricing Work?
Value based pricing is based on how much your customer perceives your business offerings are worth and the premium price he is willing to pay for such offerings.
This is different from cost plus pricing where you as a chartered accountant charge based on cost of inputs plus the profit margin. Or hourly billing rate where you charge a fixed rate per hour for your accounting services.
Therefore, it is a subjective pricing strategy and thus prices would vary from customer to customer.
In order to implement value based pricing in your accounting firm, here are some points you must keep in mind:
a. Identify a Single Market Segment
This is the first step towards implementing a value based pricing strategy in your accounting firm. Customers belonging to different segments value your services differently.
You would not be able to use value based pricing until you have a specific customer segment. If you have multiple customer segments, you must determine value based price for each of them differently.
Say for example you have the basic auditing and taxation services priced at Rs. 30,000. Now, there exists a segment of customers who want to take business advisory services to understand what their financial statements imply?
So, you include business advisory as a part of your services. According to your analysis that takes time, resources and cost into consideration, you price these additional services at Rs. 10,000.
Accordingly, your basic package for such a client segment would now be priced at Rs. 40,000. But on interviewing some of your clients, you get to know that they attach a higher value of Rs. 30,000 to business advisory service for the value they receive in return.
Therefore, you can now charge Rs. 60,000 for basic services to this customer segment.
b. Know the True Economic Value
Perceived value is also known as True Economic Value. As per Harvard Business School’s Marketing Toolkit:
True Economic Value = Cost of the Best Alternative + Value of Performance Differential
Cost of the Best Alternative
Many firms adopt the approach of ‘next best alternative pricing’ to value based pricing. It’s nothing but simply preparing a list of next best alternatives your customers have in the industry in case they do not buy from you or your business offerings do not exist.
Having a list of ‘next best alternatives’ gives you further insights about the prices your competitors charge for a given product or service. Further, it helps you set prices for your business offerings in a better way.
Value of Performance Differential
Once you have the cost of the next best alternatives, next you quantify the value of differentiation you are able to create via your accounting services.
Identify the business offerings that you provide to your customers that your competitors are not able to give and quantify the same.
This will give you the value of performance differential – that is the differentiated value of your business offerings that differentiate your offerings from that of competitors.
Benefits to Value Pricing
Value based pricing helps you demand a higher price for your accounting services. This is because you can charge for your knowledge and results you generate for your client.
Unlike hourly billing, where everything boils down to cost of inputs and time you give your customers.
Predictability in Prices
Since the prices are fixed before the work actually starts on the customer project, there is no last minute confusion and surprise for the customer for prices.
Customers know what they are paying for and how much at the beginning of the project which brings transparency. The customer is not afraid to get work done due to the hourly fees.
Since the chartered accountants in your firm are not time bound, they are able to deliver quality services to your clients.
They become efficient unlike under the hourly rate fee, where they are expected to work under tight schedules. There’s always a clock ticking price is associated with time.
Attract Great Talent
Again, since your employees do not have the time burden, they are able to create higher value for your customers. As a result, you are able to attract and retain talented employees.
Examples of Value Based Markets
Industries where firms are able to provide highly distinguished or valuable business offerings are able to take benefit of value based pricing.
There is an increased inclination towards value based pricing in professional services provided by doctors, lawyers, attorneys, chartered accountants etc.
Similarly, luxury goods and services segments such as luxury cars, high end fashion brands offering apparel, personal care products and accessories, boutique hospitality services also adopt value based pricing model.
Value Based pricing Vs Hourly Based Pricing
Even today, hourly based pricing is one of the most widely used methods of pricing services by accounting firms.
But the reality is that hourly based pricing model has certain inherent attributes making accounting firms shift from hourly billing to value based pricing:
Income is Limited Due to Time
Since the price you demand from your customers is based on the number of hours you take to complete the project,you can only charge for the time spent on the project.
This is unlike the value based pricing, where accounting firms can demand higher prices for the value they create for their customers.
Since there’s a time factor involved in cost, you can only dedicate limited hours to customer project. Customer would always keep track of time, which kills innovation and efficiency of your employees.
Higher Odds of Confusion Over Invoices
There can be instances where it takes more hours than what you committed at the beginning to complete the project.
Specifying additional hours in the final invoices gets the element of surprise for the customers making both the parties spend endless time on spreadsheets justifying the additional hours.
This is unlike value based pricing, where customers are clear with an amount of price they are paying for the services.