Everyone in the agency business has a deep hatred for two aspects of your business. The billable hour and the timesheet. My podcast guest, Ron Baker, believes agencies should do away with both. (I disagree with him on the timesheet and you’ll hear why in our conversation).

Ron’s philosophy is built around the concept of customer value-based pricing. He’s a huge value-based pricing advocate and a CPA but he’s no ordinary CPA. He and his team are committed to price certainty in all professions, including agencies.  He wants to help you have a conversation with your customer to determine the value of what you’re creating, so that you’re pricing the customer, not your services or the scope of work.

Ron and I help you understand what your customers are trying to achieve and how to assign a value to the work you do to help them get there.  We answer many customer value-based pricing questions like:  

  • Why Ron believes that the billable hour and the timesheet need to go
  • Customer value-based pricing: the differences between different pricing plans
  • Ways to add in additional value that isn’t more “stuff”
  • How to start a value conversation
  • The typical agency objections of value-based pricing and why they’re false
  • How to succeed at the transition to value-based pricing
  • Other kinds of mistakes agencies make when shifting towards value-based pricing
  • The major benefits for focusing on value and the customer
  • Action steps that agencies can take when deciding whether or not to utilize customer value-based pricing

Ron Baker is the founder of VeraSage Institute, a leading think tank dedicated to educating professionals internationally, and a radio talk-show host called The Soul of Enterprise: Business in the Knowledge Economy. Ron is the author of seven best-selling books, including “The Firm of the Future,” “Pricing on Purpose,” and “The Soul of Enterprise: Dialogues on Business in the Knowledge Economy,” co-authored with Ed Kless.

To listen – you can visit the Build A Better Agency site (http://buildabetteragency.com/ron-baker/) and grab either the iTunes or Stitcher files or just listen to it from the web.

If you’d rather just read the conversation, the transcript is below:

If you’re gonna take the risk of running an agency, shouldn’t get the benefits too? Welcome to Build a Better Agency where we show you how to build an agency that can scale and grow with better clients, invested employees and best of all, more money to the bottom line. Bringing his 25 plus years of expertise as both an agency owner and agency consultant to you, please welcome your host, Drew McLellan.  

Drew: Hey everybody. Thanks for joining us for another episode of Build a Better Agency. Today, we are gonna talk about a topic that I know is near and dear to all of your hearts, the idea of pricing and making sure you don’t leave a lot of money on the table. So our guest today is gonna be all about that. Ron Baker started his CPA firm, and don’t freak out, he’s very different than the normal CPA that you’re used to. So he started his career in 1984 and today he is the founder of VeraSage Institute, the leading think tank dedicated to educating professionals internationally.  

He also does a radio talk show on voiceamerica.com called, The Soul of Enterprise: Business in the Knowledge Economy. Ron is the author of seven bestselling books including titles like The Firm of the Future, Pricing on Purpose, Implementing Value Pricing: A Radical Business Model for Professional Firms. And he just recently launched a book called, The Soul of Enterprise: Dialogues on Business in the Knowledge Economy, which he co-authored with his co-host, Ed Kless. Ron, welcome to the podcast.

Ron: Thanks Drew. Thrilled to be here, thanks for having me.  

Drew: You bet. So I know that because we have interacted many times before, I know that agencies react one of two ways to what we’re gonna talk about today. Which is, they either get very excited and start taking copious notes or they start to sort of twitch. So let’s just dive in, give the listeners an idea of sort of the whole notion of customer value-based pricing and how you view that from a professional services firm point of view.  

Ron: Yeah. You know this started after I left the Big 8 accounting firm and started my own practice, which of course, as you know, when you run a professional firm, you’re responsible for everything. And I learned really quickly, Drew, that the billable hour was a lousy customer experience. So I got into this whole value-based pricing from the customer service side of the business, not so much the profitability or the marketing side but just trying to create a better customer experience to give the customer certainty in price.  

We all wanna know, just as human beings, what something costs before we buy it. That’s a better customer experience. It leads to less write downs, less hassles, less getting fired by the customer, because you surprise them with a bill. So I just started doing this in my practice and it worked tremendously and I got so excited. I started teaching it to my colleagues and I wrote a book about it.  And then I started teaching it with other professionals including advertisers beginning in around 2001, 2002. So that’s kind of the short bio of how I got into this.  

Drew: So talk about, again, from the customer experience because I think this is not how agencies think about pricing. One of the things I’ve always said is agencies lose clients over the $50 FedEx bill not the $50,000 project price. And that this sort of nickel-and-diming and billing by the hour invites scrutiny and invites…you know, it immediately invites that it took you two hours to do that, blah, blah, blah. Right?  

Ron: Oh, yeah. Not only does it invite scrutiny, but as you know, it’s created a whole industry of search consultants and compensation or I should say compensation consultants. You have the same thing in the legal field, you have legal auditors who go in as a middleman to audit the bill. And usually, they can get 25% to one-third reduction so they pay for themselves. This is insane.  

We don’t have a middleman in any other market where there’s transparency in prices. And so I think the billable hours is the big cause of this, and of course, I believe the real cancer is the timesheet because it’s the timesheet that keeps us mired in the billable hour mentality.  

So when I made this transition in my firm, I got rid of both the billable hours and the timesheet. And that just took my eyes off the clock and put my focus and attention on value and on the relationship. Because I really believe you can’t develop relationships or strengthen them by staring at clocks.  

Drew: So now you’ve got all the owner’s ears perked up because there is no greater bane to everyone’s existence other than the timesheet. So I will tell you right upfront I kind of disagree with you on the timesheet.  So, we can talk about that, but from your perspective, why do timesheets not make sense?

Ron: Timesheets don’t make sense because they measure the wrong things. They measure inputs, not outputs. They do something that’s very, very, I think, pernicious. They don’t help us improve future performance. If I know how many hours down to the six-minute increment you spent on something, that doesn’t tell me how to do it better next time. It gives me no further knowledge and we’re knowledge workers, especially those in advertising agencies. I mean, advertising agencies are all about knowledge, creativity, imagination, ideation and that can’t be measured in time. It’s like plunging a ruler into the oven to determine its temperature.  

So rather than recording time historically, you know, I always say, “We’re trying to manage our agency based on running timesheets is the equivalent of timing your cookies with your smoke alarm.” By the time you see it on the timesheet, it is by definition no longer manageable. So, what, I prefer instead is after action reviews because if you do after action reviews after big campaigns, then that will help you actually improve future performance and I think that’s a better investment of time. The problem is AARs are not billable, and therefore, in the “we sell time” business model, they don’t get done. And I think that comes at the expense of creativity and better value creation for our future customers. So I believe the timesheet absolutely has to go and it’s gone in agencies around the world. I mean, agencies are getting rid of it left and right.  

Drew: And how are they managing efficiency in knowing if they’re staffed appropriately and all that sort of stuff? Those things are typically tied to timesheets and all of that, so how are they getting that done?

Ron: They’re getting it done through better project management. Because as you know, project management has to look forward, it has to project capacity and resources going forward, it doesn’t look backwards. So project managers make a big distinction between effort, meaning the amount of time they estimate something to take and duration. What matters to a project manager is, are we gonna get the work out by the delivery date to the client and that’s called duration, same as FedEx. What we care about FedEx is it pops on our doorstep at 8:30 in the morning, not how long it sat on the truck or in the airplane or the hub sort, whatever. And it’s the same thing.  

So I think what you’re seeing in a lot of agencies is agile. Agile is coming in and that’s a form of project management, so also some other things, that help agencies project future capacity. And I think that’s a much more compatible type of project management for a knowledge environment rather than recording backwards time.

Let’s not forget that the timesheets came into play in the 1880s in the industrial sector by a guy named Frederick Winslow Taylor. Advertising agencies aren’t steel mills.  They deal with knowledge workers where things take place in your head not on an assembly line. And therefore the metrics we use don’t really say anything about the effectiveness or the efficiency even of a knowledge worker.  

Drew: So in terms of project management and all of that, I think one of the things that I’m seeing is agencies are evolving away from the billable hour, but instead they’re gonna a project price would seem sort of like a hybrid between billable hour and customer value-based pricing, talk about sort of the spectrum.  

Ron: Right. There’s many different types of pricing. I mean, there’s certainly the hourly billing.  There’s fixed prices. A lot of agencies will just take estimated hours and try and fix that upfront. Now I think that’s a big improvement over billable hours, at least, because there’s a fixed price involved and I know a lot of agencies do offer fixed prices. But what value-based pricing is, what makes value-based pricing different is you have to have a conversation with the customer to determine the value that you’re creating for that particular customer. So you’re pricing the customer, you’re not pricing the services or the scope of work. You’re actually pricing the customer. Because different customers have different value propositions and the work that we do for them creates various levels of value.  

So to the extent that you can customize it per customer and offer them a fixed price.  The other big suggestion I have, Drew, and I think this is something that agencies can do right out of the gate is rather than just offering one price, take it or leave it, give them options. Offer the customer three options like American Express, a green card, a gold card, a platinum card. Most businesses, if you look at any business out there, they all offer options. Every one of them, go to a Starbucks, look at the menu, Tall, Grande, Venti. So, offering options allows the agency to become a price searcher rather than merely a price taker and that can dramatically increase profits.  

Drew: Well, I think the other thing it does it allows you to say to a client, “You know, we can do this work for you and these range of prices, but you can see that something has to come or go off the list of deliverables to achieve your price point.” So it also avoids the problem which many agencies get into where the agency says, “Well, this fill in the blank, this website is gonna be $25,000. And the client goes, ‘I only have 20.’” And the agency often is beholden, then saying, “Well all right we’ll do it for 20.” And now they’re already playing catch up as opposed to saying, “Well, if you only have 20, then let’s look at the middle model which is at 18 and we can add some things or you can just buy the middle model,” as opposed to having to compromise the price without also changing the deliverable list.

Ron: Right. Too many agencies make unilateral price cuts without having the client sacrifice any value, be it scope of work or timing of that work. They wanna pay a cheaper price, great, you have to wait longer.  It’s gonna take six months to build your website, not three or two. You know, so timing can be part of this. Payment terms can also be part of your option differentiation. But you’re right, what it does do is it forces the customer and also gives them the choice to make the appropriate value price tradeoff that they’d like to make, and that’s why we, humans, love choice.  

Drew: Right. So, you know, we talk a lot at AMI about sort of this create the three options and all about the deliverables so you can sort of plus or minus those deliverables to get to any price point in between the lowest and the highest. But I think the other thing that it does is it often automatically upsells folks into at least the middle tier rather than buying the lowest priced option.

Ron: Right. I mean, we have…the behavioral economists have proved this really well. There is a heuristic, a mental shortcut that we all use when we look at three options of anything, could be a bread making machine, you know, a lawnmower or whatever. We gravitate towards the middle option because our brain says, “Well, the cheapest one is probably not that great quality, it’s probably gonna break. The most expensive ones probably have too many bells and whistles, we’ll all be safe and pick the middle option.” I mean, this is so well documented. It’s called the Goldilocks effect.  

Drew: Yeah.  

Ron: We pick the middle option. But the other thing is really interesting about the options is offering them especially in RFPs or tenders gives you, I think, an enormous competitive advantage rather than just giving a client one price, take it or leave it. Now you’re giving them options. But you can also have that cheapest priced option be very competitive.  And like you said, most customers will trade up and that additional revenue a lot of it drops right to the bottom line. Because it’s not really differentiated so much on cost as it is maybe on other things like payment terms, turnaround time, things that really don’t cost as much but the customer values it.

Drew: Yeah. I think sometimes we forget that there’s other things in the value proposition besides the stuff that we do. So I know you talk a lot about, so you’ve talked about payment terms, you’ve talked about delivery time, turnaround time. I know you talk about, you know, A team versus a different team. What are some of the other ways you recommend to clients that they add different values inside their proposals that aren’t necessarily more stuff?  

Ron: You could do it based on technology. What type of technology are you going to use? I think even project management itself can be one of the differentiators because who’s gonna take care of the project management? Because I know a lot of agencies rely on the client’s team members to do certain things.  Who’s gonna control all that? And a higher price should be charged that the agency is gonna do it.  

Also, how are you gonna deliver the work? Educational events could be put in there as well if you hold various…you know, a lot of agencies hold lunches and learns or they have a CEO roundtable or something. Maybe you make access to those. Other things that you can do that basically allow the customer to get value even though they don’t cost…those things don’t cost very much. And I think this is only limited by our imagination.  

Drew: Yeah. I think all too often agencies, as they’re putting together proposals, are too literal. And so they really it’s just write a website, it has 20 pages, 30 pages or 50 pages and it’s priced accordingly. And don’t think outside the box in terms of other ways that they can add value. That they also can take off the table to reduce the price that really don’t mean that they’re getting less money per se for what they’re actually doing.

Ron: Right, right. They’re just making the client sacrifice some value, which is really important.  

Drew: Yeah. So you talk about the difference between project pricing and customer value-based pricing is really the conversation you have with the client upfront. Give us an idea of what that conversation looks like and how does an agency who’s never had that kind of…how do you wade into that conversation?

Ron: There are some really good strategies and I’ll give you what we think is the best opening line to start that value conversation. Because in my book, Implementing Value Pricing, I lay out an eight-step process. And the first step is about having the value conversation.  And any agency, any firm that does this will tell you it’s the most important step in the process. We’ve got to step back, Drew, and really ask the client, what are they trying to accomplish? What is the end objective here? Not just dive into the scope of work, not just dive into the solution. Really take the time to diagnose what the customer is trying to achieve.  

Because sometimes maybe we can’t help them, and we should back away. I don’t think professionals for the most part spend enough time on diagnostics.  And so really the value conversation is like a physician, it’s a diagnostic procedure. They’re listening to you, they’re running tests. Because any physician that prescribed without first diagnosing would be engaging in malpractice. And I’m not saying that we engage in malpractice, but I am saying we tend to jump to the prescription rather than first having that diagnostic process.  

So I think the best opening line is something to the effect, “Mr. or Mrs. Customer, we will only undertake this engagement if we agree to our mutual satisfaction that the value we are creating is more than the price we are charging you. Is that acceptable?” Now that’s the opening line that McKinsey & Company, probably one of the most successful professional firms on the planet uses on every single client engagement, new or old, it doesn’t matter, that’s how they start every client engagement. And I find it to be a very effective opening statement.

Drew: Who’s gonna say no to that, right?  

Ron: Right. In fact, when we’ve shared that with CMOs, because I’ve talked to the client side of the agency business and the clients would go, “I’d love that.” Because a lot of times I have to justify the agency’s prices to my boss, CEO, VP whatever.  And it would help me clarify why exactly are we paying this price because then I could document it based on value. So, the CMOs and others in the organization welcome these types of conversations, but we don’t have them enough.  

Drew: Well, my guess is that a lot of listeners are going, “Oh, I know how that conversation is gonna go. They’re gonna want to a $50,000 website for $20,000.” So how do you respond to that?  

Ron: Well, if that’s really the case then we can’t do it. But I rather know that upfront than start to dive into the work and learn that later. I mean, I rather find out that the client doesn’t like my price before we do the work rather than after, because maybe there’s some things we can do. We could chop down the scope, we could push back the go-live date on the website, maybe you could do it for 20. There’s lots of options before you start to work, but once the work has already been started or worse yet, had completed, there’s not many options. You’re on your knees begging to get paid whatever the client, you know, wants to pay you. And that’s not a good option, a good predicament to be in from a pricing standpoint.  

Drew: So when a client says, “I don’t know how to value this,” whatever it is. How does an agency help a client assign a value to the work that they’re asking you to do?

Ron: And this is really an art because, you know, value is subjective. So it’s not a formula, it’s a feeling. I know I freak people out especially as an accountant. I freak people out when I say that.

Drew: I was gonna say that this is why I said you’re not a normal CPA.  

Ron: Well, because value is completely subjective, right?  

Drew: Right.  

Ron: I love water in the desert, and if I’m about to die, is priceless to me. But if I’m, you know, flooded my basement with water, now it’s got a negative value. Well, we didn’t change the water, it’s still H2O, but its value depending on the context and the job I’m trying to perform is radically different, which is why we advocate you price the customer. So you gotta have that conversation because you gotta understand the value. Let me just give you what I think is a great example of how to effectively help the customer see the value, comprehend the value and for the agency to communicate that.  

If you’re in the market for a landscaper and the first one came out, looked around your place, said, “Yeah okay, we do all this.  We trim your lawn, you know, mow it, take care of the tree, bushes, whatever.  $40 bucks an hour.” Second one comes out and says, “Yeah, I will do all that with $100 bucks, fixed price.” The third one comes out and goes, “Ron, you know, you probably don’t…you’re probably not Martha Stewart so that’s why you’re hiring a landscaper in the first place. You probably don’t want to think about your yard.  We promise to give you the best curbside appeal in the neighborhood.  You’re not gonna even think about your yard. We will take care of everything. We’ll even plant different bushes, different seasons. You know, whatever, you won’t even have to think about your yard but you’ll have the best curbside appeal with $150 bucks a month.”

Now, whom I can hire? Who did the best job communicating their value to me? The first guy just talked about inputs, you know, 40 bucks an hour. The second guy did a little bit better, he at least gave me a fixed price. But the third guy told me what it meant to me. He told me the outcome I was going to achieve as a customer. I’m gonna get the best curbside appeal. That resonates. We need to do a better job communicating that outcome to the customer.  

Drew: And for clients who are more linear and want to attach a dollar value to it, how do you get from best curbside appeal to that’s worth X to my company or whatever? Because again, part of that is helping them sell up the food chain and they may need dollars and cents, so is there a way to sort of attach those two?

Ron: Yeah. The way I think about it is I split, and this is technically incorrect because you can’t split value because it’s kind of a holistic concept. But you can certainly look at things that are measurable, what we call materialist value, things you can measure. You know, brand awareness, impact on profit revenue, market share, whatever. Certain things can certainly be measured. To the extent they can be measured, measure them. You know, and better yet, use the customer’s numbers, but there’s also an enormous component of spiritual value in what agencies do or what even brands do. I mean, think of why people pay a huge price premium for Apple.  

It’s the spiritual side.  It’s, you know, I know they’re gonna take care of me if it fails. I’m gonna be able go to the Genius Bar or use Apple Care to get a new machine or whatever. So you can’t ignore that spiritual side. And I think, Drew, this is where options come in really well because you can quantify value.  You can create that low priced option and still be relatively competitive. But then you’re taking into account the spiritual side as well for your higher priced options. And like you said, most people will trade up and therefore you’re capturing more value.  

Drew: So when you talk to agency owners, what about all of this freaks them out? What objections do you hear around this idea and how do you sort of help them get over those objections?  

Ron: Oh, boy. How much time you have? I’ve heard every objection in the book, as probably you have, too. In fact, I haven’t heard a new one in the 20 years I’ve been teaching this except one guy did tell me the Lord doesn’t want him to do this, which I didn’t have a response to. But the typical objections are, well look, what we do is a commodity and the price is just kind of a given in the marketplace and we have no control over it.  

This is actually a fairly common, you know, lament from agency owners.  In fact, all firm owners we hear this from in all markets. And it’s complete nonsense. I mean, there’s tons of empirical evidence that defies this. But because if that was true, if the market really dictated the price and you had no control over it, then why would you need timesheets? I mean, we just go do the work. I mean, the price is fixed. You’ve got to keep your cost under that price, otherwise you’re not gonna be in business very long. So obviously, agencies have some control. They’re not just price takers, they’re price searchers. And I think that’s the beauty of offering options.

Drew: Well, and in fact, they don’t charge the same amount of money to every client for doing the same thing. Right?

Ron: Absolutely.

Drew: I mean part of it is…again, so they’re sort of accidentally defining some value based on the client, but the way they look at it is, here’s what I think the client will bear or the budget will bear as opposed to thinking about it in terms of value, correct?

Ron: Right. They tend to look at the budget. I mean, I think budgets are very, very elastic. You know, they’re a form of rain dancing in the client organization. And if the client sees the value, even if it’s over their budget, they’ll find room in the budget to pay for it, if they want it. So, I always think you need one or two options above the budget if you know what that number is. Because budgets are just, you know, they’re very elastic.  

The other thing we hear is, clients will never go for this. Which I also think is nonsense because if you look at big advertisers like Coke and Procter & Gamble, they’ve already got customer value-based pricing models in place. They implemented and forced the agencies who work with them to use. My problem, you know, and I’ve looked at these models and they’re quite innovative. But the thing that scares me about it is I don’t want the clients driving this change, I want agencies to drive this change. I want the agencies to uberize themselves if you will, to innovate themselves. It should come from the supply side, not the demand side.  

Drew: But I do think it’s telling that a lot of the big brands are defining that they don’t wanna…well, it’s interesting because I have clients in AMI who work with big brands who are…you know, they have to work with the procurement officer and they’re having to submit what their employee’s salaries are. And they get a percentage of profit they’re allowed and they’re told what they can bill for that client. So on one hand, you have that and on the other hand, you do have the big brands like Coke who are saying, “No, we don’t wanna do it this way anymore, we wanna do this all based on a shared agreement of value.”

Ron: Right. And Coke’s been quite successful with it and I know P&G has as well. And you’re right, that’s another objection we hear, is the procurement. I’ve got to deal with procurement, they come in and they just force the price down. And of course, you know, that is their job. However, I would say that, you know, procurement…the best the procurement officer can do, their entire job is trying to get their company the best deal. That doesn’t mean that they have any veto power over the agency that the client hires if the CMO, CEO wants a particular agency. They’ll pay for it. They’ll still send procurement and try and get the best deal, but I think again this is where options can work wonders. Because if the agency wants to force you down, you just look at them and go, “Great, pick the cheapest option. That’s why it’s there.”

And that’s the option that the agency should never go below. I think agencies need to be better at setting a walk away price. What price will you just walk away from this business? Because I think it’s insane to believe that any business is better than no business. I don’t think that’s true at all.  I think no business is better than bad business.

Drew: Yeah, I agree. I often say that, you know, every dollar is not equal, and there are bad dollars on the table that you should just leave on the table.  

Ron: Absolutely.  

Drew: Yes, yes. So as you watch agencies sort of step into the waters of this, what are some of the mistakes you’ve seen them make and what are some things that agency owners listening to us today should be conscious of and try to avoid?  

Ron: I think one of the biggest mistakes I see and not just agencies but across all professional firms that really do. Let’s say you buy into this concept and you really wanna do it that you don’t commit strongly enough to it. And I have found the firms that set up a Value Council, maybe even appoint a Chief Value Officer are the ones that succeed with this transition. Because I believe that you need people in charge of this. It can’t just be, “We’re gonna leave it up to everybody who kind of does pricing now to, you know, move to this method.” t’s not gonna happen, somebody has got to own it.  

I want one throat to choke which is the Chief Value Officer. And then that person would work with the value council below them.  And I think pricing needs to be centralized in agencies. And part of that is because we want to take pricing authority away from people in agencies who aren’t good at it. I mean, let’s face it, not everybody can do this. It is an art but it’s also a skill. And some people aren’t interested in it, some people, it scares them.  

Well, I don’t want those people pricing. You know, if I wasn’t good at certain agency scope of work, you know, you wouldn’t give me that type of work. You put me where my strengths are, but we tend to put people in pricing who aren’t good at it. That’s got to stop and that’s why most businesses that have set up pricing, have centralized.  They turn it over to a group of pricers who do it over and over across the entire firm. And that is one of the most successful things I think you can do, is gi