Is “Skin in the Game” a Good Pricing Strategy?
Contingency-based pricing refers to a price based on taking a share of the results provided. It’s usually set as a percentage of the value, especially when that value can be easily quantified. For example, personal injury lawyers often will work on contingency because the winnings in personal injury cases can be very large, while their clients’ ability to pay cash upfront, especially if they’ve been severely injured and are now unable to work, is very limited. In this situation, the lawyer looks at the case, decides whether winning is enough of a sure thing to be worth taking the chance, and sets a percentage of the claim that the firm will receive when the case is collected upon, e.g. 33% of the settlement.
But contingency pricing isn’t just for lawyers. A lot of business people with whom I have dealt over the years have asked for our firm to provide contingency pricing on marketing services. They call it, “having skin in the game.” And they believe that if we have both upside and downside risk to the resulting sales revenue, this will make us work harder for success. Let’s take a closer look at this.
Benefits of Contingency-Based Pricing
There are a few key benefits that only contingency-based pricing can offer:
- It reduces the upfront cost (sometimes to zero) for the buyer. For example, what if you can’t afford a fancy marketing team? Maybe there’s one who is willing to work based on a portion of your sales growth.
- It makes the vendor work hard to get paid. If the vendor only gets paid if results happen, then the risk is all on the vendor; this makes the vendor push hard to overcome obstacles. (Note, if the client is the obstacle, the vendor may have to push the client very hard indeed, if he or she is standing in the way of the results being achieved!)
- It facilitates more realistic valuation of the services. Why should a vendor only get paid a small fraction of the value that he or she brings to the table? With a contingency based price, the vendor gets a share of the bigger winnings. This could be many times greater than the vendor would have earned under any other pricing method.
This last point is an important one. Imagine that all value provided by services firms were charged in the above manner; it certainly makes you think. There are certainly some professions that are being highly undervalued, for example –
- Imagine teachers being paid a percentage of the future earnings of their students; these would be some of the wealthiest people in society.
- Imagine doctors, nurses or even health clubs being paid a percentage of the lives they extended (and if those lives were given a quantifiable value, say by earnings or contribution to society).
- Imagine executive assistants being valued at say 10 – 20% of the value of the executive they assist. It would probably create a tenfold pay increase.
The argument here is that it could be important to have an understanding of the value one brings to one’s customers or clients. Perhaps a person may not want this structure, but to know that piece of the value that may be could be useful in setting the price level (see the next section).
Drawbacks of Contingency-Based Pricing
On the surface, contingency-based pricing might seem like an exciting idea. But here’s a comparison using two kinds of services, and how they differ regarding contingency pricing.
|Characteristic||Legal Services||Marketing Services|
|Quantifiable||Amount of the award, directly attributable to the lawyers’ action.||Sales revenue can be attributed to many things. Client may not share sales data with marketer, or not disclose when related revenue (referrals or repeat purchases) also comes in the door.|
|Clear Timing||Usually there is a date when payment is made clear and certain.||Sales revenue is gradual. And if client loses an existing client, it may decline despite efforts of the marketer. Economic shifts can also drag out the results.|
|Control||In a dispute, more clients will trust a lawyer to fully handle the job, and maximize the claim.||Clients do not always take marketers’ advice, especially if the marketers want them to spend. They may also have internal sales or customer service staff with weaknesses.|
When to Use Contingency-Based Pricing
Overall, then, we see that contingency pricing requires certain factors to be present in order to be a successful pricing arrangement:
- When it’s quantifiable. The amount of the “win” – whether it is money coming in to the client, or a cost savings, must be directly attributed to the vendor’s activities. The client must be willing to share this data, in full, with the vendor.
- When there is clear timing. Having a clear date when services are complete with the result achieved gives certainty around contingency payments. Without this, payment can be pushed out indefinitely while the vendor continues to work and work to make the result happen. Even in legal cases this can be difficult (as portrayed in the movie Erin Brockovich , where the case kept ballooning to include more and more claimants), and the lack of a set end-point can be a major problem.
- When the vendor has a lot of control. The vendor must have a high degree of control in the relationship, and/or the customer must be willing to give up more control in the relationship. While a lawyer can’t control what happens in court, he or she usually does enjoy a great deal of control in the client relationship to direct it in such a way to as to maximize the win. In the case of a marketing consultant, the client will almost never accept 100% of the marketers’ ideas (and getting 50% is doing very well). This means it would not be fair to punish the quality of the ideas, when they were only partially implemented.
If you’re considering some kind of contingency pricing, run your decision through the three characteristics listed above before you commit. If it’s easily quantifiable, determinable at a concrete date in the near future, and the client will give you as the vendor almost full control, it might be do-able.
But if there’s a good chance it could drag out, get messy and have the client meddling in your process, then you’re best to avoid it. If you have a client with whom you’ve already been working for some time, and you know it can put you on the same page even better than you already are, then it is something you could consider. (That said, if your client already knows how good you are at what you do, they’ll often want to avoid paying a large contingency share…it’s usually much cheaper to pay an hourly rate or project fee!)
After all, the vendor’s upside risk is the client’s downside risk.