It’s All About Baseball…
To start the show off, Ed just had to reference baseball and we - the audience - would expect nothing less. Enjoy! https://www.baseball-reference.com/postseason/1960_WS.shtml
So What Was The Show Really About…
One of the most innovative pricing strategies that should be in every firm’s pricing stack is the TIP clause. Most feedback that firms receive on pricing is negative (“Your price was too high”). Or it is ambivalent: “Your price was just right.”
No customer ever discloses how much money your firm left on the table. Innovative pricing strategies, such as the TIP clause, are outward focused and attempt to capture more of the value created for customers, in extraordinary engagements. Having more accurate cost accounting or better project management won’t help you capture this level of value, which is why pricing is the main driver of profitability.
Making the Wrong Mistakes
In 1997, Tim was the managing partner of top accounting firm, and his best, long-term customer (of 20 years) had come to him wanting to sell his $250 million closely held business. He told Tim (and I am paraphrasing here), “You’ve been my CPA for 20 years and I trust you with my life. It is time for me to sell my business and enjoy my golden years. Here is what I want you to do:
Update our business valuation to maximize the sales price.
Fly with me anywhere we have to go to meet with potential buyers.
Be actively involved at every stage of the sales negotiation.
Perform the due diligence, along with the attorneys, of the qualified buyers.
Work with the attorneys on the sales contract to make sure my interests are protected.
Perform tax planning and structure the deal in such a manner as to maximize my wealth retention.
When Ron asked Tim how he priced this engagement, he proudly proclaimed that every hour charged to this project was at his highest consulting rate of $400 per hour, indicating, right from the start, Tim knew there was more value on this project than he would ever be able to pad on a timesheet.
As a result of Tim’s work, the customer received (and saved in taxes) an additional $15,000,000, and acknowledged Tim was directly responsible for this outcome. In Tim’s own words, the customer was “elated.”
Tim then told how he priced the engagement. He reviewed all of the hours from the work-in-progress time and billing system, believed it did not adequately reflect the value he provided, and marked it up an additional 25 percent over the $400 hourly rate.
He then sent out an invoice for $38,000, which the customer promptly—and happily—paid. He believed he was value pricing. He was not—he was value guessing, since the customer had absolutely no input into the price up front, and only a customer can determine value.
When Ron asked Tim what he thought the customer would have paid if he had utilized a TIP clause (also referred to as the retrospective price, or success price), such as the following:
In the event that we are able to satisfy your needs in a timely and professional manner, you have agreed to review the situation and decide whether, in the sole discretion of XYZ [company], some additional payment to ABC [CPAs] is appropriate in view of your overall satisfaction with the services rendered by ABC.
The TIP is being based on the “overall satisfaction with the services rendered,” and not any financial contingency, which is the origin of the acronym TIP—to insure performance.
This TIP clause would be discussed with the customer before any work began. If needed, you could put a minimum price on the engagement (such as $40,000) to cover immediate firm capacity. But in this case, given the 20-year relationship with the customer, even a price solely determined by a TIP would have been acceptable, since the customer was not likely to take advantage of Tim after the services he rendered and the long-term relationship they had.
In answer to my question, Tim said his customer would most likely have paid him $500,000, a sum I believe to this day is below the real number—but at least better than the $38,000 he finally charged. Nevertheless, since Tim knows the customer better than I do, let us take his number as correct.
Ron informed Tim he had made the Ultimate Accounting Entry:
Tim was providing extraordinary value to this customer—he was at the top of the Value Curve—yet his cost-plus pricing theory prevented him from capturing a fair portion of it. Are we not ruled by our theories? This is why it is imperative to extinguish the cost-plus mentality from your firm.
No one in any seminar we have shared this story with believed Tim would have received less than $38,000 for his services on this engagement. In effect, Tim paid a reverse risk premium—he was assured he would not go below his hourly rate, but in return he gave up the added value the customer already believed he had created. This is not a risk worth taking if you want to maximize your firm’s profitability.
The deleterious effects of this are deeper than just being deprived the value from the work you provided on any one engagement. The problem lies at the very core of a firm’s measurement system and points out how it does not offer the opportunity to learn from lost pricing opportunities, or pricing mistakes.
In his inimitable way, Yogi Berra explains this situation with his quip, “We made too many wrong mistakes.”
When it comes to pricing, the wisdom from Yogi is profound. Tim made the wrong mistake, and here is why: He will not learn anything from it because the firm’s primary assessment is billable hours—once again the billable hour is the incorrect measuring device for value. When the partners review the realization report on this engagement, they will see 125 percent, which is excellent when you consider most firms realize between 50 and 95 percent overall on each hour.
No knowledge was gained by the firm on how to price the next similar engagement in accordance with value—it will simply perpetuate the same mistake, over and over. Being a more accurate activity-based cost-accountant, or even excellent project manager, would also not have helped Tim to capture the value.
This is not meant to imply with value pricing you will never make mistakes. You certainly will. The difference is they will be the right mistakes, because with value pricing, as opposed to cost-plus pricing, you are forced to receive input from the customer as to your value, and have in place pricing strategies that will capture more of that value (like the TIP clause). If you engage in After Action Reviews (AARs), which perform value assessments on each engagement, and elicit feedback from your customers, you will learn from your mistakes and become better at pricing in the future.
Most feedback firms receive on pricing is negative: “Your price was too high.” Or it is ambivalent: “Your price was just right.” No customer ever discloses how much money your firm left on the table.
Innovative pricing strategies, such as the TIP clause, that are outward focused and attempt to measure value have allowed more and more firms around the world to capture more of the value they provide.
Case Study: The Million Dollar TIP
This story comes from Gus Stearns, a partner in an accounting firm, whom I [Ron] met on September 25, 2000 at a conference in Las Vegas. Gus tracked me down at the dinner party, walked me over to the bar, and over a glass of wine told me his amazing TIP story. Here are the two e-mails I received from Gus explaining his success, the first one prior to our meeting in Las Vegas and the second one after:
April 20, 2000
I hope the tax season finds you well. I was fortunate enough to be at the Atlanta conference [January 2000] when you spoke and picked up an autographed copy of your book [Professional’s Guide to Value Pricing], which I devoured on the plane trip back.
The engagement which I refer to ($180,000 price) had already started a month or two before and I had used the old standard rate-time-hours routine and billed about $2,000 at a standard rate of $180/hour. After listening to you and reading the book, I was determined to reevaluate the price structure and simply went back to my customer and said, “Guys, this is what I am bringing to the table. It brings a lot of value which is etc., etc. I don’t believe hourly rates based upon time is appropriate. I am unable to place a value on this. I need your help. You tell me what the value of all this is to you. You are the customer and only you can truly establish the value. I know I’ll be happy with what ever you come up with.” This is almost an exact quote.
I left it at that two months ago. I was handed a check for the first installment of $50,000 on the way out at the end of the engagement. I guess this is what you call “outside-in pricing.” I like it.
Gus Stearns, CPA
It gets better, since this engagement was in two phases. Here is the follow-up e-mail from Gus explaining the final result after the job was done:
Basically the large engagement was for a previous client that I had hired a controller for. He took over the tax work, at my suggestion, as he was a CPA. The engagement was an exit and management succession strategy, which involved some fairly hefty income tax savings as well. The total time expended was about 100 hours, although a lot of the time was on unrelated things that I did not want to charge for due to the magnitude of the price (we quit using timesheets some time ago).
I used a flip chart in the presentation, pointing out the value of what they were getting. At the end of the presentation, I asked how much they thought it was worth, and suggested $300,000, $500,000, a million? I wanted them to think in big numbers. The CEO was rather excited and said a million. Knowing that this would be difficult to obtain in one fell swoop I suggested $400,000 down and a retainer of $4,000 per month. They agreed but asked that I serve on the board of directors and attend quarterly meetings through 2008, when the note to the previous owners would be paid off. They were also kind enough to put me on salary so I could participate in their pension plan, which is a 25 percent direct contribution from the company. This all adds up to a little bit over $1 million.
Never once was the word “time” used or referred to by myself, or my client. They could have cared less about time. In all of our engagements, I never use the word. By concentrating on value and encouraging the client to participate in the valuation of the engagement our prices have skyrocketed. You were absolutely on-target when you said that accountants are terrible at valuing our services (myself included).
Keep up the wonderful work,
These types of engagements are certainly not the rule in any firm, they are the exception. Nonetheless, they do arise, and when they do it is critical to recognize the value you are creating, and to utilize innovative pricing strategies to capture it. This also demonstrates why pricing is the most potent lever you have in terms of increasing your firm’s profitability, much more than cutting costs or increasing efficiency.
We include these stories not because I believe you will earn a $1 million TIP, but rather to illustrate how the cost-plus pricing mentality has placed a self-imposed artificial ceiling over the heads of firms. Never in his wildest dreams would Gus have placed a $1 million value on his work; but the customer did. Does he not deserve it?
Baldridge Award–winning firm Graniterock instituted such a policy, calling it “short pay.” This provides, in essence, a line-item veto to customers and allows them to deduct any amount of the invoice in accordance with their subjective value of the service provided.
It is not a refund or discount policy; it is a pure service guarantee, because the customer is not required to return the merchandise. Here is how owner Bruce Woolpert explained the advantages of this guarantee:
You can get a lot of information from customer surveys, but there are always ways of explaining away the data. With short pay, you absolutely have to pay attention to the data. You often don’t know that a customer is upset until you lose that customer entirely. Short pay acts as an early warning system that forces you to adjust quickly, long before we would lose that customer.
Will some customers take advantage of Woolpert’s policy? Probably. But consider Nordstrom, legendary for taking back merchandise not even purchased from its stores. It estimates that 2 to 3 percent of its customers take advantage of this policy, yet 97 to 98 percent appreciate the policy and are more loyal—and pay a premium price—as a result.
Do not let the tail wag the dog. If any one customer were to abuse your service guarantee, he would actually be doing you a favor by self-identifying himself as a problem customer. Gladly refund his money and fire that person from your company.
Case Study: Mission Impossible
Santa Monica Freeway
The January 1994 Northridge, California earthquake devastated the Santa Monica Freeway, leaving 350,000 daily commuters no access to Los Angeles. Early estimates predicted at least 12 months to rebuild, at a public cost of $1 million for each day the freeway was shut down.
Innovative constructor C.C. Myers saw it differently. He saw it as a 4.5 month project. Staking his wealth and reputation, C.C. Myers signed a $14.7 million contract with the city, which allowed a maximum completion time of 140 calendar days, with a penalty for late completion of $205,000 per calendar day and an incentive of $200,000 per day for early completion and opening the freeway to traffic.
Approach: Change everything.
Contract time commenced on February 5 with materials and equipment moving to the jobsite that same day and through the weekend, even the final construction plans were not available until February 26. C.C. Myers immediately went to work on a 24/7 schedule with up to 400 workmen on the job. On-site inspectors were used to eliminate delay and rework. Workers were running on the job. Special quick-setting concrete was used. Subcontract bids and awards were made on a daily basis. Work flowed.
Sixty-six days after the contract was signed, the Santa Monica Freeway was opened to traffic, 74 days ahead of schedule.
Source: The Elegant Solution, Matthew E. May, 2006, pg. 135.