Pricing Services – when tactics won’t work

A few recent projects have reminded me how partners often get caught in between the market and their own firm, and struggle to deal with real world pricing issues at a tactical level. The warning signs are typically of partners finding the prices they are expected to charge are simply unacceptable to their clients. At a tactical level, partners then start agreeing unrealistic budgets, reducing their hourly rates, or writing off a lot of the work they have carried out. There are a number of causes and there are solutions. But the solutions need the firm to take a more strategic view of the problem – no amount of negotiation, discounting, or team juggling will get you there. Let’s look at three of these situations in detail.

1. The Price Buyer

I first came across this expression in the works of the author and consultant Reed Holden. He used it for buyers (clients as we call them) who are focused on the cost of what they are buying. Now you might think this is all clients, but it is not. From a Price Buyer you will hear the constant need for “more for less”, “innovation” and “efficiency”, but these are cover words for “cheaper”. It is often driven by cultural dimensions in the client, who may themselves work on low margins (supermarkets, many banks) or simply as a core value (I recall a client whose core value was “frugality” and all flights without exception were in the cheapest class). Now there is nothing inherently wrong with these clients UNLESS you are set up to serve “better” ones who feed more than lowest price into their choices.

And the vast majority of professional services firms are designed, from the ground up, to serve a different segment of clients. Partners have a cost base (great City Centre Offices; big conference rooms; high associate salaries; training and marketing spend) that means that they cannot successfully serve Price Buyers. I meet these partners every month in Europe and North America. They develop a whole series of tactical responses to try to make things work – longer hours for everyone (no overtime pay in firms); not recording all their time; complex pricing arrangements. But as soon as the firm is able to examine profitability, it all falls apart. Despite the incredibly hard work of the whole team.

However, you can make good profits from Price Buyers if you make strategic decisions as a firm. You can set up a separate division, with staff and offices in a different much lower cost location. You can build your “Ryanair” version of a professional services firm with a focus on innovative working practices, low pay, technology, self-serve and so on. Ryanair makes big profits. But you need to be committed to saving money above all – and that doesn’t sit well with the typical professional service firm partner.

I have seen this work. Before visiting a bank legal department (with a ferocious cost cutting reputation) I spoke to two of the firms on their panel to get a feel for how things were going. The first firm had an easy answer – faced with yet another demand to freeze rates for two years it had refused and left the panel. Not surprising (except that this had taken so long). More surprising was the second firm – “One of our most profitable clients,” they said, “would love to get more work from them.”  Why? It turned out that this firm had a satellite office handling volume work and had simply passed all this client’s work from London to the regional office. Both the client and the firm were happy. The team in London had moved on.

Personally, I have worries about dealing with Price Buyers as they focus on price not on value. And at some point, the constant demands for savings, and a willingness to switch out of you for a small saving, causes problems. They never stop asking for more for less. But if you thrive on efficiency challenges, and if your firm enjoys a cost base advantage over your competitors, then it may be OK for you. But not for me.

2. Second Level Work

I see this issue in absolutely every professional service firm that I work with. Teams are handling work that is entirely appropriate for them, their skill level, their team and their location. It really is in their sweet spot. This is the type of work that they trained for, they can charge an appropriate fee, and have happy clients.

But….. they also have some lower level work. There are a wide range of reasons why they are handling this work, which include:

  • A client generates a lot of work – some of this is in the sweet spot, some is lower, but they do not want to turn away the lower work (but they do it at a lower price)
  • They say that need some less specialist work to train their associates
  • They say that they need to do the lower level work in order to win the higher-level work
  • They worry that if they let a competitor in on the Second Level Work, they will find that competitor will move up to the better work over time
  • Work in their sweet spot ebbs and flows. By taking on lower level work, they help to manage the quiet periods
  • They need to advise start up companies because some of them will prove to be the next Amazon – but start ups cannot afford high fees

Some of these reasons are pretty good, some of them can be challenged (and quite simply by asking the client!)

The problem arises really because partners cannot make the same profit return on Second Level Work, because it simply will not bear the same price as the better work (which is what the team is set up to do). Partners have all kind of tactical responses (the worst being to give the client two different hourly rates, a lower rate for Second Level Work) but they cannot disguise that they cannot make the same profit from this work! Not with the existing team anyway.

I see a range of possible solutions, but they need partners to step back and take a strategic decision, and stop applying sticking plasters. First, do they really need to do this work – if they do then, at the firm level, agree that it will return a much lower profit, or that you will transfer it into a low-cost division (see Situation 1 above). Make sure it is separated clearly from (and handled differently to) your best work, or the clients will soon want all of their work done at this lower price point. Or, with the agreement of the client, stop doing this work. Have an adult conversation with the client and agree what work is best for you, and what is not.

3. Commoditisation

It is an inevitability that, over time, some of the best work becomes more routine, and can be handled more easily, at a lower cost (by different people). This third area where I find partners struggling with prices, is where work that previously justified the involvement of them and their team, has “moved down” and is now seen as more routine. Clients are looking for lower prices and prepared to move the work to smaller and cheaper firms. Partners are fighting this by dropping prices to hold onto the work in their existing team. They may also argue that this work provides training opportunities for associates but, as before, the issue then becomes profitability. This work is now worth less to clients who will move to cheaper competitors if partners try to maintain the old prices.

The real problem here is that the change can be quite gradual so that it is only bit by bit that the partner finds that their profit margins are falling, or the work is being lost. Simply dropping prices may bring temporary relief in holding on to the work, but profit takes a dive. What to do? Partners tend to delay making any strategic move because they fear that they will need to fire team members in the process – people that they recruited and trained. And just like in Situation 2 above, they may argue that doing this commoditised work is important in retaining an overall relationship, and keeping out competitors. This is certainly one area where I suggest partners talk to their clients. More often than not the clients have already segmented the work and may be wondering why these partners are still doing it or fighting to keep it.

Then you are back to a strategic decision – if there are good reasons to keep it then either accept the lower profit (and changed team and procedures) or set up a Ryanair operation and really go for it (but take note – if you become great at Ryanair type work, this will start to impact your market reputation and brand, “Use that firm, they are great at lower end work”.)

Market segmentation

Of course, you can approach all of these issues by using a market segmentation project – spotting where you are strong and where there are profitable opportunities. This is a strategic exercise and needs to be carried out at Board level – not by individual partners or departments. Decisions at this level determine the profitability, market position and reputation of the firm. In addition, with the support of your own Pricing and Marketing Teams (or the use of excellent external consultants!) the answers can become very clear. But dealing it with on the front line, with tactical solutions, always fails.

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