After hearing more and more owners of B2B service firms getting nervous about their clients’ possible cost cutting in the coming year. Don’t miss this window as an opportunity to improve your profitability for next year.
For the past 15 years I have been passionate about increasing pricing power, enabling talented people to monetize more of the value they create for others everyday. However, I'm often surprised at the default assumption that this means increasing your prices. Over the years, indeed, ~60% of the time it was an increase, but ~40% of the time we ended up leaving prices flat or actually reducing them. In the current budgetary environment, I thought I would share an example strategy – one I have used successfully several times – for professional services firms facing possible budget cuts at their clients next year.
Professional Services Example:
Say you deliver $2M per year in services to one of your clients, of which your company nets a healthy 20% profit (EBIT).
Instead of waiting and hoping your services aren’t reduced in next year’s budget (after all, you deliver great value and have a great relationship),
You proactively go to them and inquire as to what cuts or restrictions they may be facing.
Then, you suggest a plan to reduce their yearly spend on you by 20%. In doing so, you align on and maintain the top three outcomes they care about most, but reduce other scope and fix your fee at $1.6M for the next year.
As part of creating this offer, you build a custom fixed fee package. This package is optimized to what you know they value the most, and in optimizing, you reduce the total scoped effort by 32% from previous years. Now that your fee is fixed, extra time spent isn't extra revenue, it lost profit. So, you create the proactive challenge for your team to improve their efficiency by 12.5%. There are often a lot of low-hanging opportunities available just by asking your team where they spend time that's not the best value add. In support, you can even authorize a $25K expense to automate, outsource, or aid them in achieving it.
When done smartly – which is of course how you would do it – here is what you have just achieved from a pricing power and profit perspective:
You just increased your net margin by 75%, up from 20% to 35%
Taking earnings from $400K to $560K, making an additional $160K
While your revenue took a 20% hit, your absolute profits increased by 40%
By proactively taking on two modest ~12% constraints, you created an opening for a step-change in your business model. By doing this, you unlock more degrees of freedom out of proactively setting your own terms (vs. the more limited options available from reacting to client cuts). And, most importantly, by working with your clients in establishing shared responsibility and aim in resolving the current obstacle they face – reducing a budget but still achieving everything they value most – you greatly de-risk being the service they put below the line and cut. [By the way, my company is currently projecting a 20% average market-wide reduction in consulting services for 2023, based on historic data and early indicators, certain segments like HR excluded].
Obviously your mileage may vary depending on your industry, operating cost, and breakeven; the above is simply an example to illustrate the larger point. While increasing revenue by optimizing pricing power is one of my favorite strategies, there are other ways to increase your earnings. Not every crop can grow in winter, but you can always harvest those that do.
There is a pricing strategy for every season.
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