Dealing with an Underbid on a Value-Priced Contract
The calendar year is quickly coming to a close.
For many businesses it's time to offer big discounts to move products.
For others it's a time to rejoice that they don't have to rely on discounting to stay in business.
Which group do you want to be a member of?
Pricing Question from a Reader
I've been hearing about value-based pricing for a while, so I jumped in and sold my very first value-priced service offering. Unfortunately, the project is taking a lot longer than I had expected. What can I do to get out of this with my sanity (and my bank account) intact?
Although bloggers and pundits love to talk about the miracles of value pricing, they never seem to talk about what happens when it goes wrong. This is a problem. After all, any contract that involves a fixed price for custom work involves a degree of risk for the seller.
We looked at the difficulties associated with selling value-priced offerings at the beginning of the year. Today we're going to look at what businesses can do after they've successfully sold a value-priced option, but have come to realize that the project is costing them a lot more than they had originally expected.
Disclaimer: Depending upon the size and nature of your project, it may make sense to contact a lawyer. I am most certainly not a lawyer and the laws in your jurisdiction may vary greatly from those with which I am familiar.
Understand Your Goals
First, think about your goals. You may think that bringing the contract to a premature end is in your best interest. The reality might not be so clear. Throwing in the towel might result in negative ramifications for your firm's reputation. Sometimes a single dissatisfied, but vocal, customer can have an enormous effect upon your organization's credibility and ability to attract quality clients.
Perform Root Cause Analysis
Second, attempt to perform root cause analysis on why the project's costs and deadlines have exceeded your original expectations. Not only can the results of this research reveal issues suitable for corrective action, they will also provide red flags to watch out for on future projects.
- Is the customer changing his mind often?
- Are resources that you need not being made available in a timely fashion?
- Do you lack a good understanding of the problem domain?
- Was your original estimate based upon solid reasoning?
A single roadmapping session, some buy-in from additional stakeholders, or a bit of prototyping might prove sufficient for eliminating the causes of the project's troubles.
Scope Out Remaining Work
Third, figure out what work remains. It may be that most of the unexpected costs are already sunk, and that there is very little risk or expense associated with any work that remains to be performed. Should this be the case, it may be worth pushing through to completion. Far more likely, however, is that you lack any formal agreement on project scope - either because it was never discussed or because it was poorly defined. If you're currently operating without one, a scope document should be created and signed by all parties before additional work is performed. Remember: if you can't articulate when a project is done, you're accepting a huge amount of risk for no reason. Your client will be able to push you around until either he finds perfection or you go bankrupt. Given the rarity of perfection in this world, the latter is a far more likely outcome than the former.
Look for an Exit
Finally, assuming significant work remains, examine your contract - if you have one. Look specifically for exit clauses that specify how each party can be excused from the requirements of the agreement (generally by paying some form of penalty).
When no such clauses exist, it may still make sense for you to simply refund a portion of the payments received and to cancel the project. This is often the ideal route to take when the size of the contract is relatively small, and the project's importance is of relatively minor worth to the buyer.
Be forewarned: some customers are hesitant to cancel projects once they have begun. Parties representing the buyer may have to answer to their bosses about the time and effort that has already been invested. As a result, your creativity and negotiating skill may prove quite valuable in efforts to persuade customers to accept the project's cancellation (hint: don't even think about using the word failure).
Sometimes you might be able to convince your client that the project is no longer desirable.
- Perhaps it is taking too much of their time and attention away from more important matters.
- Perhaps it no longer addresses their business needs.
- Perhaps another approach would result in a bigger win. What looked like a technical problem might have been revealed to be a marketing problem instead.
As the famous joke goes, negotiation is the fine art of letting others get your way. If you can convince a customer that canceling a project is his idea and in his best interest, your firm will find itself excused from remaining work while keeping its reputation intact.
As any lawyer will tell you, the best way to avoid big legal problems is to prevent them before they occur.
Before you even consider offering another value-based bid, you should:
- Have a formal agreement as to the definition of done signed by you and your client. Should this prove too difficult, hourly pricing might be more appropriate.
- Have a formal agreement as to the responsibilities of, and expectations for, the client.
- Have a relatively strong estimate of the costs (in terms of time and resources) that you are likely to incur. Proponents of value-based pricing may have a point that your internal costs shouldn't matter to your clients - but they most certainly should matter to you (and act as an absolute floor for your pricing).
- Have a list of risks that must be managed from the outset.
- Have experience offering the service in question, hopefully with a predictable process and reusable product inputs.
- Have exit clauses in your contract for both you and your client.
Value-based pricing makes a lot of sense for a lot of reasons. That said, those who use it have a duty to themselves and their clients to make sure that they understand the risks and have managed them appropriately.
Questions come from readers like you. If you'd like your questions answered, send them my way.
♫This Q&A and many others are now available on the Pricing After Dark podcast.
Pricing in the News
- UK to probe fairness of personalized pricing practices in online retail - Regulators worry that price discrimination might be discriminatory
- 9 Out of 10 People Are Willing to Earn Less Money to Do More-Meaningful Work - Interestingly, 9 out of 10 people are not quitting in order to obtain lower paying but more meaningful jobs
- Michigan Medicaid Approved for Drug Pricing Experiment - The state prepares to base payments on outcomes
- Wells Fargo: Shareholders can't sue us because they should have known we were lying - When building a brand, big lies are expected, but small exaggerations are still illegal
- Essential will sell your phone's missing headphone jack back to you for $150 - Interestingly, many cell phones cost less than $150 and include the headphone jack for free
- MoviePass Parent Lost $137 Million in Q3, May Be Unable to Raise Additional Funds - Bad pricing gone wrong (and "wronger")
- Tesla slashes prices on home solar systems to spur sales - Tesla VP: We're seen as a premium provider, so we're going to lower our prices to attract more customers. Wait, what?
- Pabst accuses MillerCoors of trying to drive it out of business - Is the cost of outsourcing a firm's production too high to consider?
- Florida judge dismisses $5M lawsuit against McDonald's over slice of cheese - Product bundling is safe once again
- MoviePass competitor Sinemia is being sued by angry customers who say it ripped them off with new fees - MoviePass is so poorly run that even its competitors are getting sued
- AIRLINES FACE CRACK DOWN ON USE OF 'EXPLOITATIVE' ALGORITHM THAT SPLITS UP FAMILIES ON FLIGHTS
- Ohio becomes the first state to accept bitcoin for tax payments - What could possibly go wrong?
- How much for that app? U.S. top court hears Apple antitrust dispute
- Comcast raises cable TV bills again -- even if you're under contract
From the Blog Archives
- Gift Cards as a Premium Good? - Can products literally be worth more than they are worth?
Notable Pricing Quote
"Fast food is popular because it's convenient, it's cheap, and it tastes good. But the real cost of eating fast food never appears on the menu." -- Eric Schlosser
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