Determining how much to charge a client is no easy task!
Not only do you need to come up with the fee in the first place, but you don’t want to risk overcharging or undercharging and losing the sale, or worse still, squandering the profits in the delivery phase.
Despite the many variations, there are only 4 different consulting fee types around which all others are based.
You could argue that there are only 2 - Fixed fees and Variable - however the different fee types described here require more thought than simply fixed or variable. They are a combination of the way the fees are packaged, and the scenarios in which they are deployed.
In this article I’ll explain the different fee types, and reveal the following 3 things:
- Which one has the greatest profit potential
- Which one is the most common - and why it should’t be!
- Which one clients prefer the most
The diagram below details each of the 4 fee types, along with the 4 dimensions of a fee. (For the benefit of those reading on a mobile device, this diagram is described in detail below)
Download your copy: The 4 Consulting Fee Types
It's a lot to take in, which is perhaps why many consultants don’t go beyond Time & Materials. But before we get into the different fee types, let me explain this model a bit first.
On the left are four categories. which represent the 4 dimensions of a fee, as follows:
In a consultancy there are two types of engagements:
- Project: The client engages you to complete a discrete project
- Service: The client engages you to fulfil an on-going need through a service
The Pricing Models is the core part of your pricing strategy and includes the following options:
- Time & Materials: Fee is based upon an agreed day or hourly rate. Billing is for the exact amount of time worked plus any material expenses. Different resource grades typically attract different rates.
- Fixed Fee: Fee is based on the cost of the total days estimated effort, then the addition of markup (Cost Plus) or a fixed sum (Value based). The client pays the same fee regardless of how much effort you expend.
- Risk/Reward: The client agrees to pay a base fee, plus a risk/reward element based on the outcomes achieved. The Risk/Reward element can be fixed or variable, and it can be based on elements of project tolerance (Time, Cost, Scope, Risk, Quality, Benefits), or it can be specific project outcomes. The Risk element eats into your profit on the project.
- Retainer: A fixed fee, paid annually or monthly. The model secures your availability to the client. It is on a ‘use it or lose it’ basis. There may be provision for additional fees on a T&M basis.
An engagement produces revenue which is either predictable (fixed) or unpredictable (variable).
The Profit Model concerns the approach taken to determine the profit on the engagement at the point of sale. There are many different pricing models, but the two most common in a consultancy are:
- Cost Plus: The fee, whether variable or fixed, is based on your costs to deliver (resources mostly) + your markup.
- Value-Based: The fee is based on your estimate of costs + an additional sum based on the value to the client of the outcomes that you're providing.
So, let's explore the different fee types in more detail. Each fee type is explained below using a SWOT Analysis (Strengths, Weaknesses, Opportunities and Threats), along with examples of when to use each fee type.
Time & Materials (T&M)
More commonly known as T&M, Time & Materials is the most common Fee Type. Why? Because it's the easiest to apply by the consultant. That doesn't mean it's the most preferred by the client. In fact, for most projects it's not preferred by the client as there's no clarity of total cost to them. That represents risk. The client will be concerned that costs spiral, and/or they simply run out of budget.
- Well suited to unclear project scenarios and with new clients
- Useful to utilise unused billable capacity
- Typically little client resistance (initially)
- No revenue predictability
- Limited opportunity to bill in advance
- Tempting to discount or write-off expended effort
- No commitment from you or the client
- Disincentivises delegation as junior resources have lower billing rates
- Can be perceived as expensive in the long-term
- Gives the client a lot of control (low risk), and can help to win an initial engagement
- Can be used tactically with high day rates to encourage a fixed fee
- High risk of non-payment or under-payment due to disputes regarding effort expended
- Encourages long working hours and downplays the value of non-billable activities
- Causes client to micro-manage
The biggest risk with T&M is that, as you and your team get better and more efficient at what you do, the time you take will be less. Unless you adjust your T&M rates upwards to reflect your expertise, you'll essentially be losing out the better you get!
Aside from the risk stated above, the primary problem with T&M is that it doesn’t offer your business the ability to plan its revenue and resources. And you’ll be working like crazy to bring in the revenue.
It’s exactly because of T&M billing that lawyers are renowned for the long hours that they work. To make this fee type work in the legal sector it is necessary to drive people extremely hard, often aiming for upwards of 40-50hrs per week in billable time. That means all of that other non-billable stuff - another 10-20hrs - needs to be fitted in too!
T&M also drives client disputes over bills. In the legal sector - which is the biggest purveyor of T&M fees - the average bill is discounted by 6% in response to client disputes.
Whilst T&M offers the most simplicity, it does not create the best foundation upon which to grow a successful consulting business. And it doesn’t really offer the mid to large corporate consulting client what they want either.
Pro Tip: Price T&M rates high to encourage the client to switch to a Fixed Fee approach. This way, at least if they don't switch, the higher profit margins* motivate you to do the work.
Of course, use caution here as you may need to be more focused on winning work with a new client. That said, it is always way more difficult to increase fees later. That's why the traditional marketing approach of low-balling a fee is nearly always a bad strategy for a consultancy.
* If you're not sure on the difference between markup and margin, take a look here.
Next up is the Fixed Fee approach. There are, however, two variants of the Fixed Fee based upon your profit model. It is important to understand each as there are some important differences.
Fixed Fee (Cost Plus)
This model is a step up from T&M and the most commonly applied type of fixed fee. With this pricing model you estimate how much time and effort a project will take, then you apply your markup to provide the client with a single, fixed fee.
- Prevents the client from clock-watching
- Provides the client with budget certainty
- Provides your business with revenue predictability
- Much easier to charge up-front fees (in full or part)
- Easier to plan resources and make strategic business decisions
- More risky if a new client and you are reliant upon their staff to complete tasks
- Profit can be easily eroded by poor time and scope management
- Requires prior experience of the project type to estimate accurately
- Good profit opportunities as any efficiencies you develop create additional profits
- Enables you to focus working ‘on’ your business rather than just ‘in’ it
- Low profits due to underestimating the required effort, or from poor time and scope management
- Efficiencies developed over time risk not built into fee, but instead used to reduce the fee
- Inaccurate time recording on previous projects results in underbidding
Pro Tip: Always be sure to add contingency to a fixed fee so that there is room for manoeuvre. The amount of contingency depends on your perceived risk as to the ability to complete the project within your estimated effort. This can be impacted by factors such as how experienced you are in delivering this type of project, and how well-known the client is to you. The less certain you are, the higher the risk and so the greater the contingency should be. You should also consider other external factors.
Since starting my own consulting firm I've never used T&M fees, instead preferring to use Fixed Fee (cost plus) as they're the easiest form of fixed fee and well suited to the strategic engagements I undertake.
In my consulting experience, I've won fixed fee engagements from a few thousand pounds to well-over a million. So, fixed fees are very versatile!
Fixed Fee (Value-Based)
Ah, the Value-Based Fee. Stuff of legend. In fact, value-based fees are stock advice in pretty much every book you can buy on running a successful consulting business. The trouble is, it's much easier said than done, and a value-based fee doesn't suit every engagement type.
With a value-based fee, rather than basing your profit on your standard target markup, you base your profit on the value of the engagement to the client.
Or more precisely, you base your fee on the cost to the client of the problem that they are facing. As you can imagine, that requires an in-depth discussion with the client to extract that cost, which may not be immediately obvious to them.
- Gives the client budget certainty
- Both client and consultant are focused on delivering business outcomes
- Higher profit margins give some protection to delivery effort underestimation or underperformance
- Requires in-depth conversation with the client
- More difficult in a competitive scenario
- May need to assist client sponsor to sell to peers and seniors
- Only really suitable to sell to very senior people and on high importance projects
- Highest profit potential
- Focus on business outcomes creates powerful case study opportunity
- High price may prompt client to seek competitive quotes
- Could have a longer sales cycle
- Profit squandered by the delivery team
Pro Tip: If you've never used a value-based fee before, a very rough rule of thumb is for your fee to be circa 1/10th of the cost of the problem to the client.
For example, if the problem they are facing is costing them £250k, then your fee might be in the region of £25k.
However, if the problem is costing them £250k/yr for the next 5 years, then your fee might be substantially higher as you're resolving a £1.25m problem.
Remember though, this is very rough guidance and only one factor. If the client is in a desperate situation and risks losing their job if the problem isn't resolved, the value to them might be higher and not so focused on the financial cost of the problem.
One of the biggest problems with a value-based fee is that the additional profit gets squandered by over delivery!
It happens just the same in big consultancies. One cause can be the measuring of delivery team effectiveness by billable utilisation alone. The solution to this is to incentivise delivery teams on profit delivered as well as utilisation.
This risk of squandering profit is why sales teams can sometimes be reluctant to tell the delivery teams what the sale price of a project is. And who can blame them!
To close a sale on value requires an open discussion with the client about the cost of their problem, and the investment required in you to resolve it. It also required the consultant to shift mindset from one of selling hours, to selling an outcome.
The risk/reward model can be seen as a variant of the fixed fee (value-based). It’s a great model, but in most consultancies it is rarely applied. It is much more common in construction industry related consultancies.
The primary challenge is that there needs to be maturity in understanding between the client and the consultant.
- Demonstrates ‘skin the game’ (shared risk) to the client
- Delivery team driven to perform
- Can be complex to set up
- Few clients have the maturity to understand a risk/reward model
- Requires robust measurement and monitoring to agree outcomes
- High profit potential
- Profit could be very minimal to zero on ‘bad’ projects
The main problem with a Risk/Reward fee is disagreement with the client over the value of what has been delivered. A Risk/Reward project therefore requires careful management of scope, and close engagement with the client project sponsor throughout.
The final fee type is the Retainer. A retainer fee is deployed where a client secures a portion of your time for their exclusive use. There are many different services that a consultancy can create to encourage retainer fees.
The best part of a retainer fee is that it represents recurring revenue to your business. This makes a significant difference in the overall value of your business.
- Provides opportunity for long-term engagement with the client
- Increases value of your business
- Not normally suited to a first project
- Complacency can set in resulting in a dissatisfied client (due to incorrect focus on delivering in the least time possible)
- Continual engagement with the client exposes other opportunities
- Depending on the service, it could lock you out from other opportunities with the client
Things to watch out for: There needs to be rules of engagement. For example, if a client retains you on an allowance of 20 days year, you don’t want them to be able to call upon it all in one month! There needs to be an expected lead time to be able to respond to the larger requirements.
Pro Tip: By being continuously engaged with your client you are best placed to spot additional consulting opportunities where you can help. Many consultancies get this wrong, instead hoping to benefit from the client not using their retained effort!
That’s a false economy. Get in front of your existing clients, and win more work. It beats trying to win new work with new prospects hands down!
In my consulting business an example of a Retainer service is our Project Lessons Learned as a Service offering. Clients engage us on an annual basis to provide this crucial offering.
To learn more about the creation of recurring revenue services in your consulting business, go here.
So which fee type is best? The answer is.....you've guessed it - it depends. On a whole number of variables.
The most common fee, especially for small and startup consultancies, is T&M. However, that really isn't the best approach (unless you make the markup very high) as it can result in overwork, under-delegation, and doesn't give the client much budget certainty.
Fixed fees are preferable to your business, and most preferred by clients.
If I was looking at it purely from a business management perspective, I'd love a business full of nothing but retainer revenue. That way my business would be totally predictable. It would ultimately be a subscription business.
However, the consultant in me sees that all a bit.... well, boring! Whilst I do love certainty, I also love the challenge of a project. That's why I believe a consulting business should have a mix of retainer and fixed fee engagements.
If you can achieve a value-based fee, you'll get the greatest profit. But if not, settle happily for a cost-plus fixed fee. Just be sure to increase your markup in light the efficiency you create as the team gets more skilled.
Risk/Reward opportunities are rare, but are also probably the most exciting. The thing I like most about them is that it drives the delivery team to perform efficiently and optimally.
Probably the most important aspect that runs across all of these fee types is the importance of accurate time recording and scope management. If you don't have time recording in place, then it's irrelevant what model you follow as you're likely haemorrhaging money through over-delivery.