Guerrilla Tactic Risk Premium

Add a risk premium to fixed-fee projects because it is easy to run into problems. When you're receiving a fixed fee, clients can enlarge scope unintentionally or create delays. Manage the scope of the project tightly. Work collaboratively with the client to reach an unambiguous understanding of scope, and set up a process in advance to discuss changes that might occur. If a problem arises, address it immediately.

In fixed-fee projects, ask for a substantial payment before the project begins. It's not uncommon to request 50 percent of the fee at the outset, 25 percent at the halfway point, and 25 percent on completion.

arrangements, a consultant's fee is based on achieving an agreed-on project result. Usually, the consultant receives a specified percentage of the gain resulting from the project.

Contingent fees seem to work well for revenue enhancement, cost reduction, litigation support, and other projects where a monetary impact can be measured with relative ease. Contingent pricing is simple to understand and administer as long as the measurement standards have been specified.

But if the measures of success are not crystal clear, it's easy to get into arguments with clients over this pricing approach. Suppose a client wants you to reduce costs by renegotiating telecommunications equipment leases, and you propose that your fee be 30 percent of the cost reduction achieved. That's a clear measure of success. Measuring precise project results can be both difficult and costly, so be careful to define the measures before the work begins.

Watch out though—contingency pricing can leave the consultant with nothing at all. What if, for some reason, you can't renegotiate those equipment leases to the agreed-on level? You've worked for free and probably alienated the client for failing to perform.

Contingency pricing calls for precautionary measures. To motivate the client to achieve target results and to help your short-term cash flow, ask for a partial up-front, good faith payment against the ultimate fee, and suggest progress payments if the project stays on course. Avoid waiting until the end of the project to receive your fee.

To reduce risk further, ask for an escape clause that kicks in if unforeseen external events make achieving the project results impossible.

Include in that escape clause a provision that you will be paid some portion of your fee for work you perform to the point when the unforeseen events occur.

Consider using contingency pricing in a limited way with trusted clients. If you are sure you can deliver the projected benefits to the client and are willing to take a set percentage of the benefits as your fee, contingency pricing might be your best bet.

A variation on contingency pricing is to tie fees to an all-out guarantee: The consultant does not get paid if the client does not deem the project a success. As clients have become more skeptical of the value that consultants provide, they want to base payment on the success achieved. The sentiment seems to be that if consultants are as good as they claim, they should be willing to put their fees on the line.

Under some formulas, only part of a consultant's fees is tied to success, and the rest is paid through a more standard pricing method. Another possibility is that consultants can agree to allow clients to hold back partial fees. For example, if a project calls for $500,000 in fees, the consultant might bill the client for $450,000 and let the client decide whether to pay the final $50,000.

Some clients want to fund projects from the eventual project benefits. Consultants have been known to bankroll projects provided the clients pay the deferred fees later when increased revenue or savings are realized from projects. Such "self-funding" projects allow clients to hire consultants without increasing their budgets.

Clients appreciate the flexibility of consultants who are willing to put their fees at risk, and that may help you win more projects. But to offset the added risk in such contracts, consultants should always ask for bonuses that are to be paid if they exceed expectations.

Contingency pricing is currently used on a limited number of consulting engagements. As clients become more sophisticated in the pricing of consulting services, that percentage may increase.

â–º Value-Based Pricing: The Consultant's Dream

Value-based billing is getting press these days because it represents a path away from the hourly rate model that is so prevalent in the consulting industry. In a value-based fee arrangement, the consultant's fees are tied to the value the project generates.

You share in the benefits but, unlike contingent price arrangements, your fees are not limited to a one-time percentage of the results.

For example, if you were to undertake a project to reduce annual corporate overhead expenses, you could be paid a part of those savings, regardless of how large they might become. So, if you negotiated a 15-to-1 value ratio and the client saved $1,500,000 in corporate overhead, your fee would be $100,000. If those savings reached, say $6,000,000, your fee would be $400,000.

Though clients haven't fully embraced the concept, value-based pricing can provide substantially higher fees for consultants because the higher the value received, the higher the fee. If the project to reduce corporate overhead was priced using either an hourly billing rate or a fixed fee, the consultant's fee would likely be substantially lower than when calculated on a value-based billing strategy.

Pegging fees to value helps clients to see consultants' fees in the context of the benefits they receive from their projects. When the consultants' fees are placed in the larger context of value, larger fees seem more reasonable.

Value-based pricing has been slow to gain acceptance in the consulting business because of difficulties in agreeing on estimates of value and finding methods to measure it. Clients are also unsure how much value they are willing to share with consultants. Some clients feel that the effort required for an equitable value-based pricing program is not worth it, especially since legions of consultants are willing to provide easier to manage, fee-for-service pricing.

How to Use Value-Based Pricing

The rewards for consultants using the value-based approach can be substantial, but the financial risks can also be great. Many events can conspire to create an unhappy ending, ranging from executive turnover to unforeseen business or economic conditions. They can affect the value of a project, and as a result, the consultant's fee.

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