Twelve Ways to Charge for Knowledge

Fourteen Ways to Charge for Knowledge

What is the value of an idea that comes in the flash of a second but is based on a life of experience? It is hardly the time spent on it. Basing the value of knowledge on time spent can never be correct, still it is the most common. What other ways are there to charge for Knowledge?

Let’s look at how the knowledge industries charge for their knowledge. They are ranked from one to fourteen, with the most attractive on my personal ranking list listed as number one.

Take Intangible Revenues into Account.

The most challenging and most creative way to charge for knowledge is to take the Intangible Revenues into account. (Read more about Intangible Revenues)

With very few exceptions authors of management books do not get rich from the royalties. So why do consultants spend long unpaid hours in front of their word processors? Because a published book generates publicity and credibility among potential clients. The process of writing the book is also a learning process in itself and it visualizes ones thoughts in a tangible way.

Consider the young accountant just employed and now on the audit team. She does not know much and cannot contribute much to the client. The big auditing firms use their large customers to train new recruits by assigning them the routine parts of the audit. The senior auditors and the large customers recognize that such customers are valuable. Indeed, the latter are asking with increasing frequency these days, what they get, in return for teaching their auditors’ "rookies" their business.

Intangible revenues are flows of knowledge and they come in three forms; revenues that add to the External Structure, to the Internal Structure or to the competence of the employees (read about how to quantify intangible revenues). Intangible revenues are seldom made explicit or taken into account in pricing decisions, yet they are often the major reason why a project or an assignment is undertaken. They tend to be argued in qualitative terms rather than quantitative. It is time to change that!

Link Royalty to Financial Output or Outcome.

The approach least filled with conflict for all concerned is to link the fee to the financial outcome of the project. The oldest and most established method is the "royalty". Authors, software developers, designers and inventors, tend to be paid for their intellectual property rights in the form of a percentage on the long-term revenues from their creative efforts, particularly if they are independent professionals. Also pharmaceutical companies often negotiate royalties for using other companies’ drugs in recipes. Royalty is a simple and good method, because it links the output directly to the input, this is why I rank it 2nd. But it is simple only if the creative effort has been formalised into a product or tangible/visible outcome that is protected by law.
Royalty becomes much more complex of the outcome is a process or a socially constructed event. It can be very hard to distinguish revenues that the client will receive from the installation of a new order entry system or the profit of a new organization or strategy implemented. Still the method has been used to great advantage by some advertising agencies for well-defined marketing campaigns. Also management consultants involved in cost cutting projects with pre-defined outcomes apply it.

Link Success Fee to Non-financial Outcome.

A success fee can be linked to a non-financial outcome. The most common today is its negative counterpart: a penalty if certain conditions are not fulfilled. For instance in construction industry, a penalty is incurred if a deadline is not met. A more positive approach and more encouraging for those involved is to link a success fee to pre-determined non-financial indicators, such as the effects achieved among the recipients of the project. Public sector projects involving infrastructure, such as water & sewage treatment or highways/railways or medicine generally have outcomes that are non-financial but possible to measure directly.
It gets harder if the outcome is socially constructed, such as the effects of education or welfare projects. The training industry, hard pressed to deliver substantiated evidence of the effects of training, is among those that are trying to find objective methods for measuring such effects. The success has not been overwhelming.
A more practical approach is to determine the outcomes using surveys, for instance establishing the satisfaction level among those concerned. Obviously, if one links a success fee to survey results the survey methodology has to be impeccable.
Despite the difficulties involved in establishing objective non-contestable indicators I believe that this method has big potential in most knowledge industries. A shift of mindsets will probably have to take place and much more research must go into this field.

Create Insurance Premium.
This might be the oldest knowledge charging systems in the world! In ancient China the patients paid a monthly fee as long as they were well but they expected to be treated for no cost when taken ill. The charges and the taxes that finance community services are financed in the form of an insurance system. You pay when you are healthy or have a job or a house for times when you are ill, jobless or the victim of a fire.
The system is a kind of a retainer with an incentive built in to think ahead and anticipate problems.

Transfer Price
Transfer pricing is common practice in team sports. Soccer clubs and basket ball clubs "buy" and "sell" their stars, sometimes at incredible prices. The star usually also receives a share of the price. A transfer price is a payment for the skill of that particular person and it is an estimate of how much future value the star is worth to the club. Transfer prices are not common in other industries, often because civil law does not allow it. The laws are the legacy of the industrial era, and were installed to protect workers to be exploited by employers. Today's professionals are more like the sports stars and perfectly capable to care for themselves, so it is likely that transfer prices will become common practice in professional services and other knowledge organisations. Transfer pricing is a good system for two reasons: First, because it allows the formal employer some protection against abuse by individuals. Second, because of the protection the formal employer can invest in an individual's career and knowledge knowing that the investment will not "walk out the door".

Let the Supplier Pay.

Now this is an ingenious system! How is it possible to charge the supplier instead of the customer? It is much more common than one might think. Why is most of the content on the Internet free? How can it be that the commercial channels on TV do not cost you as the views anything? Why do you only pay 1/5 of the cost of producing the newspaper? Because there are more people with a message to tell than there are people who want to listen. So the market forces have created a market on which the suppliers of information pay, not the consumers.
The advertisers pay 4/5 of the newspaper and 100% of the cost of television, because they want us to receive and pay attention to their messages. The information providers pay for the web sites, because they have a message to tell.

Other examples: underwriters charge a fee to the new shareholders as an add-on to the share price when they advise the company making a new share issue. The fee is so small so the individual shareholder (the supplier of the capital) does not see it, but the volume can make the total fee quite large. The Swedish central association of tenants has for years been able to charge the property owners a percentage on the rent for their services to the association’s members (don’t ask me how they achieved that!).

Charge for a Team.

Some big consulting firms charge a fixed amount per team inclusive of expenses, rather then per consultant. It is a method pioneered by the strategy consulting firm McKinsey as an approach of creating more flexibility for planning their resources. The client should in principle not have to care about who is assigned to the project; whether they are flown in or locally based. For the knowledge company the method has the nice added benefit of allowing for lifting the charges of the lowest paid associates and for the seniors to spread very thinly on many assignments. There are not many firms in the position to use this method, though. It requires a high level of concept standardisation and very high project management skills.

Package the Solutions.

The dilemma facing most knowledge sellers is that the offering cannot be made visual or real until it has been delivered. Moreover, the customer often contributes to the solution. This amplifies the pricing problem.
One approach to reduce the problem is to make the offering a "product". Most service firms sell their service as packages, for instance travel, hotels and airlines. Another common approach is to issue a card, which entitles the holder to obtain a range of specified benefits.
The knowledge company's equivalent is the "Concept". Much of the conceptual developments made by management consultants belong in this category. Concepts like "Total Quality", "Service Management", "7S", "Learning Organisation" just to mention a few. The latest trend is to trademark the concepts in order to gain more protection from "pirates", EVAä , Intangible Assets Monitorä , IC-Indexä but to mention a few examples.

Commission
A well established method is to pay a "commission". Commission is similar to a royalty in that it is generally tied to the commercial value of a transaction. The advantages are that it is easy to negotiate and simple to follow up. The major disadvantage is that commission is a one-off, thus does not encourage long-term relationships. Thus commissions have come in disrepute because it is a euphemism for bribes to political cronies in some countries or payment to fishy arbitrators.

Link Fee to other Vehicles.

What does a money transaction from one account to another really cost? The banks know it very well, but for ages they have charged for there services by concealing the real cost in the "float", the time they borrow our money without paying interest. The financial services industry charge by using "spread" (difference in buy/sell prices) or commision on the capital raised.
Union membership fees are often linked to the salary. Needless to say such practices can be very profitable for the vendor, because they conceal the real cost, but they are increasingly being phased out in the banking industry and it will be interesting to see how commission fees will hold up in the onslaught of the Internet.

Buy into Customer.

Instead of charging a fee in cash, the knowledge company might transfer the whole or part of the fee into shares in the company they work with. This is similar to profit sharing although the involvement and the risks become much greater. It is the backbone of the revenues for the venture capital industry, the most valuable and rarefied knowledge of which is their managers’ ability to pick and back successful entrepreneurs.
The method should be used with great caution by other industries. The knowledge organisation may suddenly find that they own shares in a bankrupt basketcase or that valuable cash is stuck in non-core industries or that the obligations of ownership requires valuable management time to be spent on board meetings outside their competence sphere. The approach is most common in the financial industry.

Link fee to Input.

To charge a percentage on the input is a fairly simple method and has been used by knowledge companies for a long time. Head-hunters often charge a percentage of the salary of the new employee. Advertising agencies earlier often charged a percentage of the total space cost of an advertising campaign. The method is simple, because generally the input is easier to establish than the output, but it is not a very good approach. The method is rightly regarded with suspicion by customers since it has a built-in incentive to increase their costs. It is being phased out in advertising industry world-wide and it is doubtful whether the headhunters will be able to keep it.

Retainers

Retainers are common practice in the consulting industry, particularly for small consulting firms for which it adds a sense of security. It is like being employed part-time. Retainers are also used by vendors to a large corporation that take over outsourced internal departments like recruitment, facilities management, IT-dept. Even if retainers do not have to be linked to time spent, they are no remedy to the fee-for-time problem.

Tender.
Tender has long been established practice in technical consulting where projects are well-defined. The vendor offers a fixed price irrespective of the time involved. Engineers and Architects are used to it. The advantage from the clients’ point of view is of course that they can compare similar offers.
The problem from the vendors' point of view is that the tendering process is a risk reducing exercise so it reduces the incentive to come up with creative solutions. The yardstick tends to be the price offered, so the offering is commodified to such an extent that it becomes unprofitable. Technical consulting also tends to have the lowest profit margins worldwide, the lowest salaries and the lowest added value. Tenders are spreading to most professional services, auditing being hardest hit. There is hardly an audit assignment today or a computer programming project without a prior tender process and consequently audit fees are put under hard pressure.
Public sector assignments are also generally put up for competitive tender these days and they are particularly price oriented. There is not much to do about the trend, however. Tenders are here to stay and one of the best ways to get around it, is to select what tenders are submitted very carefully based on how much intangible revenues they bring.