Most pricing literature focuses on how to price a product or a discrete service. Far less has been written or researched on relationship pricing. This creates a significant challenge for those involved in pricing professional services as many arrangements between buyers and sellers are relational rather than purely transactional.
By relationship pricing we mean a pricing arrangement that covers multiple transactions over a period of time and where there’s some commitment from the client and from the firm to do business together.
The most dominant form of relationship pricing is discounted hourly rates. Many firms offer their priority clients discounted rates as both a symbol and a reward for a more valuable relationship. Similarly, many clients seek to lock-in discounted hourly rates for a period of time by setting up preferred provider panels via tender.
There are a number of problems with this approach. Firstly, there are few incentives for the firm to invest in a new service delivery model or in technology that could significantly reduce cost. Typically within the discounted hourly rate model, major cost reductions over time result in reduced firm revenue without improved profitability. While in the short-term this appears to benefit the client, in the long-term it significantly slows the pace of service innovation and the potential for step-change efficiency improvements.
Secondly, there are few incentives for the firm to provide breakthrough ideas and service that delivers a quantum improvement in the client’s business. With a discounted rate model, the only reward for truly outstanding results maybe the chance of a greater share of wallet or just a good vibe.
And lastly, the total system costs are often significant, especially in “second bite” panels where clients ask panel firms to re-compete for discrete projects. In these instances, the client has to go through a process of briefing firms, addressing issues, receiving proposals, assessing proposals and informing all parties of the outcome. Each of the panel firms has to invest significant time and effort in preparing and presenting their proposals. If one properly accounted for all this non-value adding activity by each participant for every transaction, it’s painfully clear that over time the whole arrangement is lose-lose.
One form of relationship pricing that is worth exploring in more detail is what we call incentivised retainers. It doesn’t suit all circumstances or relationships but has a number of elements that set the scene for better outcomes for both the firm and the client.
At its most basic level an incentivised retainer has these characteristics:
- An underlying intent to achieve the strategic objectives of both parties
- A joint focus on ensuring quality outcomes
- Agreed incentives for the firm to improve their performance on things that matter to the client (eg. end-customer satisfaction, speed, consistency, reduced rework, reliability, managed risk)
- Agreed incentives for the client to help the firm reduce their costs
- An efficient and effective process to deal with matters outside of the agreed scope
- On-going processes to ensure a positive and constructive relationship.
Some interesting examples of these retainers or variations of this theme include:
- A client whose primary focus was not to exceed their annual budget entered into a retainer arrangement with a single firm at 95% of the budget. To encourage the firm to find cost savings, the contract was offered to be renewed at 95% of the previous year’s budget. While both firms have the option of exiting the relationship at the end of each year, the arrangement has now been running successfully for several years.
- A client gave one firm all the work of a particular type on a medium-term transparent retainer arrangement. This arrangement encouraged the firm to invest in new processes and technology that radically improved cost-to-serve. Having greater cash flow certainty allowed the firm to make these investments and to date it has yielded significant benefits to both parties.
- A client wanted to encourage genuine competition for a long-standing incumbent firm. They had established a panel, however this had minimal impact in changing the buying behaviour of a broad range of instructors who had deep relationships with the primary provider. An innovative competitor entered into a retainer arrangement based on agreed resources in order to provide the client with a credible high quality, cost effective alternative to an embedded incumbent provider. Individual instructors could continue to use - and pay for - their preferred firm. Alternatively they could access the innovative competitor at no charge, as the retainer was paid centrally.
- A client sought greater price consistency from one project to the next. An incumbent firm with significant historical data was able to analyse past projects, classify them into three categories, and provide a staged fee structure for each category. They then converted their pricing from hourly rates to task-based billing - at a price-point that was neutral to both parties - in order to meet the client’s primary objective.
- Firms who put a proportion of their remuneration at risk, at the sole discretion of clients, based on their overall satisfaction across a range of projects over a set time period.
- A client who wanted the flexibility to utilise a range of firms at different price points offered annual retainers to multiple firms. Selected firms were encouraged to work together on a range of projects to maximise the value to the client. Retainers were reviewed each year based on the client’s perception of the contribution made by each firm during the prior year.
Limited only by imagination
The opportunity to establish incentivised, relationship-based retainer arrangements is limited only by the imagination of the participants. While many firms offer creative arrangements, not all meet the specific needs of the clients. In our experience, the best arrangements have been created by firms and clients working together to find mutually beneficial solutions. What are the most innovative arrangements you have seen?