For the last two decades, Ignition Consulting Group has been helping professional services firms to transform their approach to pricing. The company’s founder, Tim Williams, is also a noted author and in-demand speaker on the topic; he has been featured in The New York Times, The Wall Street Journal, and The Economist, and is a frequent contributor to trade publications including Advertising A ge, Adweek and many others. Tim has long argued that service providers need to undergo a paradigm shift in how they think about pricing, and advocates that they move away from the outdated time and materials model. We spoke to him about why, exactly, he thinks this model is holding firms back.
To give some context—can you tell us about your background and the work that Ignition does?
My background is in marketing; I started out on Madison Avenue working for some of the big global ad agencies, and eventually became CEO of a few independent firms.
I founded Ignition 20 years ago to focus mainly on advising firms in the marketing services sector; not just ad agencies, but PR and digital firms, social media agencies, design agencies, digital marketing companies, and so on. What I’ve found along the way is that actually a lot of professional services firms are dealing with the same pricing challenges; whether you’re a law firm or an ad agency, a lot of the problems you have to solve are the same.
A lot of what we think of as ‘pricing’ questions are really strategic questions about your larger business model. So we advocate strongly for the idea that pricing needs to become a core competency within professional services firms. Right now, most firms simply add up their hours on time sheets and send clients a bill. They’re not making the type of calculated decisions that they would if they really wanted to maximise their revenue. Most firms have relegated pricing to their finance function; they don’t understand the difference between a chief finance officer and a chief pricing officer. But if all you’re doing is looking at rates, that’s not really pricing—it’s just costing.
And what do you think is the biggest lesson that professional services firms—and consultants in particular—need to learn about pricing?
I think firms need to bury the billable hour. My view is that the ‘cost-plus’ model is so ubiquitous in professional services because it’s easy. Keeping track of time and multiplying by hourly rates is a nice simple exercise, and at the end of the day it spits out objective numbers for you. But pricing shouldn’t be objective; if you want to get the best price for your product or services, you have to recognise the inherent subjectivity and context-dependency of pricing.
When I teach my clients how to do pricing, I start by introducing them to the theory of value. The rate card model rests on the labour theory of value, which is a concept that dates all the way back to Karl Marx and the Industrial Revolution. So it’s strange to me that so many professional services firms rely so heavily on that model when we live in such a different era and value these days doesn’t have the same connection to labour that it did back then.
When firms are delivering work, it should be the knowledge and the solution that has value, not the time they invest.
If firms need to be moving away from the traditional rate card model, should they be looking at other industries to learn from their pricing practices?
When I work with professional services clients, I start by showing them all of the different pricing methodologies that other industries have been experimenting with—dynamic pricing, congestion pricing, add-ons, and so on—and talk to them about how these different models could be applied to their sector. When you stop adhering to one methodology and start seeing pricing as a spectrum of possibilities, you realise that there are virtually unlimited ways that professional services firms can price their offerings.
And in your experience, have firms been reluctant to move towards pricing their projects based on the value they generate?
I don’t like the term ‘value-based pricing’ because it connotes too many different things to different people. When consultants hear that term, they often assume we’re just talking about performance-based contracts. Those can work, but it’s not the only way of tying your prices to value.
We describe pricing models as a pyramid. At the bottom you have pricing by input. The middle layer is output-based pricing, where you charge for the work you deliver. And finally at the top you have outcome-based pricing, where you actually charge according to the value you create for your clients. You can price your services using any of those three approaches, but we advocate completely discontinuing pricing by inputs.
A lot of firms are wary about outcome-based pricing because they’re worried about not being able to put a precise figure on the value they generate. So instead they spend all of their time calculating costs—but that’s also an estimation. I think firms need to start taking all of the energy they spend estimating costs and redirect that to estimating value.
Do you have specific examples from other sectors that you would point them towards when they are thinking about how to climb up that pyramid?
When helping consultants think about other pricing models they could use, we begin with a bit of a history lesson. We talk to them about the birth of dynamic pricing—a model that was pioneered by airlines and then later adopted by hotels, where the basic idea is that the same seats can carry different prices for each passenger. That model is now being used by parking meters in San Francisco; the price to park changes based on how much traffic there is. The price of admission to Disneyland is now dynamic. Even retailers are now doing it with the price of food. I think that’s particularly ingenious; you can reduce the prices of items as they get closer to their expiry date, for example.
Beyond dynamic pricing, you have other interesting examples, such as two-part pricing. For example, you make your razors inexpensive and maybe even lose money on them, but then you charge more for the blades. Or you make printers as cheap as possible so that you can make money from the ink.
If you took tracking hourly rates completely off the table, you would still have 20 or 30 pricing models you could look to from other industries. Will some of those be relevant to professional services firms? Absolutely some of them would be.
What about the managed services model? Do you think that could help firms get better at selling value rather than time?
There’s a lot of work that’s done by professional services firms that could be packaged up and sold based on usage. Social media programmes delivered by large PR firms, for example, are being sold now on a subscription basis. Analytics and marketing dashboards can be productised and sold in that way. When you change the way you frame a service to clients, you can move the conversation with buyers away from ‘How many people will it take?’ and towards ‘What will actually work best for you?’ It just creates a different dynamic; even the McKinseys of the world nowadays are packaging up and selling innovative products.
The mindset, for a lot of professional services firms, is that everything we do should be custom. That psychology runs particularly deep in the consulting industry. But when you step back and look at all the intellectual capital that can be productised, you realise that not everything needs to be completely bespoke. There are enough similarities between clients’ organisations that some services can be standardised.
We often suggest taking multiple services and turning them into programmes. By ‘programme’ here we mean arrays of services packaged together in interesting ways to solve client problems. You can then put a price tag on that and, in some cases, fully productise them; we’re talking about truly freestanding ‘money while you sleep’ products here.
Does selling these types of programmes require a different approach from selling traditional consulting projects?
As consulting firms start selling products and packaged services, they will need to find salespeople with a different sort of mindset and skillset. Service providers often feel uncomfortable about selling themselves; they think there’s something unseemly about it, and they’d rather make sales off the strength of their relationships than through a marketing and sales approach.
As all of these new types of services and new pricing models start to take shape, what do you see happening to the overall consulting market?
The world is being disintermediated. All professional services can be decoupled into two types of value—magic and logic. As knowledge workers in professional services, we’re in the magic business, providing clients with high-value innovation that can be priced at a premium. But we’re also in the logic business, and a lot of that sort of low-end implementation work can be unit-priced and commoditised.
When you insist on keeping everything under one roof with a blended billable rate, you’re fighting economic inevitability. Clients are going to decouple their services, and if you can’t provide them with offerings that let them do so, they will look elsewhere. Consultants are going to have to accept that a bigger split will emerge between high-value and low-value services—and should realise that these different types of services will require different pricing models.
And how important do you think automation and AI will be in accelerating that bifurcation?
If work can be automated, it will be. The rise of machine learning will be the ultimate argument against value-based pricing—good luck billing by the hour when an AI can complete a consulting project in nanoseconds.
I say, if AI can do a job then it should. Let’s redeploy the human capital it frees up to solving different types of problems. But firms, in the future, will need to find a way to grow without simply investing in people. It speaks to the scale problem we have in consulting. I like to point to the metric of ‘revenue per employee’. At the average ad agency, each employee brings in, at most, a few hundred thousand dollars. At Google, it’s US$3m. When professional services firms productise their business offerings, those ratios can change dramatically.
So what do you think firms should take away from all of this? How can they set themselves up to make the most of these new approaches to pricing?
We preach the idea of a ‘pricing stack’, analogous to the technology stack. As a firm, you should have a variety of revenue streams, and to create those revenue streams you need to deploy multiple different ways of pricing your services. Maybe there’s a little bit of licensing, maybe there are some fixed-price deals—maybe you sell some subscriptions, you have some usage-based pricing, and so on.
Professional services firms typically want all of the risk to stay with the client—that’s why they cling to the hourly rate model, because it gives them the illusion of risk-free pricing. They need to start seeing risk as an economic positive; if you have the creativity needed to create a pricing portfolio that has some high-risk, some medium-risk, and some low-risk services, then you can end up with much higher margins at the end of the day.