“How do I know how much to charge my clients?” This has to be one of the most frequently asked questions in the professional services industry. Even if you’ve been in the game for years, each new proposal or contract poses the question all over again.
Putting a price to your professional service offering is about matching the value you believe you provide with the value your clients believe they receive.
There are essentially two types of billing for contract work: fixed bid and time and materials. Both have their advantages and disadvantages, and you’d better know up-front which one your client has in mind before you start talking about money.
A fixed bid contract is just like it sounds. You bid that you can do a defined set of work for a fixed amount of money. If you are more efficient at doing the work, you make more money per hour of work done. If you are inefficient, or worse, if you overlook something about the project or if the specs change, you might spend more time on the project than anticipated, bringing your effective rate per hour way down. You might even make a loss.
A time and materials (T&M) contract is similar to being an hourly employee in that you are paid a set rate for the actual hours worked, and you may be reimbursed for specific expenses, such as travelling and printing costs. If additional work is required, you still get paid for all of your work, but if you don’t work, you don’t get paid. Ironically, if you are efficient, you might make less money overall.
What happens when the scope of your fixed bid project starts changing? It is essential that you act quickly and inform your client that your original bid does not include the new and additional requirements. Provide them with a new estimate in writing so that they know upfront how much the “small” change is going to cost in both time and money.
A golden rule is to never surprise your client – let them know in advance what they can expect to see on your invoice. Regardless of the type of contract, the price you charge has a direct effect on the profit you make. Simply put, the lower your expenses and the higher your prices, the greater your profit margin. Under-pricing will cause your business to fail, while over-pricing will lose you customers. Set prices by establishing the total cost of the service provided (including all your fixed and variable costs). Divide this by the hours spent to establish your cost price. Find out what your competitors are charging, and then decide on a selling price.
Pricing Q&A
Before settling on a fee structure or billing model, start by asking yourself a few pertinent questions:
Negotiation tips
Did you know?
The average consultant works more than 60 hours a week, of which only about 32% is billable. Administration, selling, travel and planning take up the rest of their time.
Use this formula to determine your mark-up
Mark-up % = (selling price – cost price) X 100 cost price
Mark-up is NOT the same as gross profit margin, which is calculated as follows:
Gross profit % = (selling price – cost price) X 100 selling price
EXAMPLE: If completing an individual’s tax return costs you R500 and you charge R750 for doing it, then, based on the above formulas, your mark-up is 50%, and your gross profit margin is 33%.
What is … ?
A retainer: This is a contract between two people or companies where one pays to reserve a portion of the other’s time. In essence, you are “on-call” for a specified number of hours each week or month. The client agrees to pay you for these hours, whether he gives you work or not. The retainer agreement should include the salary to be paid, the period of time to be reserved (for instance, one week per month), and details of the type and scope of work to be done.
A major advantage of a retainer is that you are guaranteed a fixed monthly income without being an employee. Note, however, that you may have to agree to a discounted rate in exchange for the steadiness of work and income offered by the retainer.
One of the main pitfalls is that when the agreement or contract is not carefully managed, you can end up over-servicing the client as they might assume that the retainer covers every possible service you can deliver, regardless of the time involved.
Scope-creep: This is when the pre-defined set of boundaries for the work expands. A telltale sign that this is happening is when you hear someone say, “As long as we’re doing that, let’s also ...”
An hour: This sounds like a silly thing to ask, but what do you do if you’ve worked on a job for 43 minutes? Do you charge for the full hour or not at all? Some consultants charge their time in half hour portions while others charge the full hour regardless of how many of the 60 minutes were actually used. Whichever you choose, inform your clients beforehand and be consistent.
Measure more than money
You know your business is making money (or not), right? But do you know why? If the answer is no, chances are that you don’t have the right measurements in place. There are a number of good reasons to measure performance in ways other than just monthly and annual profitability:
Here are some of the aspects for which you should consider putting measures and targets in place:
Productivity: Given that the bulk of a professional services firm’s costs are in salaries, measuring your team’s productivity should be a priority. Ask yourself these questions to gauge how good a handle you have on the productivity of your business:
Productivity and effective billable rates:
Productive billable hours are your business’s lifeblood. Without tracking activities, it is difficult to know how many hours per week are actually productive. Travel, admin activities, IT downtime and, increasingly in South Africa, electricity interruptions, consume a significant number of hours with nothing to show for them.
The result is that you miss your deadline, or rush and deliver an inferior service, or lose money on an unprofitable contract (or, horror of horrors, all three and a lose client to boot). Using the right measures will help you to select projects more carefully as well as guide you on how to structure your bidding.
Project management: It is important to keep your finger on the pulse of your projects to ensure that you don’t run out of available hours, time and resources. A simple measure is % consumed divided by % complete – if the number exceeds 100% the project or task is behind schedule and requires urgent attention.
Other possible measures: Length of contracts, number of leads in the pipeline, repeat clients and frequency of retainer services. Just remember to always make sure you understand why you measure something.
Two measuring tips
How not to measure...
When measurable targets are not designed well, they are a waste of time or, in a worst case scenario, downright destructive – as a paleo-anthropologist learned way back in 1937.
He was searching for bones of early hominids in Indonesia when he hit upon the idea of using low-paid locals to aid in the search. He offered 10 cents for each piece of bone they could bring him. To his horror, he found his labour force was smashing priceless bones into fragments in order to increase their income.
Perhaps he should have paid more for larger segments, or an hourly rate. Either way, his original idea should have been examined more closely before it was implemented.
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