You Have an Unfinished Business Model
LinkedIn Article by Tim Williams
December 20, 2017
If you work in the world of professional services — advertising, law, accounting, architecture, etc. — it’s more than likely your firm is missing a critical element in its business model. Without it, you're dealing with self-inflicted roadblocks to your long-term financial success.
Given that “business model” is one of the most abused terms in today’s business lexicon, let me offer a simple definition. Every business must do three essential things:
1. Create Value
This requires a clear definition of A) Markets you serve, and B) Products and services you offer
2. Deliver Value
This is dependent on an effective A) Organizational structure and B) Production model
3. Capture Value
This results from a well-defined A) Cost structure and B) Revenue model
So what’s the element from the above list that’s missing in almost every professional service firm? The answer is 3.B. — a revenue model. Professional firms have a cost structure, but they confuse this with having an actual revenue model.
Apple has a revenue model. Tesla has a revenue model. Google has a revenue model. Professional firms have a cost structure. Most have not developed a model for generating revenue outside of adding up their billable time.
Hours rates are internal metrics of estimated cost, not external measures of external value. A cost is not a price. And without a more sophisticated approach to pricing than this, professional firms can’t claim to have a revenue model.
What’s needed is an outside-in approach to valuing your firm’s services, coupled with some inventive thinking about how these services can be monitored in ways that transcend efforts recorded on a timesheet. The firms leading the way in the development of real revenue models have traded in their rate card for a “pricing stack” — an array of revenue-generating pricing strategies designed to capture the value they create rather than the costs they incur.
Your pricing stack can include the same modern pricing methodologies employed by your clients — demand-based pricing, two-part pricing, subscriptions to packages of services, bundled pricing, tiered pricing, pricing, pricing options, and more. Many of these innovative pricing strategies are already in use by some progressive professional service organizations, but there are two basic approaches that can help your firm begin to transform its pricing strategies:
A fixed price for outputs
This is the very simplest form of pricing professional services, and it need not have anything to do with hourly rates because it’s based on work delivered, not hours worked. Indeed, this is the way the vast majority of products and services are priced in the commercial world, from the mobile phone in your pocket to the car in your driveway. None of these purchases are made with any awareness or discussion of the hours or costs required to make them.
A dynamic price based on outcomes
While this approach lacks the certainty of a fixed price, for the right types of client relationships it can be richly rewarding for both parties. Ultimately, professionals are in the business of producing outcomes, not performing tasks, and this pricing approach compensates your firm for its expertise instead of its activities. It also has the advantage of perfectly aligning economic incentives: what’s "win" for the client is "win" for the firm.
Your Pricing Platform
Think of this as “value engineering,” a proactive approach to developing a pricing platform for your firm. This means setting aside the imprudent idea of selling units of cost and instead defining units of value; the benefits created by the hours you work instead of the hours themselves.
As pricing expert Tim Smith explains, “In value engineering, attributes and features are added and subtracted to offerings according to the willingness-to-pay of customers.” Identifying, packaging, and pricing these attributes is the essential work of establishing a revenue model.
Replacing your schedule of hourly rates with a well-crafted revenue model has the added benefit of making your firm stand out in your clients’ ongoing attempt to make an apples-to-apples comparison of your pricing compared to competitors. Many smart start-ups in the advertising agency space see this as an essential competitive advantage. An innovative new woman-owned agency aptly named “Joan” offers clients a half-dozen different packages in place of time-based billing. This simplifies the pricing process, say the principals, and makes the relationship easier for both the agency and its clients.
An effective revenue model also requires identifying and naming the most profitable customer segments served by your firm. Each of these sectors will have different needs, different expectations, and most notably different levels of price sensitivity. For each segment, determine the most appropriate and compelling constellation of attributes and benefits and the corresponding pricing strategies. As my colleague, Ron Baker preaches, “Not every client gets to fly first class.”
Developing a revenue model means focusing on value created as the goal and treating costs not as a determinant of price, but rather as a constraint. Costs represent a floor, not a ceiling.