Lead Article (Self-help topic – PRICING STRATEGY)

Managed Services, as with any business model, requires a pricing strategy that ensures the business owner is profitable while providing the feeling to the client that they are receiving services that are commensurate with the price that is being paid. The most common mistake I see in the world of Managed Services is setting prices at a level way below what is reasonable with the mistaken belief by the IT Provider that the objective of Managed Services is to give a client a cheaper solution. In fact, every single one of my clients that I converted from break/fix to Managed Services paid significantly more for their IT services on an annual basis once they signed a Managed Services contract. The reason was quite simple. They were receiving so much more. I would always ask a client if they expected to pay more for a car or a bicycle. Of course the answer was that they expected to pay more for a car. If someone had approached them when they always rode a bicycle to work and told them about the advantages in speed and comfort of a car, would they expect to pay less for a car? Of course not.

The same argument was easy to put forward in relation to Managed Services. I would tell the client they would pay more for a Managed Services arrangement because they were receiving so many advantages. They received regular maintenance inspections and updates. They received regular consultancy visits. They received guaranteed response times. They received higher levels of support. They received monitoring tools that delivered higher levels of efficiency to their overall network. In short, they were paying more because they were receiving more – and the common law of business says you can’t get more and pay less.

I have always been a fan of Ron Baker. He has released books and delivered strategies to accountants for many years focused on value accounting. In the value accounting world, Ron encourages accountants of the world to throw away the time sheet and charge their clients based on the value they deliver to their clients. It is a fixed fee arrangement by another name. Ideally, can you imagine an accountant that says he will charge you 5% of the increase in net profit that your business achieves each year? Imagine the pressure on the accountant to help you with strategies to deliver increased profitability! Ron doesn’t go quite this far but the philosophy is based around what accountants deliver rather than how long it takes them to deliver.

You may have heard of various restaurants around the world that don’t have a set fee for the meals on their menu. If you do an Internet search on “restaurant pay what you think it is worth” you will find lots of examples. These restaurants typically just tell their clients to pay the restaurant a fee they are happy to pay for the meal. Some just have a brown box at the door of the restaurant and ask you to insert what you think the meal was worth. It may seem like a scary and radical concept but people typically feel guilty if they underpay and the restaurant owners say that people typically pay more than the meal would have been priced at on a traditional menu – if they deliver exceptional service.

I am not suggesting that you start to price your Managed Services arrangement on the increases you deliver to a client’s bottom line or allow your clients to pay a fee of their choosing at the end of the year but it does demonstrate that many people are incorrectly scared of pricing their services too high. First and foremost clients are more concerned about service delivery than pricing.

From a more technical viewpoint, when you are deciding on your pricing strategy, there are a few components to consider. Firstly, you need to be aware of what the market says. I am not suggesting for a moment that you need to be the cheapest in town but you should be aware of what client expectations are in relation to price. It may even be worth performing a price sensitivity survey to see at what point pricing starts to become a significant factor. The risk that a purchaser feels is an important part in the pricing sensitivity. While pricing may be an important factor when purchasing a simple product that will be used once – like a box of tissues – I think most people would prefer not to go to the cheap end when buying something a little more important – like a parachute. I am not sure I would be too happy using a parachute that my wife brought home to me while telling me in an excited manner that she got a real bargain! Buying IT services is one category that people see as involving high risk as a cheap service can cause a business a lot of pain.

You also need to be aware of what your competitors are charging. Again I don’t believe you should sweat over every detail of the prices your competitors pay but you should at least know what they are charging. When a client tells you that you are twice as dear as the opposition you want to know if there is any truth in the claim. I always typically wanted to be dearer than my opposition so if my prices dropped below my competitors I was worried. I always wanted to deliver the absolute best solution to clients therefore I expected my services to be dearer.

The largest mistake you can make in your pricing strategy is to under-price your product. With low prices you have low margins and if you have your pricing strategy wrong, it is far easier to reduce prices than it is to increase prices. Due to the increased risk factor with IT, you may find that your clients are not particularly price sensitive. Low prices can also often lead to unprofitable disloyal clients.

A cost-plus strategy is what many break/fix operators have traditionally used with their staff but a cost-plus strategy can limit your profitability as the delivery of your Managed Services should, over time, use less of your staffing resources so I wouldn’t recommend a cost-plus strategy for pricing your Managed Services arrangements.

Whatever method you decide on, it is very important to continually review your prices and, at least once a year, increase your prices. When you review your prices, review items like your success rate. If you are successful in every job you quote or tender, that would be a signal to me that my pricing was too low. Similarly, if you have clients not renewing their contracts, interview them to assess whether it was the service or the price that made them decide not to renew (my bet is that it is usually the service).

With all the plans and dreams you have for business and all the wonderful services you can provide to your clients, if you aren’t making money then you can’t deliver on any of your plans. A pricing strategy that ensures your business is there for the long-term is therefore essential for you to run a successful and profitable business for years to come. It isn’t easy – but it is essential to get it right.

Tell me how you set your prices at md@smallbusinessrules.com.


Business Tip of the Month

Rule 30: You Get What You Pay For

Since I am talking about pricing strategy this month, I thought it was appropriate to give you my favourite 100 words related to pricing. The words are written by John Ruskin who lived from 1819 to 1900. When you read the words, they may as well have been written by someone giving you advice yesterday – it is amazing that John wrote these words over 100 years ago. Business value vs. price has been an ongoing issue since Noah first started to decide on a weight based pricing policy. John had a particularly elegant way of saying that you get what you pay for.

“It’s unwise to pay too much but it’s unwise to pay too little.

When you pay too much you lose a little money, that is all.

When you pay too little, you sometimes lose everything,

because the thing you bought was incapable

of doing the thing you bought it to do.

The common law of business balance prohibits

paying a little and getting a lot.

It can’t be done.

If you deal with the lowest bidder,

it’s well to add something for the risk you run.

And if you do that,

you will have enough to pay for something better!”

Science Quiz Question

I walked out of my office yesterday and it was raining. My car was parked about 100m away and I didn’t have an umbrella. The rain was a constant drizzle and I couldn’t see any movement in the trees so I deducted there wasn’t a lot of wind in the air and therefore the rain was going to stay for some time (the clouds were not going to be blown away). Now I needed to work out what to do. Should I go back inside, find a beer in the fridge and just drink until the rain passed? With the lack of wind and the stupidity of driving a vehicle while drunk, I decided against this course of action. I really needed to get to my car and since my car wasn’t KITT (Knight Industries Three Thousand from the Knight Rider series) then I had to get to my car. The big decision now was whether I should run to my car or walk to my car. Assuming I want to stay as dry as possible, what do you think I should do? Run or walk?

Science Quiz Answer

The answer to this question seems simple enough but it has actually been the subject of extensive research by a number of organisations over the years. I found evidence of a Harvard mathematician tackling the subject from a scientific perspective as far back as 1976. The first reaction might be to simply run – but to complicate the answer, there are two components to consider. The rain that might hit the mostly horizontal surfaces of the human body – such as the top of your head and your shoulders – and the rain that might hit the larger vertical surfaces of the human body – such as your chest and legs.

For the first part, hopefully you can agree with me that the longer you stay in the rain, the wetter your head will become. The wetness factor for the top of your head is simply a function of time. The longer you are in the rain, the more rain will hit the top of your head. This seems fairly clear-cut. Run to the car!

But wait – when you run, surely you are exposing the larger vertical aspects of your body to more rain. Surely your chest will be wetter than if you walked? Well… yes and no. You actually do have more drops of rain hit your chest per second when you are moving through the rain faster. But you also reach your target faster. The net result of the increased rate of raindrop intersection and the decreased exposure time is that – within parameters of slow walking to fast running – the amount of rain that hits your chest over a given distance is identical. It doesn’t sound completely logical but the mathematics and the experimentation show the results to be true.

So if you can accept the fact that the rain that hits your chest is identical regardless of your speed then it is simply a matter of staying in the rain for the least amount of time. That is achieved by running as fast as possible.

As is often the case, your first reaction when asked what to do is the correct answer. Run like the wind!

Footnote: Actually – if there is a wind then running like the wind is exactly what you should do. If there is a 10km/h wind blowing from the west then running at 10km/h towards the east will actually reduce the amount of water that hits your vertical surfaces.

See http://www.dctech.com/physics/features/0600.php if you want to calculate exactly how much water will collect on your clothes. Some people have too much time on their hands!

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