How consultants price their services can mean the difference between making it in the business and going broke. Depending on the competitive environment, consultants from large firms and independents need to know how their services compare with their industry rivals and how to successfully price those services to insure success for both their clients and themselves.
How do firms go about pricing their services when they propose on a large project?
The two classic approaches are either time and materials or fixed bid.
Time and materials is essentially charging an hourly rate for every hour worked by each team member on the project. It also allows for expenses such as travel.
With time and materials, or T&M, all of the risk is on the client, because they’re just paying for the consultant’s services with no defined end date.
The opposite of the spectrum is the fixed bid contract. Here the consulting firm says, “We’ll do this project for a fixed fee of $x. Now all of the risk is on the consultant to complete the defined scope of the project by a defined deadline. If they get behind, they may have to work extra hours or add additional people for free just to get the project done.
I would assume consulting firms push the time & materials projects while clients push fixed bid contracts.
That’s what you see in general. Both sides are trying to reduce their risk. But it often depends on the client and the nature of the project.
If the scope of the project is a concise statement of what the project will entail and can be easily defined, a fixed bid project can be more easily agreed to by both parties.
If the outcome of the project is ambiguous in any way, or if there is a significant risk of a lot of changes in the project, then a consulting firm is less likely to agree to a fixed bid project.
What type of risks would cause a firm to shy away from a fixed bid project?
Anything that could potentially cause cost overruns really. Let’s say that the client is using contractors from three other consulting firms. And their contracts end at different points of time before the project is supposed to end. That’s a huge risk to the firm because they could lose key people during the project.
That could cause them to spend extra time and resources finding replacements and, assuming replacements can be found, bringing them up to speed on the project and any technology they need to learn.
Another risk could be the number of key client employees that need to commit their time to the project. If the client commits their key people to the project 100% and they end up only being able to dedicate 50% of their time to the project, the project is going to experience delays which will cost the consulting firm more than they planned in a fixed-bid agreement.
How do firms protect themselves against these overruns?
The two primary ways firms have of protecting themselves is by building in contingency in the project and having a well-defined change control process.
Let me explain contingency first. I’ve always thought of contingency as a slush fund of time that a consultant or a project manager has in his back pocket to allow for cost overruns.
When a consulting firm agrees to a fixed bid project for, let’s say, $250,000, they may say that they reserve 10% contingency for unplanned changes. They’re essentially having the client agree to an additional $25,000 in fees if any of the risks become actual issues.
A change control process allows the consulting firm to draw on that contingency as issues occur that will cause the cost to increase outside of their agreed upon fixed fee.
So, using the example of using contractors from other firms whose contracts end before the project ends. If it turns out that one of those contractors leaves and it takes a month to find a replacement and bring her up to speed, there is a tangible cost to the project.