Theory of Constraints Handbook - James Cox Iii [574]
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Although it might seem that these marketing pitches, as well as the services they encompass, have little in common, when enterprises in the PSTS sector market such services, they almost always start with cost-plus pricing. That is, they base their bids on standard billing rates, which in turn are based on standard costs plus a standard margin. This, however, assumes that there is only one fair price that all clients ought to be willing to pay.
Of course, standard rates have nothing to do with the business value that clients perceive in a service offer. Two clients receiving identical services may derive substantially different business value because their needs are different. Consequently, negotiations that take place during the sales cycle of large contracts move the provider and the client toward a mutually agreeable price for a given scope of work. How far the provider will negotiate is nevertheless strongly influenced by the margin between standard cost and bid price, which keeps the provider anchored on cost rather than value. Consequently, providers often have no other way to decide whether they are under- or over-pricing their services.
Something similar happens on smaller contracts, which can include high volumes of services too small to negotiate separately. In that case, the service provider may have discounts based on volume or customer loyalty—and premiums based on local market conditions. Nevertheless, standard rates and margin analysis still lie behind the discounts and premiums, even when there is no overt price negotiation.
The upshot of this is to the degree that standard cost is fallible, the resulting standard rates and gross margin do not maximize Throughput. Furthermore, the nature of the services themselves affects what clients will buy. When every service provider is proposing fundamentally the same services, marketing and sales gravitate to price as a differentiator. This, of course, opens the door to new competitors with different business models that not only change pricing, but also what value clients get for their money.
Strategy
Every enterprise in the PSTS sector tends to have the same fundamental strategy as its competitors. That may sound like a bold statement, but consider this: A typical PSTS strategy says, “the enterprise will provide a given set of services in its fields of expertise to particular types of clients for standard charges—or a negotiated price (within limits based on cost).” It doesn’t matter whether the field is a profession, science, or technology—the strategy is the same.
From the service provider’s perspective, expertise is the primary differentiator, and the tasks are to maintain the firm’s reputation while managing cost, protecting gross margin, and winning new contracts. From a client’s perspective, however, price is the primary differentiator because expertise is essentially unmeasurable. Clients thus ask themselves, “Am I willing to pay a higher price when I cannot objectively evaluate expertise, or can I get reasonably comparable service elsewhere for a lower price?”
This disparity in perspectives opens the door to new entrants who are able to compete only on price. Then the entrenched firms seem to have few choices. They can begin serving different clients with the same services, or existing clients with new services, either of which can shift the battleground to more favorable terrain. Alternatively, they can stand their ground on reputation and hope that their clients are sufficiently risk-averse to low-cost competitors, which means the firm’s rainmakers have to cement the firm’s relationship with its client base. On the other hand, those entrenched firms can join the price war sparked by the new entrants and watch the market race to the bottom.
There is, however, another possibility: Alter strategy to pursue