High Impact Fee Negotiation and Management for Professionals (002)

Ori Wiener, author of High Impact Fee Negotiation and Management for Professionals, asks the question many of us want answering, how much are we worth?

Price is what you pay, value is what you get.

(Or so said, Warren Buffet, who was himself quoting Benjamin Graham in the Berkshire aHthaway 2008 annual report)

As the quote above demonstrates, irrespective of what might be determined as the value of an assignment, professionals and clients need to agree a price for the service. Given the difficulties in determining value it is not surprising that many professionals and clients skip the value challenge and go straight to price. One contributing factor is the tendency for clients to ignore value as soon as they are able to identify a PSF’s rate structure, eg billable time units such as hourly or daily rates (Weiss, 2008a). This backdrop and the wide usage of such rate structures add to a professional’s challenges to focus fee discussions on value.

Practitioners tend to adopt one of four methods for determining the price for an assignment:

  1. Simple value-based
When a value approach is used, it tends to be based on a crude percentage of the value of a transaction or project, eg the amounts of capital raised, the amount of costs or tax saved or the total expenditure in relation to the construction of a building. These percentages tend not to reflect any differences in quality of service or other differentiating service attributes.
  1. Input or cost-based
Under this approach an estimate is made of the total cost of providing the service or project. In the case of most PSFs this means using some sort of time-based cost (hourly, daily or weekly rates) and adding a profit margin. This requires an accurate estimate of the volume and scope of work required.

Many PSFs will apply different rates according to the level of skills of the professionals involved, particularly if leverage, ie the application of junior or support resources, is possible.

There are a number of issues associated with this approach, which are extensively covered in the literature. The biggest problems with a cost-based approach to pricing are that it:

  • provides relatively little incentive for efficiency;
  • does not on its own pay attention to the benefits accruing to the client; and
  • tends to limit the earnings capacity of the professional or firm to the total amount of resources available, typically time.
Some writers (eg Weiss, 2008a, 2008b) on this topic also suggest that this approach creates ethical problems in that any productivity improvement gained as a result of acquired expertise (ie faster completion) will lead to cross-subsidization from early clients, effectively paying for the learning curve in favour of subsequent clients. Others (eg Hill, 2013) point out that many professionals do not understand that the ‘plus’ in cost-plus includes a profit margin, usually set as the required profit margin to meet the year’s budgeted profit and hence profit distributions. This leads all too often to excessive discounting on the wrongful assumption that a discount will still yield an acceptable profit.
  1. Market-based
For many PSFs and practitioners the most common approach is to set a price in relation to the ‘going’ or ‘market’ rate. Under this approach, firms and individuals will set their price at a premium or discount relative to their competitors and will then attempt to negotiate with their clients based on perceived or actual differences in offers. In theory, this should result in efficient pricing as the above listed factors would contribute to price determination. In practice, however, few markets are sufficiently transparent and few services sufficiently comparable to be able to guarantee efficient and fair pricing.

Under such a system the firms with the greater negotiation power and skills are likely to capture the lion’s share of economic value. The issue here is that too many professionals take the price (assuming they can establish one) as a given rather than questioning how they could differentiate. This would require enquiring further into what clients would pay more for and why. Likewise the market price may not be acceptable to a specific client.

  1. Last year plus
The fourth method found in almost all PSFs is to use last year’s prices and add a bit. This ‘bit’ is usually linked to inflation and sometimes but too rarely to changes in the market. There are a number of problems with this approach. The first is that it perpetuates prior mistakes where prices have been based on cost or market values. The second is that clients may or may not be experiencing the same inflation as the PSF firm, so the disconnect between price paid and value received is likely to increase and prompt further resentment.

Another perspective to be considered is the overall relationship. Some pricing structures such as volume discounts or success/abort fees only make sense if there is a minimum number of projects in a given time frame. This allows risks to be spread out over the total number of projects, rather than be concentrated only on one. A success/abort fee may be too risky if applied only to one instruction (especially if it is material in size). On the other hand, assuming a reasonable spread of wins and losses, the risk of only applying the ‘abort’ part of such a fee arrangement is dramatically reduced when several projects are considered.

My view is that none of the above methods is sufficient on its own. Rather, my preferred approach would be to view pricing from a number of perspectives. I would, however, try to put as much effort as possible into the value perspective as this is, to my mind, the only way to generate premium value and to differentiate from competitors.

This extract from High Impact Fee Negotiation and Management for Professionals by Ori Wiener is ©2017 and reproduced with permission from Kogan Page Ltd.

High Impact Fee Negotiation and Management for Professionals by Ori Wiener offers the most comprehensive and practical guide available to help all professional services fee-earners ensure that they get paid exactly what they're worth.

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