by Tim Williams
It’s human nature to dislike uncertainty. Your flight is delayed, but for how long? If the information on the departures monitor just says “Delayed,” our sense of malaise is high. But if it reads “Delayed by 35 minutes,” this precision makes us feel less concerned. Similarly, when searching for a restaurant that can serve us in time to make an 8:00 p.m. concert, most of us would gladly pay a little more for an eating establishment that guarantees delivery of our meal in time to enjoy it.
When faced with uncertain situations, we mentally ponder two questions: 1) What is the likely outcome? and 2) What’s the worst that could happen? Behavioural economists teach the principle of “variance reduction.” Reducing the variance of possible outcomes is a high value not just when flying or selecting a pre-show restaurant, but in virtually every human activity — including business.
The perceived value reducing risk
The higher the stakes, the higher the fretfulness when it comes to uncertainty. The shopworn axiom “Nobody ever got fired for buying IBM” underscores the perceived value of making a safe choice. Advertising executive and behaviourist Rory Sutherland provides the example of a pizza delivery service that promises “As soon as possible.” By changing this pledge to “In 60 minutes or less” (which might actually be a longer wait) customer satisfaction goes up because the level of uncertainty goes down. Calling an Uber on your smartphone is preferable to standing on the street to hail a taxi in part because the app tells us exactly when our ride will appear. “The goal of behavioural economics,” says Sutherland, “is to introduce mechanisms that reduce or remove uncertainty.”
Risk as an economic positive
In a business context, reducing a buyer’s uncertainty means decreasing their level of risk. This means that some or all of the risk inherent in any purchase must be transferred from the buyer to the seller. But rather than embracing risk as an economic positive, most sellers run from risk. This is especially true in professional services, where the risk aversion of most accounting firms, law practices, and advertising agencies is legendary.
As Advertising Age recently observed, “Risk-free agreements commoditise agencies and do much to ensure that ad shops are viewed as vendors rather than partners. To get out of this cycle, agencies need to look at risk differently. They need to take a hard look at whether their output for marketers has value beyond churning out a commodity product, whether their work is something worth making a real bet on.”
Ad agencies, who are overwhelmingly risk-averse themselves, are famous for prodding their clients to support “risky” work. They are right to encourage marketers to break with convention, but usually fail to cast risk in the proper light. As brand strategist Martin Weigelexplains:
”Exhorting clients to be ‘brave’ enough to buy ‘brave’ work is not just poor psychology. It misrepresents and undermines creativity, passing it off as some roll of the dice, or reckless shot in the dark in which the possibility of total failure is deeply embedded. Yet if we look at what makes for effective work we see that it entails eschewing category norms and conventions, being distinctive and interesting not merely relevant, evoking visceral reactions, and leaving behind long-term memory traces. None of this is being ‘brave’. It’s not embracing of failure. It’s not reckless. It’s just prudent, effective brand-building.”
In the insurance business, the brightest actuaries believe “There’s no such thing as bad risks, only bad premiums.” This insight applies equally well to other professional services. Regrettably, most professional firms are trapped on the hourly-rate treadmill, and there’s no model for pricing risk by the hour.
In his new book Pricing Creativity, my friend Blair Enns offers a methodology for incorporating risk into pricing professional services by taking an approach like this:
“I’ve got three ways we might work together to help you achieve your goals and deliver the value we discussed. I have a low-risk option (to you) that’s priced at $100k. I have an option that meets your desired budget of $45k, but as you’ll see, at that price you’ll be assuming all the risk. And I have a middle option at $65k that sees a more balanced sharing of the risk. Let me explain each of them, beginning with the low-risk option.”
The illusion of a risk-free relationship
When faced with the opportunity to charge a premium price by assuming more of the risk, the great majority of professional service firms display an allergic reaction. Rather than accentuate the potential upside, leaders of professional firms are prone to enumerate the downside, citing the variables they can't control. They fixate on all the ways they could lose and almost never on the ways they could win. In the end, they fail to appreciate that the way to make more money is to take more risk. As Peter Drucker put it, “All profit is derived from risk.”