The following guest column is by Richard Hinwood, based in London.
Richard is the Head of Strategy & Chief of Staff at Withers. As Head of Strategy, Richard leads the formulation and implementation of firm-wide strategy and business planning across the firm’s Asia-Pacific, European, and United States offices. As Chief of Staff, Richard is part of both the firm’s Partnership Board and the firm’s Senior Management Team. Richard holds an MBA from Cranfield School of Management and a degree in Jurisprudence from the University of Oxford. Particular areas of interest include: international strategy, decision making, innovation management, new venture creation, and implementing change.
Take it away, Richard.
Think, just for a moment, exactly like a client.
You asked me to provide you with a quote for a particular legal service – one that you are relatively unfamiliar with. You have just received a copy of the firm’s terms of engagement and a fee quote that tells you that the work will cost £10,000 and is payable within 28 days of the final bill being issued, which is estimated to be in two months’ time.
Do you have any questions for me?
“A horse, a horse! My kingdom for a horse!”
Richard III, Act-V, Scene-IV – William Shakespeare
How does one successfully value a kingdom? It all depends on the context. Perhaps the only time a horse could be valued more than a kingdom would be when the horse represents the difference between living and dying. Of course, some kings would rather die than give up their kingdoms in exchange for their lives, which takes us neatly into the heart of the pricing debate. How much anything, whether a product or a service, is worth, essentially depends on what someone is willing to pay for it at a given moment in time. While the numbers are important, understanding the psychology of pricing can make the difference in achieving the best outcome.
What do we mean by the psychology of pricing? Take a coffee shop loyalty card as an example. Coffee shop ‘A’ offers one free coffee for every ten stamps collected. On the first purchase, the first stamp is collected, leaving just nine more until the free coffee. Coffee shop ‘B’ offers one free coffee for every twelve stamps collected. On the first visit, just because it’s the first visit, the first three stamps are collected, leaving just nine more until the free coffee. There is no significant difference between the taste and cost of the two coffees or the location or environment in either shop. In both cases, the customer needs to purchase nine more coffees to receive a free coffee. However, when they look at both cards in their hand the next day, they perceive that they are only 10% of the way to the free coffee at shop A, but 25% of the way there at shop B – ‘3 out of 12′ looks like greater progress than ‘1 out of 10′. In most cases, the customer decides to return to shop B, simply because they perceive that they are closer to the final goal.
As a brief follow on to the coffee shop example, some coffee shops realised that it was quicker to pre-stamp their cards so that they could just be handed over on the first visit. However, personally stamping the card in front of each individual customer (especially when explaining that they were giving the customer three stamps because it was their first visit) further increased the likelihood that the customer would return to that shop, simply because of the psychological ‘reward’ that they experienced on that visit.
“Have you figured out what you’re going to say to your board when they realise you paid me thirty million more than others were offering?”
Thomas Crown – The Thomas Crown Affair (1999)
In 1867, America bought Alaska from Russia for the sum of $7.2 million. Was this a good price to pay? Given the size of Alaska, this sizable sum worked out at just two cents per acre. Significantly at the time, Russia was glad to sell it (they thought they may lose it in future wars anyway) and most Americas were generally positive about the purchase. Of course, the cost of maintaining and policing the land was likely to far exceed the purchase price, but this was an ongoing cost, rather than a lump sum. Time has shown than perhaps America got the better of the deal, since the oil and minerals subsequently discovered under the land have proven to be incredibly valuable, but then again. Then again, maybe Russia didn’t exactly lose out, because they received $7.2 million for land they may otherwise have lost for nothing (or more accurately, lost while incurring the costs of trying to defend it).
Staying with the US for a second tale, in 1626, Dutch Colonists bought Manhattan for 60 guilders (or, as a very rough estimate, $1,000). If that sum had been invested for the 390 years since at an interest rate of 4%, that would equate to $3.75 billion today. Although a large sum in isolation, it is far less than Manhattan would be worth today. That does not mean that the seller necessarily had a bad bargain, since at the time of sale, the land was completely undeveloped. However, if the purchaser could have got an interest rate of 6% over the 390 years, the 60 guilders would now be worth around $6 trillion, suggesting that the seller would have got the better of the deal.
An early example of value-pricing saw Christopher Columbus agree with Queen Isabella of Spain that he would be entitled to 10% of all revenues from all lands that he discovered. Unfortunately for the explorer, the Queen subsequently failed to honour this part of their agreement, but had she done so, his personal return would have been far greater than under almost any other pricing strategy he could have proposed.
“Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result: happiness. Annual income twenty pounds, annual expenditure twenty pounds nought and six, result: misery.”
David Copperfield, Chapter 12 – Charles Dickens
Cost-based pricing (understanding what it costs to produce a product or service and then pricing the product or service to achieve more than this in return) is an important part of pricing. It is not surprising that the prevalent method of pricing legal services is based predominantly around cost-based pricing derived from the billable hour. However, cost-based pricing should be just part of the overall pricing picture. The following example is overly simplistic, but should serve the purpose: