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Professional Service Pricing: Beyond the Hourly Rate and into the Deliverable

February 2016 Pricing

While some professional service companies are laggardly stuck with the billable-hours business model, leading professional service providers in legal, management consulting, and accounting have adapted to deliverable based offerings and pricing.  How do they do it?  Why do they do it?  And, is it really happening?

Pricing Legal

Is Deliverable Based Pricing common in the Professional Services Industry?

Deliverable based pricing is not only possible in the professional services industry, it is common. We can find examples of it from legal services to consulting and accounting.

For example, Attorney Drew Vaughn has a NuVorce offering. For a pre-paid fixed fee, Mr. Vaughn will provide divorce settlement services in Chicago. The reported results are both a more profitable practice for Mr. Vaughn and a lower overall cost of representation for most divorce clients.

Similarly, tax accountants often offer fixed fee services for completing tax filings and otherwise providing regular accounting services. Set-fee services are not just offered for individual retail tax clients, but also many small businesses can purchase routine accounting services on a fixed-fee basis.

Even in management consulting, leading firms are offering fixed-fee contracts. At Wiglaf Pricing, we offer fixed-priced services in modeling the exchange value to customer, voice of customer research, conjoint analysis, price variance analysis, price management diagnostics, and many other areas.

How to Get to Deliverable Based Pricing

Deliverable based pricing requires a different skill set than simply billable-hours pricing. It requires project management.

In deliverable based pricing, prices are tied to deliverables, not effort.  In order for that to work in favor of the service provider, that provider has to know, plan, and execute what it takes to achieve the defined deliverable with the client.  (Laggard service providers may be afraid of deliverable based pricing precisely because of their project management skill-set deficit – but it is something they can learn.)

Basics of project management include scope, timing, and budget.  (The budget is often based on the billable-hour rates, which implies that service provider must first know how to price their billable hours before attempting to price a deliverable. See Standard Service Pricing:  Easy Enough but Not So Easy)

Project Pricing

Every project is managed by its scope, a timeline to accomplish that scope, and a budget required to execute. Prior to entering into a client engagement, the scope, timeline, and budget must be defined with the client.  During the project, the professional service provider must manage his/her services to that scope, timeline, and budget.  If any of these variables start to change, the professional service provider must determine whether that change requires a change order (with an increase in fees) or if those changes can be accommodated under the current contract. Upon delivery of services, that service provider must get sign-off on the contract indicating that the project was completed to the client’s satisfaction.

To get to this level of project management, the professional service provider has to develop two input skills: (1) They have to know the action steps required to accomplish the scope and how much work each action step requires.  That takes experience within the specific areas where defined offerings will be made.  (2) They have to be able to manage client engagement as well.  Value is co-created with the client in professional services.  As such, many of the action steps require input from clients. Thus the service provider will often find themselves managing the client as much as his/her own work.

Benefits and Pitfalls of Deliverable Based Pricing

Compared to billable-hour based pricing, deliverable based pricing in the professional service industry is far superior when it can be done.

For the client, it allows them to clarify, up-front, the expected outcome and cost of the project. This greatly reduces the perceived financial and outcome risk of the client. It also places the burden on the client to know what they really want before they enter into the contract. (To get the client to that stage, the selling effort has to move beyond “this is how great I am” and into “let me understand your problem so I can define a route to solving it with you.” Such solution-based selling is difficult for some industry laggards, but again, they can learn.)

For the professional service provider, it creates a more predictable and manageable business. That service provider can wake-up each day knowing what actions they have to take to deliver to client expectations, forecast their revenue based on when they anticipate completing a project for a client, and even forecast required support (costs) to accomplish that effort.

Plus, most of the time, the professional service provider makes more money through two routes: (1) By reducing the perceived risk for the client, the professional service provider may find it easier to close business, therefore they find their revenues growing faster than their laggard competitors. (2) By including project management in their offering, they find they can mark-up the price of their services over that which they could achieve in a straight billable-hour basis.

Deliverable based pricing is not without its pitfalls though.  If the project is ill-defined or ill-managed, or if the client fails to participate appropriately, the project may spin out of control.  Fortunately, with deliverable based pricing, the professional service provider does hold the power to cease servicing the client, and thus stop the project creep before it gets too bad.

Why Deliverable Based Pricing is Superior

The underlying reasons which make deliverable based pricing arise from aligning risks and incentives.

Prior to entering into a contract, clients rarely know what is required to accomplish their objectives as well as the professional service provider. As such, the client is ill-positioned to manage the project. This creates unnecessary project risk: risk that the project will take more money and time than the client anticipated, and therefore risk that the project will fail to satisfy the client.

In contrast, the professional service provider should have experience in the area they are providing services. As such, they should be able to anticipate the required effort and time, and therefore budget, required to accomplish the objectives. Hence, they are able to mitigate and/or manage the risk that the project will fail to meet the client’s objectives on time and on budget.

As for incentives, billable-hour based pricing provides an incentive for the service provider to deliver a bunch of billable-hours regardless of the value of the time spent with a client. Limiting this incentive may be the desire of the professional service provider to earn a good brand, retain a client for future work, reduce high-bill complaints, and their own code of ethics. Yet, even with these other factors, it is impossible to deny that billable-hour based pricing encourages professional service firms to sell a bunch of hours.

Deliverable based pricing provides an incentive for the service provider to deliver the defined objectives efficiently and effectively.

Put in these terms: it is almost amazing that billable-hour based pricing still exists for it basically gives the professional service provider an incentive to be inefficient and ineffective once they have captured the client.

Laggards Convert!

Given the precedence, benefits, reasons, and pathway to deliverable based pricing, it is almost amazing that any professional service firm still sells billable hours. Yet we do.

Not every client engagement can be well defined. Not every service can be “productized” and sold on a deliverable hour basis. Sometimes, clients really do want an open-ended relationship. When these things happen, reverting to billable-hours is the most appropriate pricing method.

But where it can be turned into a project, professional services should bill accordingly. It is more profitable and creates higher client satisfaction. And that is what professional services really aims to deliver isn’t it? Client satisfaction, if not delight, along with some profit?

 

References

Bushey, Clair. “A new twist in divorce litigation”. Crain’s Chicago Business (23 November 2015), p.4.



About the author

Tim J. Smith, PhD is the Managing Principal of Wiglaf Pricing, and an Adjunct Professor at DePaul University of Marketing and Economics. His most recent book is Pricing Strategy: Setting Price Levels, Managing Price Discounts, & Establishing Price Structures.

Tim J. Smith, PhD
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