More Praise for Implementing Value Pricing: A Radical Business Model for Professional Firms

“This is THE book I have been hoping Baker would write for the last 10 years. Value pricing as a concept is quite well known but not very well understood. Despite pricing being the most important determinant of enter-prise profi t it is given relatively little attention in the literature compared to other elements of the so-called marketing mix. At last we have a book that nicely blends elegant theory with a robust practical solution for imple-menting VP. I consider this book to be required reading for anyone inter-ested in developing a business model that is based on the simple, but time-honored, idea that we should be paid what we’re worth. For that to happen we need to focus on creating more value AND then implementing a system for capturing our fair share of that value. This book answers both these issues.”

—Ric Payne, Chairman of the Principa Group of Companies, www.principa.net

“Implementing Value Pricing not only produces more evidence that the historical cost-based system of pricing professional services is wrong-headed, Ron Baker shows the way to execute win/win pricing that both customers and professional fi rms will value.” —David G. Littlefi eld, President and CEO,

Littlefi eld Brand Development, www.littlefi eld.us

“As a reader of all of Ron Baker’s previous works, I can state unequivocally that this is by far his most thorough and enjoyable read to date. He not only builds upon the ideas about which he has previously written, he integrates them into a new and fully fl eshed-out business model. If his Professional’s Guide to Value Pricing was the Old Testament, Implementing Value Pricing would be the New.” —Ed Kless, Senior Director, Partner Development

and Strategy, Sage

“Once again, Ron’s work turned an endless fl ight into an intense reading experience. Unease about the task of moving beyond the billable hour was mixed with excitement about the tools, experiences, and intellectual ammu-nition that Ron provides to make it happen. It is far from certain that effort-based pricing will disappear, but it is more likely because of this book. Ron has not just shown the way; he has paved the path. Now, we shall walk or we will fail—our profession, our purpose, and, ultimately, our place in society.” —Friedrich Blase, Director of Strategic Initiatives,

Holland & Knight

“I wish I had been able to access this book fi ve years ago when I started moving my business from the ‘old model’ to pricing up front. For those accountants and lawyers out there seeking a ‘how-to’ on design and imple-mentation of value pricing, this is the bible. This book should be required reading for any person who owns, runs, manages, or works in a profes-sional knowledge business. What they do with it then comes down to courage. Be courageous and learn from Ron’s experience. A brilliant read and seminal text.” —Matthew Tol, FCA, Principal, mta optima,

www.mtaoptima.com.au

“Every professional must read this book. Be brave and trust that Ron Baker knows what he’s talking about. You’ll fi nd comfort in reading the amazing real-life examples of the innovators that took the leap. You’ll want to slap yourself for not believing in change sooner!” —Brandy Amidon, CPA, Brains On Fire,

Greenville, South Carolina

“Ron Baker is already regarded by most professionals who understand the impending implosion of a time billing business model as the pricing guru. In Implementing Value Pricing, Baker manages to further cement his repu-tation by comprehensively answering the ‘elephant in the room’ question of every professional fi rm looking to price on value—that is, how it is actually done. The book is a truly compelling read for any professional wishing to implement or improve a value pricing business model based on selling intellectual capital rather than time.” —Matthew Burgess, Partner, McCullough Robertson—

Lawyers, Brisbane, Australia

“Ron Baker does it again. Just when you think you have heard all there is about value pricing, Baker produces yet more challenges as well as solu-tions in this informative, well-researched, and at times humorous book on the practical implementation of pricing by value. How any leader of a professional fi rm could lead their business in the future without both reading this book and adopting many of Ron’s practical concepts is beyond me.”

—John Chisholm, former Managing Partner and CEO of law fi rms, and now Principal John Chisholm Consulting,

www.chisconsult.com

Implementing Value Pricing

Implementing Value Pricing

A Radical Business Model for Professional Firms

RONALD J. BAKER

John Wiley & Sons, Inc.

Copyright © 2011 by Ronald J. Baker. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifi cally disclaim any implied warranties of merchantability or fi tness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profi t or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

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Library of Congress Cataloging-in-Publication Data:

Baker, Ronald J. Implementing value pricing : a radical business model for professional fi rms / Ronald J. Baker. p. cm. — (Wiley professional advisory services ; 8) Includes bibliographical references and index. ISBN 978-0-470-58461-3 (hardback); ISBN 978-0-470-92955-1 (ebk); ISBN 978-0-470-92956-8 (ebk); ISBN 978-0-470-92957-5 (ebk) 1. Pricing. 2. Value. 3. Fairness. 4. Professional corporations—Prices. I. Title. HF5416.5.B34 2010 658.8′16—dc22 2010024729

Printed in the United States of America

10 9 8 7 6 5 4 3 2 1

To my mother and father, for genetically encoding me to challenge the conventional wisdom, and providing the most immeasurable of all blessings: their love and unwavering support in everything I do.

“ At every crossway on the road that leads to the future each progres-sive spirit is opposed by a thousand men appointed to guard the past. ”

— Maurice Maeterlinck (1862 – 1949), Belgian Nobel Laureate in literature, 1911

“ It does not take a majority to prevail, but rather an irate, tireless minority keen on setting brushfi res of freedom in the minds of men. ”

— Samuel Adams

Contents

ix

Foreword xvii

Preface xxiAbout This Book xxiiiAbout the Web Site xxivAbout the Words Used in This Book xxv

Acknowledgments xxvii

About the Author xxxi

PART I A RADICAL BUSINESS MODEL

CHAPTER 1 The Firm of the Past 3

CHAPTER 2 The Firm of the Future 7

The Business Model of the Firm of the Future 8Revenue Is Vanity—Profi t Is Sanity 8Businesses Have Prices, Not Hourly Rates 8Why Intellectual Capital Is the Chief Source

of Wealth 9Negative Intellectual Capital 11Why Effectiveness Trumps Effi ciency 11What, Exactly, Is Productivity? 12There’s No Such Thing as Generic “Effi ciency” 13Where Do Profi ts Come From? 15If Only I Knew Then What I Know Now 17Summary and Conclusions 18

x Contents

PART II FOUNDATIONS OF CREATING VALUE

CHAPTER 3 Why Are We in Business? 21

The Economist’s Defi nition of Profi t 21The Marketing Concept and Total Quality Service 23Summary and Conclusions 24

CHAPTER 4 A Tale of Two Theories 25

The Labor Theory of Value 26Karl Marx, False Prophet 26The Marginalist Revolution of 1871 28Why Are Diamonds More Expensive Than Water? 29Wrong Theory, Suboptimal Results 30

CHAPTER 5 Four Ps and Five Cs 31

The Five Cs of Value 34You Are What You Charge 36

CHAPTER 6 What People Buy 37

The Dynamics of Customer Expectations 38

CHAPTER 7 How People Buy 41

Relative, Not Absolute, Price Matters 42Price Psychology 43Search, Experience, and Credence Attributes 44Understanding Customer Risk 45The Four Ways to Spend Money 47

CHAPTER 8 Your Firm’s Value Proposition 49

Moments of Truth 51What Is Beyond Total Quality Service? 52

CHAPTER 9 The Consumer Surplus and Price Discrimination 55

Price Elasticity 56Consumer Surplus 57Price Discrimination 58Requirements to Price Discriminate 59

Contents xi

CHAPTER 10 Macro Pricing Strategies 65

Skim Pricing 66Penetration Pricing 66Neutral Pricing 67Two More Curves for Value 67Implications of the Curve 71

CHAPTER 11 Price the Customer, Not the Service 73

Ten Factors of Price Sensitivity 73

CHAPTER 12 There Is No Such Thing as a Commodity 77

The Perils of Benchmarking 80Purging the Commodity Word 80

CHAPTER 13 Baker’s Law: Bad Customers Drive Out Good Customers 83

Customer Grading Criteria 83The Adaptive Capacity Model 87Firing Customers 89The Forced Churn 90

CHAPTER 14 Value Pricing and Self-Esteem 95

There Is No Standard Price for Intellectual Capital 98

CHAPTER 15 Ethics, Fairness, and Value Pricing 101

The Morality of Price Discrimination 106Prospect Theory 108Is Hourly Billing Ethical? 109

PART III THE GENESIS AND CONSEQUENCES OF HOURLY BILLING AND TIMESHEETS

CHAPTER 16 A Brief History of Hourly Billing and Timesheets 113

The Father of the Billable Hour and Timesheet—in the Legal Profession 115

Summary and Conclusions 117

xii Contents

CHAPTER 17 The Deleterious Effects of Hourly Billing 119

The Advantages of Hourly Billing 119What about the Customer? 123The Disadvantages of Hourly Billing 124Summary and Conclusions 138

PART IV WHAT REPLACES HOURLY BILLING AND TIMESHEETS

CHAPTER 18 Why Carthage Must Be Destroyed 143

What, Exactly, Replaces Hourly Billing and Timesheets? 147

CHAPTER 19 Price-Led Costing Replaces Hourly Billing 149

Wisdom Is Timeless 151Summary and Conclusions 153

CHAPTER 20 The Wrong Mistakes 155

The Almighty Hourly Rate 156Making the Wrong Mistakes 157

CHAPTER 21 Who Is in Charge of Value? 163

The World’s First CVO 164Leadership 167Attitude 168Commitment 168Experimentation 169Youth 170Not Final Thoughts 170

CHAPTER 22 Measure What Matters to Customers 173

The McKinsey Maxim 174Developing a Theory 175Pantometry versus Theory 176A Gedanken 177

Contents xiii

CHAPTER 23 Firm-wide Key Predictive Indicators 181

KPIs for a Professional Knowledge Firm 181KPIs Equal Customer Accountability 188

CHAPTER 24 Knowledge Worker Key Predictive Indicators 191

A Model for Knowledge Worker Effectiveness 192

Key Predictive Indicators for Knowledge Workers 196

CHAPTER 25 After Actions Reviews 205

We Know More Than We Can Tell 206The Economics of Structural Capital 207Knowledge Lessons from the U.S. Army 210Summary and Conclusions 214

CHAPTER 26 O’Byrne & Kennedy: A Firm of the Future 215

PART V EIGHT STEPS TO IMPLEMENTING VALUE PRICING

CHAPTER 27 The Eight Steps at a Glance 231

Three Different Kinds of Problems 232Eight Steps to Implementing Value Pricing 233

CHAPTER 28 Step One: Conversation 235

The Conversation 236Naïve Listening 236Focus on Wants, Not Needs 238Starting the Conversation 238Conversations Lower Asymmetrical Information

and Adverse Selection 240Questions You Should Ask the Customer 241Ordinal Value, Not Cardinal Value 243Discussing Risk with the Customer 243Summary and Conclusions 244