Learn Cost Based and Value Based Pricing from Mike
Pricing is one of the least understood subjects.
We all think we know it. After all, aren’t we in the financial services field? The reality is that very few get it.
In our industry, most think of pricing in terms of negotiating with AMCs. This is because we have never had to learn pricing as an art or science. Our Pricing Guidance typically came from Asset Managers and we never had to develop independent thinking in this space. Most RIAs also do not know how to price as majority of them have years of conditioning in the distribution model, where their pricing was decided by Asset Managers. The New RIAs who have come look at what existing models are.
Thus, no independent thinking has really developed in this space.
I will today highlight one of the key elements of pricing that you must understand.
Cost Based Pricing: In this method, you price your product or service based on the costs that you incur. It is also known as “Cost Plus” Pricing and is one of the most commonly and erroneously followed pricing models in our industry.
Value Based Pricing: You Price your Service based on the Value you deliver. Few people understand this concept and even when they do, this is Hard to implement. Who really wants to do what is hard? Thus, you will see very few people truly implement this.
The overall Pricing Laziness or Intellectual Laziness in the industry has caused many problems but the most important ones are:
- Creation of a Solid Value Proposition
- Articulation of the Real Value we provide
- Perception of a Commoditized Offering (something that can be done by anyone).
Let me share a story that many of you might have heard.
A carpenter is fixing something in a house. The job takes him around 10 minutes. The house owner “Bob” asks him “How much do I pay?”
The Carpenter “Mike” confidently responds $100. Surprised Bob tells him “$100. Are you kidding me? The nail costs 25 cents and it took you like 10 minutes.”
Mike smiles and says “Yes the nail cost me 25 cents and that is exactly the cost of the nail. However, my value is in knowing how deep to insert the nail in your wall. That is partly Art and partly Science. So, the other $99.75 is for accurately inserting the nail deep enough. Any mistake here can set you off by thousands of dollars (not to mention the potential liability for me). You should actually be paying me $200.”
Bob was thinking in terms of Cost based Pricing, whereas the Real Professional (the Carpenter) was thinking in terms of Value Based Pricing.
In our industry, the simplest thing is to figure out direct costs and add margins on top of it. Even this is done in such a rudimentary way that most firms can generate outsized value overall by getting their pricing right.
Do you have a Pricing Strategy in Place?
How do you do your Pricing? Which one are you practicing (Cost Based, Value Based or None)?
Pricing has an overall impact on your business right from your Offering to the Team, Process, Technology, Client Experience, Compliance, and hundreds of other things.
Cost based Pricing is a lazy way of pricing for Professionals. Let the Commodity Products and Services Providers focus on Cost as a Differentiation or Pricing Strategy.
The best ones focus on VALUE not only as a Pricing Strategy but more importantly as a Source of Competitive Advantage and Differentiation.
Here are 4 simple (not easy) steps (each of which involves allocation of time and energy to learn and master):
- You need to first Believe in the VALUE you are delivering.
- You need to articulate and demonstrate that Value.
- You must deliver that VALUE.
- Finally, you need to figure out how to price your offering based on that value.
Mike completely believed in his value, could deliver it, articulate it and most importantly knew how to utilize value-based pricing.