The price-value gap

If there’s one theme coming through loud and clear from our conversations with consulting firms at the moment, it’s price competition.  Whatever kind of work you do, wherever you work, it’s an issue; and for some firms in some countries the only question is whether prices have now been driven down to such an extent that they’re financially unsustainable.

We have some idea about what drives prices from an economic point of view (over-supply, for instance), but what happens if we ask clients how they price consulting services? In a client’s mind it all comes down to a simple equation: price = (expertise x scarcity) + brand. The amount they’re prepared to pay is determined by the skills they need (and the more scarce the skill, the higher its price) and the brand of the consulting firm involved (the bigger the brand a firm has, the more it can charge).  One of the interesting things about this is how simple it is: as suppliers looking in, we can be tempted to develop all sorts of arcane ideas about how clients price – but we shouldn’t.  Another is that price is therefore a combination of an individual (the person with the valuable skill) and a firm (which has the brand).  Although these often go hand-in-hand (well-known firms can afford to pay the highest salaries), they don’t have to: it’s possible to charge high rates if you’re an independent expert or if you have a well-known name.  The very highest fees do, though, need both.

But price is not the same as value.  If we ask clients how they value consulting services, they cite a different but equally simple equation: value = outcome + leverage.  Business outcomes (as opposed to project outputs) are something the consulting industry has been talking about for some time, although perhaps what’s new here is that clients stressed that outcomes don't have to be measurable (they know as well as consultants how difficult that is), but they do need to be tangible, and the more tangible – the more they can point to a concrete result – the more valuable the service.  Leverage, from a client’s perspective, relates to how well the consulting firm makes use of resources the client already has (joint teams, for example), but also the legacy it leaves behind (skills transfer, tools, etc).  The most valuable projects combine the two, but it’s also possible for a project to generate a lot of value along just one of these axes.

With two simple equations, it’s possible to compare the price charged against the perceived value.  Indeed, we have a hypothesis that, if there’s a gap between price and value, the two will converge over time.  One obvious scenario is that prices will fall when value is thought to be lower – and that’s clearly what’s happening in the consulting industry at the moment.  But what if value were actually higher than price?  If we could demonstrate that – make the outcomes and leverage far more visible than they currently are – then we could put prices up.