Understanding Value Pricing for Architecture and Engineering Firms

Why One Hour is Never Worth Another Hour

By David Stone, Stone & Company

Many years ago, while operating a design practice, I used the services of an accounting firm. One year, just before tax time, I discovered that they had made a very large error. With only days before the deadline, it was too late for the necessary financial moves. Despite their last-minute scrambling, I paid a big tax bill and was blessed with a $6,000 invoice for their last-minute services.

Needless to say I was livid. But when challenged to rationalize the mammoth bill they confidently replied that the hours spent times the billing rate produced an entirely rational invoice of $6,000. Following a brief and sometimes colorful discussion about value versus price, I wrote a check for a much smaller amount and fired them.

The scary part of this true story is the number of design and construction professionals who regularly find themselves in the same indefensible situation: pricing work for hours expended, not value delivered.

A curious route to today

A curious history has led to professionals selling hours by the pound. Ronald J. Baker tells a detailed story1 in his book Professional’s Guide to Value Pricing, but we’ll tell the short version here.

Baker, Ronald, J. Professional’s Guide To Value Pricing, Third Edition. New York: Aspen Law & Business, 2001. Pg 79-83.

Until the mid-20th century most professional services were priced on a value basis. Smith the businessman retained Jones the engineer for a project and a lump-sum fee would be set and paid. Jones would have little idea if a given project made or lost money and profitability was determined at year-end by subtracting total cost from total revenue.

As professional associations emerged around the turn of the last century, fee schedules were published, aiding professionals and removing them from the fray of competition. Around the same time businesses were learning to adopt formal cost accounting methods. By the 1940’s professional service firms, whose largest cost was staff time, introduced time sheets to keep track. By the 1950’s cost accounting was fully embraced and time sheets were its foundation.

As social moods swung in the late 1960s governments began viewing fee schedules as evidence of price-fixing among professional groups and by the 1980s they were largely banned by anti-trust legislation. No problem! Armed with cost information from timesheets, pricing was almost easier than using a fee schedule. Estimate the hours involved, multiply by the hourly rate and bingo, you’ve got a fee!

No one seemed to notice that, in the short span of 40 years, design professionals had abandoned a system based on value for one entirely derived from cost and now, instead of debating the value of services delivered, we are debating the value of an hour’s time.

What’s an hour worth?

In many of my seminars, I have polled the attendees to determine the highest hourly rate charged by any of the architecture or engineering firms represented. So far, after 20 years, the highest rate I’ve encountered has been about $350 per hour for very specialized expert witness work. Taken at face value, this means that no one, in any of the thousands of AEC firms I have met in the past 20 years is capable, in the span of one hour, of doing anything worth more than $350. Does this seem as nutty to you as it does to me?

When was the last time you attended a permitting or zoning meeting on behalf of a client? When was the last time you negotiated a concession in such a meeting? Maybe it was a concession that saved or earned your client tens, or even hundreds of thousands of dollars. What did you bill for that one-hour meeting?

Crazy Numbers

The billing rate for an employee making $15 per hour in an architecture or engineering firm with a 35% payroll burden, a 120% overhead and a 20% profit margin is $47.81 and it’s a crazy number. It is hard to remember and even more difficult to rationalize. Imagine you have two employees, one earning $31,000 per year, the other, who has been with you longer, earning $32,500. They are both equally qualified and experienced. Their salary difference is simply reflective of their tenure at your office.

Using normal calculations, with the percentages above, the billing rate for one would be $47.50 and the other would be $49.83. Imagine, now, that you are negotiating with a client for a project. You have shown them your rate sheet and have assigned the $49.83 per hour employee to the project. The client is now arguing with you and insisting that you assign the equally qualified, but less expensive employee. This kind of ‘nickel and dime’ bargaining is pointless, tiring and a waste of your valuable time.

Instead of using each employee’s exact, multiplier-based charge-out rate, round both employees up to $50 per hour and avoid the silly arguments. This will also allow you to accommodate moderate fluctuations in salaries without having to readjust the billing rates each time.

Even crazier numbers

Some years ago, I encountered an AE firm that prepared and circulated a sheet listing the rates they charged for various levels of skilled labor. The sheet listed rates for drafters, interns, technicians, graduates, engineers, architects, and multiple levels of each of these categories. In all, there were 17 different labor categories, each with a different billing rate.

The firm had only 11 employees.

Webster’s claims that value is “that quality of a thing that makes it more or less desirable or useful” and there are plenty of examples of some services being more valuable than others. A client defending against a lawsuit readily agrees that engineering expert witness services are more valuable than a run-of-the-mill survey. Hence the $350 billing rate.

In his book, Baker defines value pricing as:

The maximum amount a given customer is willing to pay for a particular service before the time of delivery.2

2 Baker, Pg 139.

There are some vital implications here. First, different clients are willing to pay different amounts for the same service. Second, the value of that service is established before it’s delivered. This is the opposite of all clients paying the same amount for an hour’s time, regardless of what’s been accomplished during the hour.

Why might a client be willing to pay more for the same service? An environmental firm in Ontario, Canada received a desperate call from a potential new client. The irrigation system of their 30-year old golf course had expired from old age. Worse, the grandfathered pumping permit from the river had died along with it. Golf season opened in four weeks, a new system had to be operational and the engineer had been recommended as the only one that could help. The firm did a quick evaluation and determined that they could indeed get the system running in time for opening day. A perfect opportunity for value pricing.

But when the hours were totaled, the engineers collapsed from sticker shock and, with no prompting from the client, lowered the price! The client was willing to pay almost anything yet the engineers volunteered to negotiate against themselves.

Popcorn & Airplanes

Have you ever bought a last-minute seat on an airplane? Have you ever paid five dollars for movie theatre popcorn? Have you ever had the winning bid on eBay? Then you’ve proven that value pricing works. It only works however, when you sell something on which people place high value. The expensive, last minute seat works because the business traveler absolutely has to get there. When the traveler has the luxury of flexible plans, she refuses to pay a high price.

When the services you sell are commodities, when identical or very similar services are available from many sources, your clients use a different kind of value pricing – the low price they pay will be equal to the low value they place on the services. This also explains why you encounter tremendous resistance to using value-pricing methods for traditional services that are available anywhere.

A firm in Chicago reports that a client had just secured funding for a property development project and was now under a tight deadline to get the work underway. The firm, recognizing an opportunity to sell value, negotiated three different kinds of pricing for three different elements of the project.

Unit prices were set for permit approvals and land acquisitions, lump sums were established for clearly defined work packages and 3.0 multipliers were set for undefined work. Value pricing was an option because the firm was providing a specialized service in unique circumstances. The value to be delivered was clearly identified and the client was willing to pay a premium because of the schedule.

Beating back profits

Although situations like this arise regularly, many architecture and engineering firms hesitate to try value-based pricing for two reasons:

First, the subject remains a sensitive one. Many design professionals see higher-than-average profits as somehow unethical or unprofessional. The Canadian firm fell victim to this condition.

Second, the inherently risk-averse nature of AEs leads many to shy away from fee arrangements that leave them exposed. Higher profit will always be accompanied by higher risk but entrepreneurial firms are comfortable with these variables.

Want to increase the opportunities your architecture or engineering firm has for value pricing? Consider these three options:

Niche services

Clients are always willing to pay a premium for specialized knowledge or capability. Niches can include expertise in particular market segments (the politics of municipal water systems), project phases (permitting experts), project delivery methods (Engineer-Procure-Construct, or EPC specialists), project delivery options (high-speed production) and technologies (intelligent transportation systems) to name just a few examples.

The “value spectrum”

The core of traditional design services is the preparation of design and construction documents – available at low cost from many sources. Today clients are placing value at the front and back ends of projects: Strategic planning, conceptualization, financing, commissioning, operation and maintenance are all high growth and high profit areas.

Outstanding service

Companies like Nordstrom’s and L.L. Bean long ago proved that we will pay a premium for over-the-top service. The concept applies to professional service firms too. Unfortunately, clients have grown used to late deliveries, poor communication and constantly changing project teams. Why not shock your clients with a new approach to customer service modeled on these pioneers? Your clients will become more receptive to both value pricing and expanded services.

If you’re ready to offer value services, take these steps to lock in your opportunities for value pricing.

  • Hold an internal discussion to see if your firm is ready for value services and value pricing. The culture has to be there.

  • Learn how other industries and other firms use value pricing. Read Baker’s book to study the economics.

  • Begin with clients with whom you already have a strong relationship. They will be more open to seeing the potential win-win of value pricing.

  • Watch for the unique situation. If there is significant value to be added or the circumstances are right, don’t hesitate to make the pitch for value pricing.

Value pricing represents a culture change for design professionals. But it’s one that will bring the profession full circle back to the value it used to bring to clients.

David Stone, Stone and Company 

Stone and Company provides consulting, training and coaching in marketing, business development and sales for companies serving the design and construction industry.

David Stone, President, is a 35-year veteran of the design and construction industry. After 15 years as a practicing architect, he shifted his focus to marketing and business development. He has been the VP of Marketing and Sales for both a $250 million construction company and an international design firm. He has been a Senior Consultant, speaker and trainer with both FMI Corporation and PSMJ Resources and has launched three of his own companies. He has advised and worked closely with hundreds of design and construction firms around the globe ranging in size from one person to $2 billion in annual revenue.

He is the author of 12 books on marketing, and project management and is a regular speaker at design and construction industry gatherings around the world.