Pricing – The Role of Fees in Practice Development

This article is specifically about Pricing for Professional and Specialist Consulting Practices, but the concepts should have wider interest for Pricing in other fields.

Clients – like all buyers weigh their concept of the total price (financial cost; time, risk etc.) against the perceived-values of using the offer. If the price exceeds the sum of the benefit values, buyers will not buy the offer.

Understanding what price buyers are willing to pay requires knowledge of the actual and perceived valuethey place on owning/having the product. Pricecan be a tool that the buyer uses to assist in making judgements about the quality of the offer relative to other offers in the market place.

Buyers will make decisions regarding the cost of acquiring the offer relative to the value received in owning the offer. Buyers differ in the values they assign to different offer features, and marketers often vary their pricing strategies for different price segments. Buyers compare an offer’s price with the prices of competitors’ offers. Price and value also need to be discussed in terms of expectations about cost, quality and of delivery.

Priceneed to be understood in terms of the Value Exchange Model

 Price/Payment and the Concept of Value

In the past the focus of most marketing exchanges was on what the supplier/provider/seller did to create a marketing exchange. That there was not have a true market focus – a focus from the customer’s perspective. For many marketers, the focus was on creating the pricing of products, not on understanding the wider elements of customer value and investment.

When we focus on the customer, demonstrates that price is rarely the sole or key factor. Priceis really only what the seller asks. From the perspective of a buyer, what is important are the broader elements of the Investment or Total Payment. Payment is in fact a more complex element than price.

Total Payment is a set of factors that creates an investment that a buyer makes. There is not only the money to be paid (or its equivalent) but also time to be invested (information search, shopping time), indirect costs (for example, transport, parking), acquisition and consumption costs (delivery, credit charges, installation, additional equipment to use the product, disposal of the existing product or the costs involved in changing over to another product or supplier etc.) the risk/uncertainty involved (have I made the right decision? Will my friends laugh at me? What if it doesn’t work?) and opportunity costs (if I buy this I cannot buy something else – what is the better investment at this time?).

Valueis what a buyer believes they will get from a transaction compared to what they have to invest or sacrifice to get it. If a buyer doesn’t believe they will get receive more than they invest it is not considered value – and the transaction will not occur. If they receive less than they perceived they were going to get from the exchange, they will certainly reconsider a similar exchange in the future.

The Price(monetary value) is an element in the assessment of value, but it is only part of that assessment.

Not everyone wants the lowest price – but everyone wants the best value!!

The Target Market’s Evaluation Of Price And Value

Although we often assume that price is a significant issue for buyers, the importance of price depends on perceptions of valuethe type of product, the type of target market, and the purchase situation.

Setting prices

Setting prices in creating our value offers requires careful analysis of numerous issues.

Nowhere is the clash between the self-image of professions and the image of commercialism better demonstrated than discussion of the charges for service. The belief that `one who performs a service for satisfaction not gain’,’ which permeates many definitions of professionalism, effectively removes `price’ from overt (if not covert) examination.

Standard fees

The problem of establishing suitable fee levels did not exist when almost all the professions had standard scales or ‘gentleman agreements’ so far as their charges were concerned. Fees have only moved into the centre of the stage since price fixing has been increasingly condemned in most industrialised countries followed in some instances, for example the EEC and the USA, by this practice being made illegal. Even so there still remains a strong element of agreed fees in many professional services although some formal tariffs, as in the case of conveyancing charges, have been abolished. Nevertheless, chartered surveyors practising as estate agents operate a very similar range of charges (called commissions in this case). Architects have begrudgingly modified and under government pressure discontinued the `obligatory status of minimum fee scales’ while amending their rules to ‘provide a satisfactory formula for flexibility over fees but outlawing the worst evils of irresponsible fee quotations’?

Where such inter-professional agreements, whether official or informal, are reached or when fee levels are fixed by those who ultimately pay them (the State or insurance organisations) there is neither a need for nor an opportunity to apply fee strategies unless some practices not constrained by professional rules wish actively to dissent.

Costing

If the use of fee strategies in professional services is virtually non-existent, it is in part due to the inadequacies of most costing methods for services which still operate on a ‘faith, hope and 100 per cent’ basis. The vagaries of costing the output of surveyors, veterinary surgeons, dentists, patent agents or actuaries’ activities have caused many of them or their managements to adopt empirical and ad hoc approaches.

In relation to practice development a far more relevant approach is one which first divides costs between chosen activities designed to increase awareness of the organisation and its services and to create favourable images. The second type are those incurred in presentations and negotiations with individual clients. These costs can be evaluated at three levels:

Upper cost – income sacrificed by the professional with a full work load plus expenses caused by the practise development activities.

Lower cost – for professional staff not otherwise fully occupied in their discipline. Only expenses are incremental items.

Middle cost – principally the professional’s staff remuneration plus expenses.

Considerations in establishing a satisfactory and acceptable fee structure

The moment the service organisation or practitioner looks at the techniques which enable it to devise and operate a fee strategy, it finds itself faced with a dichotomy. These are the approaches offered by theorists engaged in developing a simplified model that helps to understand complicated reality and the approaches of marketing specialists discussing pricing on a descriptive level explaining what businessmen do, or say they do. Neither procedure is satisfactory. Any model is limited in use by psychological aspects–that is the psychology of service provider as well as the client. Either concepts or techniques alone are insufficient and probably misleading. A combination and balance is needed, but difficult to achieve. This situation should be recognised in considering the strategies suggested.

Six basic methods for arriving at fees have been identified:’

Cost-based fees

A conventional method of arriving at fees by summating the chargeable cost. The fee is arrived at for various levels of activity and time utilisation which will yield the desired profit. Cost-based fees, although very commonly used, do have the disadvantage that cost does not necessarily lead to an effective and acceptable fee. Basing a fee on costs plus a desired profit takes no account of competition nor demand. The fee can impact heavily on itself since it can attract or inhibit demand at a level which affects costs.

Competitive salary-based fees

A variation of the cost – pricing system based on the average or competitive salary levels for the professionals involved and charged for the time utilised. This method means that fees are determined by the major cost centre which for the professional service organisation is personnel, not materials, machinery or stocks.

Contingency payment

This is essentially the service equivalent of piecework rates in manufacturing or commission for salesmen. The fee for services performed is contingent upon a certain act being performed or by accomplishment. This is a method used by estate agents, some contract R & D, application engineering and operational research consultancy and in the USA by lawyers undertaking litigation work. A variation of contingency pay pricing is the ad valorem method of calculating fees – that is based on values involved in the service. The contingency and ad valorem it must be said is only a description of a method and does not describe just how the actual fee or percentage is calculated, which may be arrived at by the other methods listed.

Fixed fees

This is a uniformity within a profession achieved by a controlling or strongly influencing body. This body might be the government (fees payable to both its own professional advisers and those funded by the government such as legal aid), professional associations, insurance organisations (medical fee rates). Fees may and frequently are fixed informally as in some types of consultancy fixed fees which, as Sibson points out, are the results of a fee decision not a method of reaching one and whatever the level fixed it may well have been set by one of the other techniques described.

Contract fees

This is a method of arriving at a fee by negotiation with a single organisation; for example, rebates for insurance services such as reimbursable provisions on contracts covering group insurance. This method of fee setting is also common in some branches of management and engineering consultancy.

Value-based fees

Or what the market will bear. Other methods are only rough guides to value. Value pricing assumes that buyers will respond to fees in accordance with the value they place on the service. This is common practice in accountancy particularly for audit work (despite what is said to the contrary), some areas of research and again various branches of consultancy.

Psychological factors

The deficiency of all the methods other than value-based fees is that the mechanistic approach ignores what is perhaps the most pervasive factor in client decisions relative to fees, that is their perception of the expectation being purchased. It is impossible to discuss fees without considering the psychology of the client. Indeed, as has been pointed out The price [fee] setter should therefore never forget that especially in the absence of previous experience, the potential customer [client] will frequently decide in favour of the more expensive quotation … [and will] seldom accept a low price [fee] as a valid excuse for shoddy work:5 Given little or no knowledge of the service, the organisation or practitioner, the difficulty of competitive comparability, the client will use the fee level as a guide to expected quality and efficiency, however inadequate such an indicator may be. As with products, services perceived as under-priced are viewed with suspicion and the client will seek the safety of the middle to top range.

Clients for all professional services tend to have psychological blockages on many aspects of the service-fee relationship. While, for example, they are reasonably happy to pay for collateral evidence in the form of documentation there is a resentment of charges for ‘advice’ in the form of telephone conversations. Consequently the wording of invoices takes on a considerable importance in making fees acceptable and thus in client retention and in stimulating referrals. The essential requirement is to notify the client on the invoice of everything that has been done. That Mo invoice can be too long’ is an over-statement but it contains a great deal of truth so far as fee acceptance is concerned.

Fees and the non-client public

Before going on to consider how the specific fee or fee structure can be arrived at it is as well to appreciate that although the fees should be set to satisfy both the client and the practise, there arc other publics to consider who may not have a direct or immediate pecuniary interest yet whose involvement can be crucial to the professional organisation.

Most of the approaches to fee strategies either view the situation purely from the standpoint of the professional practice or practitioner or the client or there is an uneasy attempt to reconcile widely different interests.

A multi-stage approach for setting fees and fee structure

It is at this stage that an inexorable rule has to be considered no matter how much information, how much skill and how much science go into establishing what the fee will be.

Objectives

Just as with the total practice development strategy an early step must always be to decide and to obtain agreement on fee objectives. These can be as variable as the objectives of the total strategy; a given level of profitability, return on investment, achievement of specific growth rates, high cash flow, optimisation of special skills and resources, attracting new clients/higher level of repeat consultations or instructions.

Designation of targets

This stage will have been completed in the preparation of the practise development strategy referred to in Section 5, ‘Devising a practice development strategy and plan’,. Clearly, the fee structure must fit the target market and it may well be that having arrived at the fee structure either because of the nature of costs or of demand, it may be necessary to reconsider the market targets in the total practice development plan.

Demand estimate

The next step must be an estimate of the demand which will be generated at a particular fee level. Because it would be impractical and unprofitable to undertake marketing research for every occasion, but by no means impractical to arrive at general level of acceptability, this must be best judgement.” The teleological nature of pricing decisions is nowhere better illustrated than at this stage where fee level can generate or inhibit demand and where high or low demand has an immediate favourable or adverse impact on costs and thus fees. Nevertheless, those responsible for setting fees cannot sit on the fence. A view must be taken on assumed demand at given fee levels.

Fee–image relationship

There is a direct correlation between fees and image. As has already been pointed out a professional service just like a product can be suspect if the fees are perceived as so low as to affect the quality or delivery of the service. Conversely, high fees will frequently indicate a high level of qualification, experience or ability.

It is unwise to an extreme to attempt to arrive at a fee level without first considering what image the practise wishes to convey both overall and in the specific transaction under consideration.

Selection and use of communication techniques The decision which now has to be taken is which of these will generate the demand estimated at the fee level proposed. This again must be a judgemental decision towards which not even the most advanced thinking on marketing can contribute.

Evaluation of competitive offers

In most cases, marketers are in a better position to establish the prices of their value offerings when they know the prices charged for competing value offers. Learning competitors’ prices should be a regular function of marketing intelligence

Marketers in an industry in which price competition prevails need competitive price informationto be comparable with its competitors’ prices. In some instances, an organisation’s prices are designed to be slightly above competitors’ prices to give its products an image of better/best value.

Competition oriented pricing

In using competition-orientated pricing, an organisation considers costs and revenue to be secondary to competitors’ prices. The importance of this method increases if competing products are almost homogeneous and the organisation is serving markets in which price is the key variable of the marketing strategy. A firm that uses competition-orientated pricing may choose to be below competitors’ prices, above competitors’ prices, or at the same level. Competition-orientated pricing should help meet a pricing objective to increase sales or market share. Competition-orientated pricing methods may be combined with cost approaches to arrive at price levels necessary for a profit.

Customary Pricing- For some products where tradition, a standardised channel of distribution, or other competitive factors dictate the price, customary pricing is used.

Above-, At -, or Below-Market Pricing – For most value offerings it is difficult to identify a specific market price for a product or product class. Marketing managers often have a subjective feel for the competitors’ price or market price. Using this benchmark, they then may deliberately choose a strategy of above-, at-, or below-market pricing.

Loss-Leader Pricing – For a special promotion many retail stores deliberately sell a product below its customary price to attract attention to it. The purpose of this loss-leader pricing is not to increase sales but to attract customers in the hope they will also buy other products, particularly discretionary items carrying larger mark-ups.

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