I think everyone would agree that a business, or rather the business’s products or services, is defined by the value it creates for customers. Value is in the eye of the beholder, and it makes sense for businesses to price their products and services according to the value those products or services generate for the customer.
Yet as real estate investors, when calling upon your CPA, attorneys, and other professionals, you typically want to know what their hourly rate is. Have you ever wondered, though, if billing by the hour is truly client focused? Is being billed by the hour really the best way to determine the value you will realize from a particular service?
In the recent months, I have implemented a pricing model called value based pricing for my clients, and they have showered me with appreciation. I’ve received comments such as, “This is an excellent business model” and “You are doing something no one else is doing, and it really makes you stand out.”
I learned of value based pricing through the AICPA and figured, since I’m operating a new practice, I may as well give it a shot and test the model for a few months. After working with clients and utilizing the value based pricing model, I know I’ll never go back to the dreadful billable hour.
What is Value Based Pricing?
The value based pricing model is a movement that has been sweeping across professional services firms as of late. The model aims to redefine how professional services firms price their services by placing the focus on the value received by the client. Value pricing adheres to the Subjective Theory of Value, which places value on how scarce and useful an item is, rather than basing the value of the object on how many resources and man hours went into creating it.
Firms that bill by the hour adhere to the Labor Theory of Value, which stipulates that the value of a good or service is dependent upon the labor used in its production. But is that really a true statement? Labor should not determine the price of goods or services; rather, the price is a function of supply and demand for such goods and services.
Take for instance two people, A and B, who have hired a CPA to prepare their taxes. “A” has a W2 job, no investments, and does not need to itemize. “B” owns a company, has several real estate investments, owns shares of S&P 500 companies, and takes advantage of many itemized deductions. Should these two people be billed at the same rate per hour?
Value pricing looks at these starkly different situation and asks, “What value will each of these clients derive from effective tax preparation services” instead of simply billing each individual at a fixed rate per hour. Since I’m a CPA, I’m using a tax example, but this logic can be applied to all types of services rendered.
Value Based Pricing Compared to Hourly Billing
Wouldn’t it be nice to end a conversation with a lawyer or CPA and know exactly how much you will be obligated to pay for their services? That’s what value pricing aims to achieve; in fact, a cardinal rule among those who utilize value pricing over hourly billing is “no surprises.”
Value based pricing has been defined as the maximum amount a given client is willing to pay for a particular service, before the work begins. Firms using value pricing only provide services after price, payment terms, and project scope have been determined. Overall, it creates a better client experience because the client is involved in the pricing discussion and doesn’t have to worry about extra fees due to additional hours worked. Ideally, value pricing allows service providers to quantify the value the client will realize at the beginning, leading to fewer rebukes and questions as the project comes to a close.
Value pricing begins with the client and focuses on the value the client will realize from the provided services. Price is then discussed as the service provider works out their costs and an appropriate profit margin. Only then is the service provided.
On the other hand, hourly billing focuses on the service first, then the cost incurred for providing the service, the pricing required to realize a profit, the value derived from the service, and lastly the client’s needs. It’s a backwards model, one that does not prioritize the client’s needs and the value the client will realize from any performed service.
For firms that use value pricing, costs will not play a role in determining the value the customer realizes or setting a price, except as a minimum to cover costs. The model is very client value focused and involves the client in pricing discussions. It steers away from discussions about estimated hours and more so about the scope of services to be provided and the value realizes from those services.
That’s Great And All, But Why Should You Care?
As real estate investors, you are looking to build a solid team of professionals that can provide you excellent advice when you need it. More than likely, two members on your team will consist of a lawyer and a CPA. Both of these professionals will likely bill you by the hour for their work – but this is a poor model, as not every hour is created equal, and valuing a service based on the labor required to provide that service is backwards, de-prioritizing the client’s needs and value perceived from the service provided.
Sometimes you will have a pretty basic question or need; other times, it will be imperative that you receive specialized and thorough advice. These services should not be billed the same, on an hourly basis, because you are realizing different levels of monetary value for the diverse services provided.
You may protest by saying, “But the less intricate service will take less time; therefore, fewer hours will be billed and the price will be less.” And that’s a valid argument; however, it doesn’t put the client’s realized value in perspective. To take it a step further, it places the pricing risk on the client. By billing by the hour, you (the client) take all the pricing risk. If a project goes over the estimated hours, you have to fork out the extra cash (hard earned, if I may). Value pricing places the risk on the services firm because it’s fixed upfront before the work begins. The firm must figure out how to provide high quality services in the most efficient way possible to boost their profits, rather than simply billing an extra 15 minutes.
Value pricing allows for increased transparency and communication. Since you are involved in the pricing discussions, you understand how the price was determined. No longer will you have to put up with a blanket $150/hr (because how was that determined in the first place?). You won’t have to worry about being billed for a 10 minute question, as the price has already been set.
Value pricing also aligns the interests of the firm with that of the client, which is what you really need. You need a firm that will fully understand your needs and work with you to not only increase the value of services provided, but help you understand the full value you are going to realize from provided services.
Lastly, you should care because you will sleep easier at night knowing that you can trust the professionals you are working with and know that they are committed to your cause, whatever that may be.
Thousands of firms are moving in the direction of value based pricing, though that doesn’t even begin to scratch the surface of the number of professional services firms operating in today’s market. But they are out there, and their clients are extraordinarily happy with the value based pricing model.
Eventually, value pricing will be the universal go-to model for professional services firms. As real estate investors, we should be jumping for joy as service quality, transparency, and overall satisfaction is bound to increase.
What kind of pricing or billing do you use? Would you consider trying value based pricing?
Leave your comments and questions below!
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.