Perhaps the ultimate in value-based pricing comes from hedge funds (where else?). Hedge funds purport to offer a “sure bet” on the market, using hedges to protect against downturns in any particular area. In reality, hedge funds are a largely unregulated way for people with lots of money to invest. Hedge funds have created such an aura of value, especially in a period when the stock market is not performing well, that they have been able to extract enormous commissions. The typical arrangement is “1 and 20”, meaning 1% of the capital, plus 20% of the profits. As the New York Times reports:

Steven A. Cohen of SAC Capital Advisors, for example, takes as much as 50 percent of all profits his hedge funds earn, netting him $450 million last year, according to Institutional Investor. Even after this big cut, his funds still returned around 23 percent, not bad in a year when the Standard & Poor’s 500-stock index rose 8.99 percent.

Performances like this attract big money from university endowments, pension funds, and the wealthy. Paydays like this attract some of the best minds on Wall Street. After all, who wouldn’t give 50% of the gains if the remaining 50% still meant you came out ahead of any other option?

So am I saying that pricing people should charge 20-50% of their value? No. Hedge funds have several things going for them that makes it easier to implement these types of aggressive pricing schemes. First, you can easily measure the gains. Second, the market is even more obscure than mutual funds. There is a huge range of options, and unlike mutual funds, companies don’t have to report all the results. If you run 20 funds, chances are that one or more of them will outperform the market for several years. You can market that one and bury the results of the others. Still, pensions funds, endowments and the like aren’t naive investors– some of the funds do seem to genuinely beat the market for extended periods of time.

What we can learn from hedge funds is the notion of value-based pricing, which can make up the vast majority of profits from high performing funds. Hedge funds aim to create a profit pie, then take a (pretty hefty) slice of that pie. While they can measure the size of that pie more easily than most of us, we can all take a stab as approximating the size of the pie, and taking our rightful piece of it.

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