PRICING FOR VALUE.

• Author: BAKER, RONALD J.

THE Shift From Hourly BILLING TO VALUE PRICING

Challenging the status quo may very well be the greatest risk individuals can take both personally and professionally. The status quo in public accounting for more than half of a century has been the hourly billing pricing structure. The time has come to reflect on the basis for that paradigm, shatter it, and build a better; more efficient and profitable model based on value pricing.

Ideas have consequences. Indeed, individuals are ruled by little else. An idea that changed the history of civilization--and affected the lives of billions of people in the 19th and 20th centuries--recently marked its 150th anniversary. For decades, The Communist Manifesto was the leading intellectual paradigm on several continents and commanded the destiny of many nations. This famous revolutionary treatise, published in 1848, by Karl Marx and Frederick Engels, still wields considerable power over the world's political systems, American universities and even the professional's pricing strategies.

Even though empirical evidence has thoroughly repudiated Marxist ideology and theory, we still pay Marx the ultimate compliment: His ideas are so deeply ingrained into our value paradigm that we don't even notice them, let alone analyze their validity. In the 19th Century, Marx posited what is now called the labor theory of value. In its simplest form it says that the price of an item is determined by the amount of labor used to produce it.

Taken to an extreme, the labor theory of value would predict that countries in which people work longer and harder should have higher standards of living. This is demonstrably false, since China should have the highest standard of living given its large amount of available labor hours.

If the labor theory of value is correct, then a diamond found in a mine would be of no greater value than a rock found right next to it, since each took an equal amount of "billable hours" to locate. Yet how many rocks do you see at a jewelry store in your local mall?

When you go to lunch today, perhaps you'll have pizza. Under the labor theory of value, you must necessarily value the 15th slice just as much as you valued the first, since each took the same amount of "billable hours" to produce.

The labor theory of value doesn't take into account the well-established law of diminishing marginal utility, which states that the value to the customer declines with additional consumption of the good in question.

A BETTER THEORY

Fortunately, the Austrian school of economists in the late 19th Century suggested an alternative to the labor theory of value by observing that value is subjective. The subjective theory of value concludes that goods and services have no inherent value. They are only valuable to the extent that someone desires them.

In 1748, Ben Franklin wrote, "Remember, time is money." However, time is not money. I have never seen a clock write a check. The results you create within the time you have is what creates value. The profession needs to replace the labor theory of value with the subjective theory of value.

IMPLEMENTING VALUE PRICING

There is a sensible replacement to hourly billing--value pricing. Today, many successful professional firms price their services according to externally created value that is perceived and determined by the customer, rather than by internal costs incurred while generating those services. One method that has been adopted to implement value pricing is the fixed price agreement. Essentially, an FPA requires meeting with your customers to...