Rant: World’s Worst Pricing Model
… which may also be the most popular.
How about a pricing model that ensures that the more brilliant you are, the less you get paid? That the more efficient you are, the less money you make? Yes, it exists. And in the area I know most about, the creative sector, a recent report stated that 60% of agencies used it. In other sectors, I suspect the figure is even higher.
So what is this killer (as in killing your profitability, and quite possibly your business) model? To answer the question, and explain just why this model is so horrible, let me take a detour into a past project.
I was engaged by a private equity firm to do a post-investment review of European engineering group into which they had just put €100m. I discovered many interesting things, including this:
There were some types of project which the UK company was selling for a margin of 25% but where the Italian company was achieving 70%. Why?
The Brits had a pricing model – cost of components plus a percentage. The Italians didn’t have a model. They had a process, which could best be described as “let’s all get in a huddle and think of a number.”
The reason for the difference was that, in some cases, they weren’t just selling components, they were selling solutions to hard engineering problems. The customer wanted a hydraulic installation to give a particular level of performance, at a particular temperature, to fit into a small awkward space on a machine. They couldn’t work out how to do this, but my client could.
The difference between the Brits (25% margins) and the Italians (70% margins) had nothing to do with who was the better engineer, but everything to do with realising that what you could do was actually something special. The Italians got this, and expected to be paid for it. The Brits didn’t.
There was lots of money being left on the table in the UK, but it got worse. The group was under cost pressure and had responded by saving money by sourcing materials from lower-cost countries. Can you see the trap? If your pricing is based on cost plus so that your profit margin is x% of cost, the more you save on inputs (whether industrial components or creative hours) the less money you make.
So, to come back to the creative sector:
- Average agency takes a lot of time to produce a so-so result, and gets paid quite a bit.
- Brilliant agency takes less time to produce a spectacular result, and gets paid a lot less.
WTF?? And as I say, 60% of agencies are reported to be using this model.
If you are the head of a business which is like those Italians with powerful skills, insight and experience that can produce dramatic results for your clients out of all proportion to the time taken, you’d probably like to be properly paid for your brilliance. I suspect, though, that the “let’s all get in a huddle and think of a number” method I described is frustratingly vague. Instead, investigate Intelligent Pricing Architecture.
Intelligent Pricing Architecture is a systematic process which enables you to stand out from your competitors and put yourself in a category of your own to get paid what you are truly worth.
There are twice-monthly briefings, which you can book here. Or if you would prefer to talk one-to-one, you can book a time here.