By Ronald J. Baker
One of the most frustrating aspects of teaching Value Pricing to professionals is their tendency to believe that customers have to be part of the change process.
This is demonstrably false. Customers may have to be convinced of a firm's value in order to accept it's price, but customers should not be expected to be participants in changing a profession's (or industry's) pricing strategies, any more than they should be expected to innovate new products and services.
I can find scant few examples in the history of commerce where buyers changed a pricing paradigm for an entire industry. Pricing changes are nearly always done by the sellers.
Why? Basic economics. Sellers sell hundreds, thousands, or millions of times, whereas buyers purchase relatively infrequently. Therefore, sellers have every incentive to maximize the sales price, and as any economist knows, incentives matter.
It doesn't matter if it's Business-to-Consumer or Business-to-Business markets. This is the nice thing about economic theory. It applies to all human behavior, no matter the product or service, or type of customer.
No customer ever asked the airline, hotel, cruise ship, retail, or software industries to adopt Yield Management (YM). Yet, YM is one of the largest innovations in pricing strategies since the airlines began to adopt it in the 1970s after deregulation.
They didn't ask their customers if this was acceptable. They didn't hold discussions and roundtables with both buyers and sellers, facilitated by third parties, trying to figure out if this was the right thing to do, as the legal profession has been doing for more than a decade. They just did it. Once it proved successful, the rest of the airlines followed.
If buyers changed pricing strategies, organizations such as the Professional Pricing Society wouldn't have sellers as members.
The incentives are all on the supply side, not the demand side.
In the June 2006 issue of Harvard Business Review, Editor and Managing Director Thomas A. Stewart interviewed Jeff Immelt, chairman and CEO of General Electric. Stewart pointed out that Jack Welch tended to focus on efficiency, with initiatives such as Six-Sigma and so on.
Immelt's focus is different. He wants GE to grow organically, two to three times faster than world GDP. Immelt explains how he intends to achieve this goal, recognizing the realities of the knowledge economy and the importance of pricing on purpose:
If we can create a sales and marketing function that's as good as finance at GE, I'll change this company. In a deflationary world, you could get margin by working productively; now, you need marketing to get a price.
How do we make sure people don't say, "Jeff doesn't care about productivity"? I think a lot about how to shine light on a new commercial leadership program and assure the audit staff that I still love them.
I tell them, "Can you imagine how great this company is going to be if the salespeople are as good as you?" We're getting the sales force better trained and equipped with better tools and metrics.
A good example is what we're doing to create discipline around pricing. Not long ago, a guy here named Dave McCalpin did an analysis of our pricing in appliances and found out that about $5 billion of it is discretionary.
Given all the decisions that sales reps can make on their own, that's how much is in play. It was the most astounding number I've ever heard — and that's just in appliances. Extrapolating across our businesses, there may be $50 billion that few people are tracking or accountable for.
We would never allow something like that on the cost side. When it comes to the prices we pay, we study them, we map them, we work them. But with the prices we charge, we're too sloppy.
Yes, you read that correctly — $50 billion is "discretionary," a polite term for how much GE is leaving on the table because of sub-optimal pricing.
Put this in perspective. For the year ended December 31, 2006, GE had total revenues of $163 billion, hence they are leaving approximately 30 percent of TOTAL REVENUES on the table with sub-optimal pricing. And GE is an intelligent company.
Does anyone think GE can increase "productivity" or cut costs by this amount? Or increase revenues by this amount through growth?
The number one argument we at VeraSage hear about our philosophy is: "How would you know if you're making money without timesheets"?
This is the wrong question. Of course you're making money, especially in a Professional Knowledge Firm (PKF) environment where margins are not thin.
Yet no matter how accurate your timesheets and cost accounting, you will NEVER be able to answer this far more important question: "How much money are you leaving on the table because of mediocre pricing"?
It's obvious — I hope — that the amount in answer to this question will dwarf the amount at risk in the first question. PKFs will not become better at pricing by becoming better at cost accounting. If that were true, GE wouldn't be leaving $50 billion on the table.
What possible good is it to know your costs to the penny without understanding the value of your services to the customer? This is why enlightened PKFs let value drive price, and price drive costs.
In effect, cost accounting is performed before the work is started, not after. This is especially important since no one really knows what a cost should be; something cost accountants don't understand at all, since they only see the costs after the fact.
This is precisely how Toyota prices without ever having a standard cost accounting system. That should send a shutter down the spine of everyone who believes that you need cost accounting to be a profitable, dynamic company. It falsifies that theory, to put it mildly.
If GE is leaving $50 billion on the table, how much is your firm leaving on the table due to substandard pricing? Your timesheets, realization, utilization, or any other myopic cost metric you measure, will not answer this question.
This number dwarfs what you could achieve by cutting costs, rainmaking, or increasing so-called "efficiency."
Work on creating value, and capturing it through excellence in pricing. It's the number one driver of profitability in GE, and your firm.
About the author
Ron Baker is the best-selling author of "The Firm of the Future: A Guide for Accountants, Lawyers, and Other Professional Services;" "Pricing on Purpose: Creating and Capturing Value;" "Measure What Matters to Customers: Using Key Predictive Indicators;" and "Mind Over Matter: Why Intellectual Capital is the Chief Source of Wealth," from which this article has been adapted. You can reach him at (707) 769-0965, or e-mail at Ron@verasage.com. He Blogs at www.verasage.com. Copyright © 2007 Ronald J. Baker. All Rights Reserved.