PROFESSIONAL SERVICE PRICING AGREEMENTS
This section includes BIG information on:
- Written Pricing Agreements
- Forms of Pricing Contracts
- Daily Rates
- Time & Materials
- Cost Reimbursement Contracts
The cornerstone of a good relationship with your clients is a solid pricing agreement. The pricing detail serves as an advisable, absolute legal protection, representing in black and white the meeting of minds between parties. The practical value of the pricing agreement depends on the quality of the relationship between you and your client. The pricing detail becomes a tool normally considered the contract that both parties can use for mutual benefit.
The pricing detail can take the form of a simple letter of agreement, or it can be a formal contract with clauses, sub-classes, and all the legal trappings. A verbal agreement is usually a legally binding contract, but it is hard to enforce and suffers from the characteristics of the human memory. You can always take a written agreement out and look at it, but when two or more people are trying to remember what was verbally discussed weeks or months ago the result is nearly always conflict and confusion.
For most projects a simple letter of agreement is sufficient. It outlines the project, sets the milestones and deadlines, and sets up a scale for paying the professional service firm. Written agreements can also deal with matters such as support the professional service will receive on the job, performance expectations, handling unexpected problems, and any other items that seem important. A letter of agreement is actually a contract and is legally binding.
Whether you use a letter of agreement or a formal contract, there are a number of standard arrangements, which are listed and discussed below. You want to choose the kind of arrangement that is appropriate to the project and the client. When you begin work with a clear understanding of responsibilities and financial arrangements, you will find that the job is done more smoothly and will almost always end with both parties feeling satisfied.
FORMS OF PRICING CONTRACTS
The relationship between you and your client can take a number of forms:
- Fixed-price contracts
- Daily rate
- Time and materials
- Cost reimbursement
Each type of contract may be useful at one time or another, depending on the situation and the demands of a particular project.
The fixed-price contract is very simple. After ascertaining the client’s precise needs, you state that you can perform the services required for a flat dollar amount of your estimation. Once the fixed price is accepted and a contract is drawn, you are then bound to deliver the services for that amount. If you handle the work efficiently and the services cost you less than you estimated, then you make more profit than expected. If your expenses are higher than estimated, you lose some profit.
Payment is linked to your performance. At the conclusion of the work, if the contract has not been fulfilled by the professional service firm, not only could the final payment be withheld, but also the progress payment amounts might have to be returned. Clients run little or no risk with a fixed-price contract. The professional assumes nearly all the risk. But, the reason for the fixed-price contract is that it usually results more profitably than other types of contracts.
Various Types of Fixed-Price Contracts.
a.) The firm fixed-price contract
b.) The escalating fixed-price contract
c.) The incentive fixed-price contract
d.) The performance fixed-price contract
e.) The fixed-price contract with re-determination
f.) The fixed-fee, plus expenses
- Firm Fixed-Price Contract – This contract offers a firm, fixed-price for specified work and is not subject to change except when the scope or character of the work is changed. All risk is with the professional service firm, whose opportunity for monetary profit is greatest for this risk.
- Escalating Fixed-Price Contract – This agreement is similar to the firm fixed-price contract except that it has provisions for upward or downward adjustments of the fee on the basis of predetermined contingencies, such as the cost of living index.
- Incentive Fixed-Price Contract – This contract has an “adjustment formula” designed to reward the professional for additional efficiency and penalize inefficiency. If the professional service firm is below the ceiling price, the firm gets the extra profit. lf the outside professional exceeds the ceiling price, the costs are divided according to a predetermined schedule. Both parties might agree that additional expenses are to be borne by the client at a rate of 75 percent and by the firm at a rate of 25 percent, reducing the professional service firm’s profit by one-fourth.
- Performance Fixed-Price Contract – This contract is the same as a firm fixed-price contract except that it compensates the professional service firm for special performance. Consequently you might get a bonus for bringing the contract in early or as a result of some other special achievement.
- Fixed-Price Contract with Re-determination – The same as a firm fixed-price contract, this contract has a provision that allows both the outside firm and the client to re-determine or reset the price after the contract has been signed. This contract is best used when the nature of the task is so vague, so uncertain, or so unknown that an accurate estimate cannot be made. At the time the contract is signed, both parties agree on a point in time for re-determination on the basis of their experience with actual costs and expenses. By agreement the parties determine whether the change in price will affect prior work, future work, or both.
- This kind of contract is usually in the interest of the professional service firm who is working on some blind or unknown task for which the costs may be much higher than anyone would have conceived. Yet the re-determination may be downward, too. lf actual costs are a great deal less than anticipated, this contract may be to the advantage of the client.
- Fixed-Fee Pl us Expenses – When the direct expenses are difficult or impossible to foresee, the professional service firm can submit the direct labor charge, overhead and profit as a fixed-fee, but the client is liable for the direct expenses.
Working on a daily-rate basis may be safer than submitting a fixed price. Some projects may appear too speculative or too unpredictable for you to guarantee either services or expenses. Sometime the client’s personality may even create an element of uncertainty or a situation just “looks” as if it has surprises in it. Although under similar situations some professionals do submit a fixed-price contrast with some price padding for protection. You might pad the fixed-price contract you are going to submit. A little padding should not hurt, but a lot not only can dull your competitive edge, but it can also border on being unethical.
Therefore, in daily rate contracts, true professionals submit an estimate of time and expenses, but they are not responsible for overruns. The clients assume all risk for overruns in both cost areas, and they enjoy all the benefits of under-runs.
TIME AND MATERIALS
This contract works exactly like a daily labor contract with a couple of exceptions. One is that the outside professional service firm pays for expenses and adds a handling charge, normally at the same rate as the professional’s profit. The professional then bills the client for the total. Another exception is that the clerical support is not built into the daily rates. Instead, this work is usually charged as an expense. A time and materials contract is a kind of fixed-price contract in that the labor and overhead rates are fixed. What the client winds up paying, however, is far from fixed. Hence this time and materials contract is an incentive for professionals to be anything but expeditious, as the longer the project takes, the more money they earn.
COST REIMBURSMENT CONTRACTS
Cost reimbursement contracts focus on costs rather than on fees. ln such contracts professionals are reimbursed for the costs that they incur. ln the contracts that call for fees–some of them do not–the fees are emphasized less than the costs.
The underlying assumption for these types of contracts is that the clients pay all costs or the outside professional service firm ceases performance. Whereas professionals act as principals in a fixed-price contract, they act as agents of the client in a cost reimbursement contract. They run no risk of loss and do not earn the profit normally associated with fixed-price contracts.
Cost reimbursement contracts are used when the professional service firm cannot accurately estimate costs and when the professional service firm’s cost accounting system enables clients to monitor the professional’s costs. Clients as a rule do not favor these contracts because they have to expend a lot of effort keeping track of the professional service firm’s costs.
The success of these contracts depends on the definition of costs” At the outset, both professional and client must agree on “allowable costs.” Perhaps the professional considers the cost of capital an allowable cost, while the client does not. Other costs such as automobile transportation might also be disputable. If you enter into a cost-reimbursement contract, define what you mean by cost.
Several different types of cost reimbursement contracts are used by professionals, including :
a.) The cost contract;
b.) The cost-plus-fixed-fee (CPFF) contract;
c.) The cost-plus-incentive-fee (CPIF) contract; and
d.) The cost-plus-award-fee (CPAF) contract.
The Cost Contract – With this contract the client agrees to reimburse the professional for all allowable costs but pays no fee (profit). !t is most widely used when a nonprofit consulting agency can learn technology that will benefit it in the future. Cost sharing, in which the client agrees to cover a part of the costs or to share the costs, is another alternative.
Cost-Plus-Fixed-Fee Contract (CPFFI) This contract is the most frequently used form of a cost reimbursement contract. lts popularity in general professional services developed as a result of its widespread use by the federal government. The client and the professional agree on the total estimated cost of the consultation. They further agree on the allowable fee or profit to be earned by the professional over and above these costs. lf the actual costs are lower than those estimated, the professional service firm earns a higher percentage fee on the costs.
ln theory the professional service firm is motivated to keep costs down and thus earn a higher percentage return, ln actual practice this is not always the case, Professionals are largely assured of reimbursement for all “allowable” costs. They are normally not required to spend funds in excess of the agreed-upon amount, even though the project or engagement has yet to be completed.
Cost-Plus-Incentive-Fee Contract (CPIF). Rather than a fixed fee, this contract form has a minimum and maximum fee. The minimum fee may be negative or zero. Clients and professional service firms may also share costs in some contracts. lf the actual costs turn out to be lower than estimated, the professional service firm gets a greater fee – up to the maximum. lf costs run over the estimate, the fee is smaller, and it may even be reduced to zero if the cost overrun is great enough.
ln theory the risk for client should be equal to that of the professional. ln practice each party tries to get as much advantage as possible during contract negotiations. Frequently CPIF contracts involve multiple incentives – one for early completion, another for cost efficiency, & so on.
Cost-Plus-Award-Fee Contract (CPAF) A cross between the CPFF and the CPIF contracts, this contract was first used in federal procurements to handle technical items that were too difficult to estimate in contract negotiations. In the CPAF, unlike the CPIF, an external third party awards the minimum or maximum fee based on an objective evaluation of the professional service firm’s cost efficiency and compliance.
These evaluations can be scheduled anytime, usually on a monthly or quarterly basis. One advantage of frequent evaluations is that they provide feedback that may enable professional service firms to perform more in line with the client’s expectations and thus earn the higher fee.
While the term “retainer” is used in many ways, it generally implies an open-ended agreement between client and the professional to make the firm available to the client for a specified amount of time or scope of work. Usually, additional work is billed out at some pre-established hourly or daily rate. From the professional’s viewpoint, the retainer contract makes good sense only when the outside firm is able to predict with strong accuracy the amount of time needed by the client. From the client’s standpoint, a retainer agreement is of value because the client can tap quickly and easily the specialized talent of the professional without extensive formal arrangements.
a.) Availability Retainer Agreements Availability retainer agreements have become more common in recent years. ln these arrangements, professionals make themselves available in the event that the client needs their services. The professionals agree to reserve a specified block of time for the client in the event of need. Since this reservation reduces the time flexibility of professionals, they are rewarded a portion of the value of the reserved time. Usually this amounts to a sum of between 20 and 30 percent of the value of their time.
ln a time-retain agreement, the professional performs a specific activity on a periodic basis (usually monthly). Occasionally professionals find themselves spending more time with the client than the retainer is worth. Yet they put up with the “overwork” because the up front money is a kind of insurance policy.
SUMMARY ON PRICING AGREEMENTS
Practice good project management and never surprise the client with changes to the project plan projections — after the changes have already occurred.
Develop a project plan in order to submit solid pricing assumptions, planning, scheduling and controlling activities.
Selecting the right pricing contract is measured by how well you can define; How objectives are to be accomplished. What are the interrelationships of the identified tasks. When will the work be completed. Who is responsible for completing specific tasks. Where is the work to be performed.
The basis for fee estimates & pricing format selection stems from your project plan.
This completes our overview of offering professional services. You began by learning the fundamental principles and ethics of offering client services. Then we shared the necessity of effective communications in understanding your client’s needs. You were given a formula to reduce the most common anxieties prospective clients need help in overcoming before selecting your firm. We took a glance at the importance of identifying client body language in your presentation that can add a pivotal adjustment for making the sale. Our discussion then lead you to broadening your marketability by offering expanded services, networking to develop teaming resources, while identifying your talents and skills to maximize profitable opportunities. Lastly, we gave you pricing definitions for setting your fees, and what to consider for selecting pricing agreements.
lf you follow good marketing principles, you will not get caught in the large buying organizational maze, or end a project only to find that you are out on the street looking for another. The good professional service firm delivers a quality product at a fair price and makes a reasonable profit. Sound professional service activity represents the last oasis of our country’s free enterprise system, enabling you to have whole success and legacy.
ABOUT THE PRESENTER
Dean Jones is widely recognized and respected for his work to expand, retain, and attract enterprise to the greater southern California region. He is a notable business and labor engagement advocate currently operating the Southland Partnership Corporation, a nonprofit economic development corporation. In this capacity, he serves as the director for the POWER Collaborative Network (P.O.W.E.R. — Promoting Opportunities with Essential Resources), an independent human resources services organization delivering capacity building for workforce service providers in the non-profit sectors. Under his management, this inter-professional Los Angeles County network sponsors the www.IStartOnMonday.com, Jobobama.com, JobCollaborative.com, and Joblip.com community social services assistance web sites.
Similarly, he works with the African American Engagement Collaboration that supports better integration processes between small and large corporations. This collaborative is comprised of the Black Business Association, California Black Chamber of Commerce and National Black Business Council that targets emerging suppliers to enhance their request for proposal responses through improved estimating techniques. This collaborative manages two web sites; www.TheArtOfBidding.com and BlackSuppliers.com, each offering business tools to encourage, recruit and utilize black-owned and operated enterprises to access and supply products and services to major public and private organizations.
As a Certified Purchasing Manager (C.P.M.), his consulting services have extended best viable practices to a diverse range of major organizations, such as; Blue Cross of California, California Endowment, City of Compton CA, City of Long Beach CA, City of Los Angeles Department of Water and Power, City of Los Angeles Neighborhood Initiative, Comerica Bank, First American Title Corporation, GTE, Kaiser Permanente, Los Angeles Black Business Expo & Trade Show, Los Angeles Music Center, Los Angeles County Office of Education, Southern California Edison, Verizon Communications, West Coast Expo.
A second generation Angelino and Los Angeles Unified School District graduate, he earned a Bachelor of Science Degree in Business Administration – Accounting from San Jose State University. He has received a range of recognition and distinction awards for his work in support of socioeconomic programs, including a special recognition from the California State Legislature for his extensive service and contributions to the regulated utility corporation’s supplier diversity programs.