I met with a colleague recently who told me about a consulting experience that that didn’t go so well for him.
A year or so after retiring from P&G, he had chosen to do some work with a local Consulting Company that had just recently opened its doors. Someone else decided how to price the engagement and, despite the fact that there were several unknowns in the project, it was quoted as a fixed bid to be completed on a very challenging timeline.
As my friend began to work with the client he realized that the project would likely take twice the amount of time that was proposed. He did some checking with the ‘bidding department’ and quickly realized the constraints, and that he would be working long days and for half his going rate!
Get your pricing strategy wrong and you create a problem you can rarely overcome.
Knowing my friend, he will still deliver top quality work so this particular client will get what they need, but he will not make this mistake again, nor will he continue to contract through the Consulting company who evidently has a strategy to get work by being the low bidder!
Perhaps the client got this work done for half of what it should have cost – but the set up is not sustainable, neither for the client nor the Consulting firm. In a previous post, I talked about the fact that you get what you paid for… I wonder how many other contracted consultants this company employs and how many are as conscientious as my friend – who are Ok with being paid half of what they are worth, or half the value they have contributed to the client’s bottom line.
And, this is the reason I argue for a Financial Model when you are hiring any firm for a critical or long term Services Engagement.
The reason is simple – to price, or source, Goods is objective – you define the elements required to provide the finished product. Pretty straight forward – the costs are all relatively clear and easy to account. Pricing or sourcing for Services, on the other hand, is quite subjective with many variables that are hard to empirically define.
Don’t confuse Financial Model with financial modeling – I am not talking about a large spreadsheet with formulas and algorithms. Crafting good business deals requires a good bit of math, but if you immediately jump into the spreadsheet, you’ve missed an opportunity to talk with your Partner and find a win for both parties.
A Financial Model is the composite of the way the Supplier PRICES the Service and how the Buyer PAYS for it.
It includes not only the unit cost of resources over the estimated time to complete the work but other financial element and the allocation of risk. Understanding what is most important to both parties can open up options and opportunities that had gone unexplored in a simple bid/accept approach.
Back to the situation in which my friend found himself. Recall the firm he was contracting with had just opened it’s doors. Perhaps the Consulting firm could have asked for a recommendation or testimonial; this word of mouth advertising offsets marketing spend and is valuable to any firm. This could have enabled the firm to pay my friend what he was worth and retained a valeable asset! Think about it: what will the firm do the next time they have an opportunity to perform work in this niche area if one of the key experts is no longer interested in contracting through them?
Here are the typical Value Elements that could be part of your Financial Model. The opportunity examples in each category are only the start of what might be considered.
- Compensation Method – Fixed or Reimbursed Look at a previous post for more detail.
- Service Level Agreement – Clarity on the outcome you are expecting is probably the most significant consideration when pricing a Service engagement. Take more time aligning the expected service levels than talking about how the work will be done.
- Rebate Structures – Many firms receive rebates or volume discounts from their suppliers. When you bring additional value, perhaps that rebate could be shared or reinvested.
- Incentive Schemes – Digital solutions might deliver productivity savings. Who will make the investment and who will benefit from the improvement?
- Investments – If you are negotiating rather than running an RFP, your Service partner is saving substantial ‘cost of doing business’ expenses associated developing proposals, sending the new business development team to pitch to your crowd. These funds could be invested in the business and bring meaningful value to both.
- Foreign Exchange, Currency Assumptions – Will business be done in another country? How will you deal with currency exchange? You might consider who has the greatest exposure or the lowest currency fluctuation risk.
- Cost of Financing and Payment Terms – Cash flow is important to consider and extended payment terms are the norm these days. While this can cause an issue for smaller firms, extending borrowing credit may enable the Service provider to be paid sooner with better borrowing rates than what they could obtain themselves.
- Risk Allocation – Risk allocation refers to any uncertainty in the engagement between client and Service Provider. Talk over the unknowns and try to eliminate as much as possible. Consider moving some risk elements to a separate compensation method. In Facility contracts, the amount of snow a site will receive in any given year is an unknown – so better to price by occurrance than lump services into the on-going service fee.
That consulting gig my friend performed may have been better priced as Time & Materials but that does not mean that ever Service engagement should be priced this way. Just watch out for situations where there is a built in reward, sometimes a “Price by the hour” approach enables the provider to simply bill more. Likewise, when the Client is more focused on reducing the billing amount than considering the outcome or results expected from the work you are setting yourself up for quality complaints.
One final thought, the duration of the contract can also play into the final cost of the Services delivered; supplier investments and other costs can be amortized over the life of the expected engagement. A longer contract period represents book value that does not have to be filled next year – this means your Service Provider can focus on improving your results rather than selling to someone else.
Have you spent time designing Financial Models for your Service engagements? If so, I’d love to hear your examples. Talk to me!