By Joel Barolsky. Based on the pioneering work of Colin Jasper
The 2-5-3 Method of Pricing Professional Services
PRICING PROFESSIONAL SERVICES can be a bit tricky. Go too high and you lose the client. Go too low and you leave money on the table.
One of the main reasons for this complexity is that the perception of value is different for every client and for every project. Each time you make a pricing decision it needs to be tailored to the specifics of the client and context. A one-size-fits-all approach to pricing is a recipe for profit disaster.
Keeping it simple and memorable
The 2-5-3 Method is a simple and memorable way to approach pricing every project. The “2” relates to your primary objectives in setting price. The “5” relate to the inputs or factors that should go in to the pricing decision. And the “3” are the three pricing decisions that you need to make, that is, price structure, price level and the pitch.
Pricing a project starts with being shockingly clear on your pricing objectives. In most instances there are just two: [i] getting the client to perceive good value and say ‘yes’, and [ii] delivering a handsome profit to our firm. Pricing is largely about finding the sweet spot where both your client and your CFO are happy.
Undoubtedly there will be times when your primary objectives will vary, such as winning an iconic brand-making project, getting onto a panel, buying share-of-wallet, positioning for future work, relationship building or revenue (not profit) maximising, but these are more the exceptions or variations of the rule.
Once your objectives are clear, you need to start to gather data to inform your pricing decisions. In the spirit of keeping things memorable I have labelled these the five C’s:
Cost – understanding cost of selling and delivering the project is clearly important in determining your margin and your BATNA (Google it if you think I’m speaking Bulgarian). It is recommended to use a simple spreadsheet to scope and cost the project before you price it.
Client value – the client’s perceptions of the importance of the project to their business and their relative price sensitivity will have a material impact on whether you can charge more or less. To help you explore what your project or service is worth to your client you may find Bain’s new 40 elements of client value framework particularly helpful.
Competition – pricing is likely to be quite different if the work is sole-sourced or, at the other extreme, your price will be compared to many other specialist firms.
Capacity – most high fixed-cost business like airlines and hotels use price as a key lever to optimise capacity utilisation. With large salary, rent and insurance bills, professional service firms should take a lesson or two from their corporate cousins. Offering discounts when your team is doing 16-hour shifts is not the smartest way to do business.
Connection –Your pricing will clearly be different if the client is a one-off transactional buyer (ad-hoc relationship) versus a partner relationship. Interestingly, there are different views on the level of discounting for partner relationship clients. One opinion is that you should offer your best deal to these clients as a loyalty dividend. Another perspective is that your fees should be higher to reflect the extra value you’re creating by knowing their business intimately.
Our firm's PRICE HIGH OR LOW app has been designed to help professionals set the right price level by rating and weighting these five 'C' factors and other criteria if relevant. This app mirrors the decision process sellers typically go through in their head and brings some rigour to the calculation.
With clear objectives and the right data in hand, you’re then in the position to make some choices. Pricing usually encompass three inter-related decisions: what price structure(s) should we offer; what price level should we set; and what’s the best way to pitch our offer.
In law and accounting firms the most common pricing structure is still time-based hourly rates. Fixed fees, value pricing and retainers have been gaining in popularity in recent years. In consulting and engineering, project fees with variation clauses are most common. Investment bankers usually price with a percentage of transaction value contingency fee.
An excellent reference article on different pricing structures can be found on the Patrick on Pricing website.
In my view, there is no one perfect pricing structure. The structure chosen will usually be a function of, amongst other things, client preference, relative bargaining power, nature and level of risk, depth of relationship, scope and benefit certainty and degrees of co-creation. Quite often you can augment your pitch by offering clients multiple pricing structure options. My recommendation is to become expert in three or four structures along the risk-sharing continuum. This way you can offer clients more choices and respond to different contingencies.
Price level is the amount to be charged within the structure you’ve selected. So if it’s hourly rates then the level is ‘$350’ per hour, if it’s a fixed fee then the level is ‘$8,500’.
Pitching involves the strategies and tactics of communicating value and getting to ‘yes’. It includes the approach to presenting different pricing options, project staging, pitch presentation, and the approach to conversations about price and value.
To illustrate the importance of price pitching, Qantas’ website usually presents its customers with three benefit-price options for every flight. Interestingly, the 8:00am flight from Melbourne to Sydney on 15 March has one option that’s 598% higher than another. These three options involve the same brand, same plane, same pilot, same airports, same flight duration, just a different level of amenity, status and flexibility. Qantas’ pitch is noteworthy for three reasons:
It optimises value capture, i.e. those seeking more benefits and/or are less price sensitive pay a lot more,
It ‘frames’ the economy option to look like an amazing deal, and
It discourages customers to shop around (if just one option was provided most customers would immediately jump on Virgin’s site to compare).
So lock 2-5-3 method of pricing away in your brain. It’s not rocket science, but hopefully it will make sure your next project is priced fairly and profitably.
Credit to Author: Joel Barolsky. Based on the pioneering work of Colin Jasper - September 9, 2020.