The Justice of Price Premiums
How much does a logo cost?
Your answer probably begins with the words, “That depends…” and it does, but have you spent much time thinking about what it really depends on?
The difference between a $10k logo and a $100k logo is not the amount of time it takes to design it or even in the quality of the creative. The difference is $90k worth of reassurance – confidence on the client’s part that you won’t screw this up and that the business goals will be met. “Nobody ever got fired for buying IBM,” was the refrain from the 1970’s that justified the computer company’s premium pricing, to which I like to add, “or Landor.”
In 1971 Phil Knight paid design student Carolyn Davidson $35 (about $200 today) to create the global icon that is the Nike swoosh.* In 2009 PepsiCo very publicly paid design firm Arnell five thousand times more ($1 million) for what was seen as a “tweak” to their iconic Pepsi logo.
What would cause one company to pay five thousand times more than another for roughly the same thing? Did one client get ripped off? Did a designer? The answer is nobody got ripped off; all parties benefited because implied in the prices were a fair trade of risks and rewards.
Two Definitions of Premium
In marketing parlance, a premium is an amount paid above an ordinary or benchmark price. In the insurance world, a premium is the amount paid for the policy to insure against risk. They are the same thing. If you properly understand this and just one more pricing concept, I think you can easily apply them to your own pricing strategy to increase profit in your firm almost immediately.
Paying More to Insure Against Risk
There are many types of risk in hiring your firm that a client might gladly pay a premium to insure against. The largest is the financial risk tied to poor performance, or the answer to the questions how do I know you’re going to get this right, and what is this going to cost me if you get it wrong?
The same Arnell that PepsiCo hired to tweak their flagship brand in 2009 was also asked to redesign the packaging for Tropicana Pure Premium orange juice at about the same time. The redesign triggered an estimated drop in sales of more than 20%, which by many reports exceeded $135 million, in the two months before the old packaging was restored and the disaster corrected.
That’s a big number. The irony is that the Tropicana failure shows how a $1 million fee is nominal in relation to the potential impact a logo might have on certain brands. For a brand like Pepsi, with annual sales of around $10 billion, that’s a $2 billion a year mistake. Gulp.
What kind of premium do you think Arnell or any other firm could have commanded had they somehow been able to guarantee just that Pepsi sales wouldn’t decline? How much more could have been commanded from any firm that could guarantee an increase of just 2%?
You might view guaranteed value as an ideal that you could never really achieve. Regardless, my point is it represents the highest end of the pricing spectrum, and you can move closer to it by thinking about the risks you might take away from your clients. What kind of premium could you command if your clients saw an engagement with you as a sure thing? How much closer could you get to that sure thing status, in the client’s mind, if you bundled up some additional services, deliverables and promises?
Clients Should Be Allowed to Choose Their Risk Level
The second pricing concept I’d like to explore here is that your clients should be able to choose the risks they’d like to mitigate and therefore the premiums they want to purchase.
I once had an auto mechanic who used to routinely decide for me that I could squeeze a few more miles out of a battery, a starter or some other component that was worrying me, so when I picked the vehicle up the part wasn’t replaced. He was proud of the money he had saved me. He didn’t see how grossly unfair it was to impose his own risk-premium preference on me (save the money, Blair, and take the risk) when I would have gladly paid the premium (the incremental cost of replacing a part before it absolutely had to be replaced) to mitigate the risks of breaking down and the weight of worry while I drive. He saved me money and increased my worry when I had wanted the opposite.
Do you ever do this to your clients?
I believe such a mistake is the norm in a knowledge-based business. (I’ll confess that I’ve made this mistake for more than a decade, forcing one-size-fits-all solutions with the same premiums on clients with vastly different risk profiles.) The lesson is that your guess at the risks your new or prospective client wants to take is probably wrong. You should price your engagements with this assumption of your own ignorance built in. This implies the need to offer choices.
If you don’t believe that you should offer risk-premium choices to your clients, consider this: they already have them in the form of your competition. You win and lose business, often, not solely because of price or projected performance but because you didn’t offer the risk-premium tradeoff the client wanted. Why don’t you let the client make that tradeoff within the options you offer rather than forcing them to solicit options from other firms?
Two More Principles in Support of Options
Of the many principles in the complex and fascinating field of price theory, two in particular speak to the power of offering options. The first is the core economic principle that all value is subjective – it is in the eye of the beholder, the buyer.
The second is the psychological principle that humans cannot subjectively perceive absolute values, only contrasts. Taken together these two principles mean that people cannot accurately assign monetary value to something, they can only discern whether one thing is more valuable than another. When a buyer is endeavoring to measure value therefore, he has to make a comparison. By implication, any seller that can control or at least affect the items being compared can impact the buyer’s perception of value. Dramatically. By orders of magnitude, even.
When you neglect to provide options, the client goes in search of something against which to compare your offering and its price point. It might be past experience, similar services from other firms or a host of other comparison points. By offering options, you move the question from “how do I know this is good value?” to “which of these is the better value?” The latter question is the one the brain is equipped to answer; the one you should be enabling your client to answer. (If the enormity of this point hasn’t hit you, you had better read these three paragraphs again.)
The Capacity-Guaranteed Value Spectrum
I’ve already introduced guaranteed value as the lowest risk and therefore highest price solution you might offer. At the nearer end of the spectrum, the highest risk and therefore lowest price offering you have is capacity or time.
“For X budget, we will sell you Y number of hours.” Implied in this type of pricing is that the client takes all the risk, like a traveler declining accident coverage or snow tires at the car rental counter. If you choose to sell time at all, it should be clear that you’ll do your best but the risk is the client’s.
Sticking with the car rental example, a proposition of guaranteed value at the highest end of the pricing spectrum would focus on the client’s desired outcome and have little to do with the mechanism of getting there. It might sound like the rental agent proposing, “Forget about the type of car or the options – leave that to me. For $5,000 I promise you will arrive at your destination on time, unharmed, in comfort and in no way inconvenienced.”
There are times when the seller can make such blanket guarantees and others when he cannot. Equally, there are times when the customer sees such premiums as priceless and times when he sees no value in them. Every situation is different and hourly rates or even standard packaged pricing doesn’t acknowledge those differences.
Premium Bundles for Risk Profiles
In between the extremes of capacity and guaranteed value are all kinds of options from which you might ask the client to choose, just like the rental company. “The GPS will mitigate against you getting lost. The accident coverage will protect you against insurance claims. The snow tires should help with your safety concerns, and if you’re really concerned about safety, perhaps you’re interested in upgrading to the SUV? The choice is yours, mister customer – what risks do you want to take on and what do you want me to make go away?”
Such premiums allow your market to self-segment based on their risk profile. There are an infinite number of services, deliverables and promises that you might package up into premium bundles to help your clients insure against the various risks in hiring your firm. Visit the website of any software as a service (SaaS) company and you will see they all understand the power of bundling such premiums.
Profit From Time is Just the Baseline
When you build your firm around selling capacity, the convention is that a 65% firm-wide utilization rate should yield a profit margin of around 20%. If you choose to sell capacity at all however, this profit margin target should serve merely as the starting point before any premiums are purchased. Car rental companies make very little on the basic rental and their counter employees make close to minimum wage. Both the company and the employee make the real money on the premiums their customers gladly pay for increased peace of mind.
How much more money could you make if you offered your clients a few options to increase their own peace of mind?
*Years later, after the risk of hiring a design student had long paid off, Knight reportedly gifted to Davidson a diamond ring with the Nike logo on it and shares of Nike stock said to be worth six figures.