Costing Is a Science, But Pricing Is An Art

By Tim Williams

Knowing the costs of serving your clients is important, but it’s not the same thing as knowing how to price your services. Costing is objective and tactical; pricing is subjective and strategic. Costing uses formulas; pricing requires judgment.

When it comes to compensation, the misstep professional firms make is mistaking costing for pricing.  They are not at all the same thing. One discipline requires scrutiny and analysis; the other requires creativity and innovation. Just because your firm has an outstanding competency in accounting, it doesn’t mean you have a competency in pricing.  You may have a Chief Financial Officer, but to maximize your profitability you also need someone that plays the role of Chief Pricing Officer.

Professional selling meets professional buying

Agencies leave money on the table because they pay very little attention to the discipline of pricing. When’s the last time anyone on your management team read a book on pricing?  Attended a pricing conference?  Participated in a pricing webinar?  For most firms, the answer is “never.”  It’s little wonder new business and client service teams struggle to match wits with the professional buyers at their client organizations.  In compensation discussions, we put amateur sellers across the table from professional buyers.  It’s an unfair fight.

But it doesn’t have to be this way.  It’s not too late to catch up to the pricing revolution that has been sweeping the business world for the past several decades.  What it takes is not just a change in practices, but a change in paradigm.  Professional firms like advertising agencies, law firms, and accounting firms are trapped in a model first developed in 1919: hourly billing.  As we approach the 100th anniversary of this misguided model, you can either remain in the ranks of the organizations that missed the pricing innovations of the last 20 years, or decide you want to be as progressive — and effective — in this area as your clients are.

The revenue models of most 21st century client organizations have evolved with advancements in pricing methodologies away from cost-based, past competitor- based, all the way to customer value-based.

By definition, pricing based on customer value is subjective and contextual, which reflects the true nature of value.  While cost remains constant, value is always variable.  The cost of a 12-ounce can of Coca-Cola is constant and calculable, but the value can range from less than $1 dollar in a grocery store to 12 Euros at a Paris bistro.  Pricing expert Hermann Simon says studies have shown the range to be as much as 400%.

Both quantitative and qualitative

Many pricing professionals would argue that there’s plenty of science even in pricing, citing examples the complex “adaptive capacity” pricing systems used by airlines and hotels, which offer upwards of 10,000 ever-changing prices per day to customers.  But even here the underlying approach is based on perceived value to the customer.  The different prices offered by a single Marriott hotel on a given day are all variations of a price determined by customer value, not hotel cost.

If you want to understand the demand curve and the price elasticity in your particular industry and market, there’s no question you’ll need to employ some math. And there’s certainly some solid science behind Van Westendorp’s useful Price Sensitivity Meter — the four questions that help assess what the Dutch economist calls an “acceptable range of prices.”

But the essence of pricing is appraising, not counting. As Tom Lewis, Finance Director of the U.K.-based Institute for Practitioners of Advertisers (IPA) recently observed in a post, the artful objective of the pricing professional is to set a price somewhere between cost and value where both parties — the buyer and seller — earn a profit.

While the concept of the seller’s profit is well-understood, the “buyer’s profit” is equally important. While firms must make certain that their price is set above their cost, they must also ensure that the value (to the customer) is higher than the price. It’s always under these conditions that a sale is made.