In this post I lay out the five levels of pricing success and ask you to do an assessment of where you are now. Then I identify the best resources to help you move up from your current level.
Where Are You Now?
The five levels are described below. Find your level.
Level One: Labor Arbitrage
Most people and firms start here, selling their time as solo practitioners and leveraging the time of others in a firm of multiple people, making money on the spread in the market value of their labor.
An employee will work for $x per year and the client will pay much more on an hourly or daily basis. So you fractionalize the bulk buy of annual salaries into higher-yielding hourly rates and sell as many hours as you can.
As a solo practitioner it’s a job more than a business, but as people are added, the risk level ratchets up and a profit can be earned above the fair market salary you pay yourself. Congratulations, you’re in business.
Level Two: Maximum Utilization
Level two is the peak of level one. You reach the maximum rate you feel the market will bear and maximum utilization—you are selling all the hours you can with the staff load you have. At this point increasing revenue means adding more bodies.
This is frustrating initially—you’re trying to grow the bottom line and instead you keep growing the head count. You pull every efficiency lever you can find—systems, processes, technology, ruthless managers—as means of squeezing more profit.
Your efforts yield you a few more percentage points, but still you’re stuck in a narrow band of profit margin, bumping up against an invisible ceiling.
It’s not horrible; you have a profitable business and a good living but still you feel trapped in a prison of sorts. Eventually you resign yourself to the idea there is no other way to grow the net profit than to increase the firm’s size; that there is something about the physics of your firm or of the market that means you will never get above a certain profit percentage.
Most firms never move past this level. I wrote in more detail about the problem and the solutions in The Complex Battle for Margin.
But there are three more levels still.
Level Three: Progressive Pricing
The prison you’re in is one of your own making, but you don’t understand that yet. You still see yourself as constrained by the market or business type. Here at level three you begin to see the artificiality of your constraints.
Progressive pricing, to me, means embracing some basic pricing principles to dramatically increase the size of your prison cell, to raise the band of profit margin that seems so immovable.
These principles of progressive pricing are easy to learn and they show quick results, so much so that initially you will be under the illusion you have escaped from your cell altogether.
You haven’t, but the amount of extra room you’ve easily created for yourself in increased pricing and profit gives you a renewed enthusiasm for the business.
Some of these progressive pricing principles are what I consider to be the foundational rules outlined in my book Pricing Creativity: A Guide to Profit Beyond the Billable Hour, such as always offering multiple options and using a high price anchor.
Other principles include taking a little bit of risk in your pricing by delivering price certainty (charging for deliverables instead of time) and getting creative in how you bundle together solutions in your multi-option proposals.
A more advanced idea within this band is to limit your proposals to one page, thereby changing the dynamics of the close from that of a presentation to a conversation.
Most of these ideas are easy to understand and apply, and almost any firm at the lower levels can easily move up to level three with some simple reading and experimenting.
Level Four: Value-Based Pricing
In level three you expanded the walls of your cell—the narrow profit band you were previously stuck in—and it feels great. But after a year or so you feel stuck again.
For those that are able to make it here to level four, the walls fall away completely. You realize the prison isn’t “real,” it is in your mind, of your own making. Like a scene from The Matrix, the walls dissolve before your eyes and you are free.
Economic success is no longer tethered to effort. There is no limit to what you might charge and earn. You no longer have to grow the firm to grow your profits.
And the added bonus is the impact of your work on your clients’ businesses makes an equivalent leap. You are earning more because you are no longer focused on time or deliverables but on value creation.
Value-based pricing is where your prices are set based on the value created for the client by a solution. Read that again: the value of a solution. Not any one specific solution. Not your solution. It is not the solution you are selling but the value creation: the outcome.
When you price based on value, you set pricing guidance before you even think about a solution. You let go of solutions altogether until after you have set price. Let that sink in.
That mental shift is hard for someone who has spent years selling time or deliverables. The more of an experienced subject matter expert you are, the more you will be triggered by the patterns you spot—triggered to leap ahead to solutions, cost and price.
Subject matter expertise got you this far but now you need to let go of it and learn to truly focus on the client if you are to master the value conversation and make the required mental shift. When you do, everything changes.
People are often surprised to hear me say I believe an ability to conduct a meaningful value conversation is the most valuable skill in all of business. But once they develop that ability they understand.
Level Five: Performance Pay
The highest level of pricing success is where you are using progressive pricing principles from level three, you have mastered the value conversation and the mental switch to thinking about and pricing value creation instead of inputs or outputs (level four), and you cherry pick the few well-suited opportunities to earn extraordinary income from extraordinary value creation by putting compensation at risk.
Let me be clear that the firms at level four (value-based pricing) and here at level five (performance pay) do not price these ways exclusively. Rather they adroitly use these pricing forms as part of their pricing mix.
Ron Baker, in his book Implementing Value Pricing suggests viewing your client portfolio as you would your investment portfolio, with a mix of high and low risk-reward engagements that together balance out to your own risk level. Performance pay is the highest level of risk and reward.
Read my post You Don’t Really Partner With Your Clients to learn why you wouldn’t dream of pricing this way with just any client. You have to pick your spot and get the details right.
When you do, it takes only a small number of these properly constructed performance pay deals to transform your financial fortunes. It can sometimes be done in one deal. Welcome to true entrepreneurship.
Moving Up From Level One: Labor Arbitrage
This is the level of a young or struggling firm. If you find yourself here, resolve to skip level two altogether and move right to the progressive pricing techniques of level three, most of which you can learn simply by reading about them. Buy Pricing Creativity for $100-$320 and focus on the principles I identified in describing level three above.
Implement as many as you can—it’s not an all-or-nothing proposition. Make the progress where you are able. You will find a new pricing and profit reality.
Moving Up From Level Two: Utilization Maximization
It’s harder to break out of level two than level one. If you find yourself here, you too should read Pricing Creativity, but first read the post The Complex Battle for Margin, especially if you have been at this place for a long time and identify with the idea of being trapped in a narrow utilization band (discussed in the post) below which you are unprofitable and above which you are understaffed.
Large firms that have institutionalized the tools of efficiency I mentioned in describing level two above end up building the infrastructure that makes it difficult for them to move up.
They can still implement progressive pricing principles to raise their prices, but as the post describes, without some changes to systems and culture, that margin can end up getting “donated” back to the client.
Some private training might help, but it needs buy-in at all the right levels of the firm and a willingness to blow things up that others see as working just fine.
Moving Up From Level Three: Progressive Pricing
First of all, congratulations on arriving at a place few firms do. If you’re here at level three you’ve probably read Pricing Creativity or pieced together many of the principles on your own through various sources.
You’ve applied many of the principles and have expanded the size of your pricing cell but you’ve hit a new limit and you haven’t been able to make the fundamental switch in thinking that opens up the value-based pricing of levels four and five.
We also deliver the learning in private training engagements for firms of any size.
Moving Up From Level Four: Value-Based Pricing
You’re breathing rare air here. You’ve put in the value conversation reps, you easily identify the spots where it makes sense to put forward a value-based price option and you understand the power of getting your proposal to one page.
You have left behind the idea your income should be tied to effort. You are making money that looked impossible a year or two ago and you are no longer unnecessarily inflating the size of your firm.
And still you find there’s room for more risk/reward in your client portfolio.