I’ll always remember the bakery owner who offered this special: “Buy any number of cakes and cupcakes now for delivery anytime in the next six months, and you’ll get 50% off the total price, payable upon placing the order.” After fulfilling the orders, the company went out of business.
The health and wealth of a company is measured by its profits and its accumulated cash. No matter how many sales you make, if those sales reduce or eliminate cash profits, they are bad sales.
Three internal business decisions directly cause your low cash balance: pricing models; policies and practices causing unfavorable cash flow; and tax planning.
This week let’s look at your choice of pricing model– how your company arrives at the prices for the services it sells– and how it affects cash accumulation.
Pricing model: Hourly Rate
The hourly rate is most common pricing model used by services firms in all industries. The buyer pays the company for the time it takes to deliver its services. The rate may vary according to some hierarchy. No matter the actual dollars associated with a specific person or activity, the hourly rate emphasizes above all that value lies in the TIME consumed.
There is no inherent value in time. Even the highest-powered law firms reach a ceiling on hourly rates. If you try to exceed what your buyers believe is “fair” they’ll challenge your hourly rates.
If you charge by the hour, your CPA has also likely advised you to book your expenses by the hour. This leaves you very little margin because you’re tying the costs of tangible resources to the time it takes you deliver, which has no inherent value. Cash accumulates very slowly if at all.
Inventory. There are a limited number of billable hours in your inventory of time. Even if you go beyond the norm of the 40-hour work week, at some point you’ll run out of inventory. When you run out of inventory your revenue stops.
Another factor regarding inventory is deciding what activities are covered by hours billed to the client. Travel, admin tasks, emails, meals with clients, customer appreciation events, white papers or reports, tips or newsletters? Most buyers will object to being billed for what they regard as activities not specific to their needs, so the inventory of billable hours is further reduced, and therefore so is revenue and cash.
Competitive pressures. Clients and customers will compare hourly rates for similar services just as they compare product prices. If they perceive your rate is too high, they’ll find a lower-priced option. If they feel your prices are low or just right, they’ll stay with you—unless a lower price comes along.
Charging by the hour for services makes the company subject to price competition just as surely as those companies that sell products. Why? Because you’re selling time, not VALUE. Time is time, and your company’s time is no more valuable than any other company’s time.
Alternative Pricing Model: Value Delivered
The alternative to hourly rates is to price your services according to the value delivered to the buyer.
Value may be delivered in a short time or a long time. It doesn’t matter. The buyer pays for the value they receive. Everything you do and say to the buyer must emphasize that you are delivering value to them.
The inventory is unlimited. There’s no limit to creativity and imagination and the ways to turn those into value for buyers. The value derives from all the company resources needed to deliver that value, and your value-based price covers it all.
You’re not subject to price comparisons because no other company will deliver the same value you deliver. Value can be tailored to the specific needs and desires of each buyer. No competitor can compete against that tailoring or customization.
What about Complexity?
The owner of a bookkeeping company commented that hourly rates would only work for simple services; complex services like those offered by her company couldn’t be priced for value.
My response? Complexity is a hugely powerful reason to charge for value. Your company is THE expert. You know what it takes to deliver your services to meet a particular need or desire. Do your homework about the client, write a powerful services agreement and live up to it. I agree that the risk of undercharging falls on your shoulders. Will you learn from that? Absolutely. And within a couple of months the fees commensurate with the value will be close to perfect: plenty of cash to be accumulated and completely thrilled clients.
You Can Increase Cash
Creating fees commensurate with the value delivered to meet your buyers needs and desires is not easy. Neither is it impossible. It requires deep comfort with the belief that buyers want to experience value, not just tick a list of benefits off their fingers. We at Trivers Consulting Group have immersed ourselves in value-based fees for more than a decade. Give us a call for a complimentary conversation about how your company can become sales and cash rich. 703-801-0345.