How to determine the optimum fee and fee structure for your firm

Despite ultimately being in business to do business, “price” is often the hardest word for many professional services businesses. We’re revisiting the subject because in the current commercial climate, not paying sufficient attention to your pricing can mean the difference between comfortable profitability and an uphill struggle. 

Clients are increasingly concerned about the risk of cost and time overruns. To mitigate this risk, many have taken the understandable step of giving accountability back to their service providers with two  blunt instruments: fixed fee structures, and shared risk contracts.

Between 2009 and 2014, according to Service Performance Insight, the percentage of work delivered under fixed-fee arrangements steadily increased by around 10% (33.5%-44%.)

But the 2023 Professional Services Maturity Benchmark reveals that almost half of all contracts are still priced on a time-and-materials basis. This places an even greater onus on firms to accurately manage resources, time tracking, and reporting, rather than simply on their ability to estimate their resource expenditures under fixed fee agreements. Project overruns aren’t just bad for your clients – they’re bad for you too, as they negatively impact both your NPS and the likelihood your client will consent to be used as a reference.

There’s no “right” or “wrong” way to structure your fee agreements. But your chosen approach will require slightly different tactical and strategic approaches to guarantee success and optimize profitability.

Let’s take a look at the 4 main fee structuring models and what you need to do to make them work for you:

The fixed fee agreement

This one’s the simplest on the face of it, and the easiest to explain. Every project or project bundle you undertake for a client is charged at a fixed rate, hopefully with resource commitments, expectations, failure standards, and project planning requirements carefully scoped in advance.

Because fixed fee or fixed time agreements are set well in advance of either payment or project delivery, they depend heavily on the capacity to accurately estimate resource needs in order to ensure profitability. They’re also dependent on excellent project management, good communication, and, critically, on flexible processes and workflows – particularly when it comes to change control.

The major advantage of a fixed fee structure is that it gives both clients and your firm a clear idea of what both sides are getting out of the arrangement. Clients appreciate the simplicity of the fixed bid, but this ties into its biggest disadvantage: inaccurate scoping or inflexible workflows – which are the typical cause of cost overruns for PSOs – can quickly eat into margin. This means that most of the project’s downside is typically borne by your business. 

For this reason, a fixed fee schedule is best deployed for standardized projects with clear deliverables. They should be avoided for projects involving major uncertainties (new technology or services/deliverables, scarce resources, and new clients or geographies.)

Click to read Selling services with ERP – the view from 2023 (Gated)

Time and materials

Time and materials contracts are the most traditional fee arrangement in professional services, and for good reason. Clients buy the time of your fee earners on a pay-as-you-go basis, and cover the cost of any expenses incurred by their work.

The major advantage for this arrangement (from your perspective) is that the client absorbs a great deal of the risk associated with overruns and scope creep, and they also tend to be significantly more profitable. As SPI note in their 2023 report, " firms who primarily use time and materials pricing are significantly more profitable than those who favor fixed pricing." The major disadvantage lies in the fact that your clients will also be aware of this, and will generally expect you to be accountable for the accurate measure of billable time, resource usage, and costs incurred. 

Since accurate resource management, time tracking, and reporting have traditionally been significant headaches for professional services (they are taken to be an “administrative” process that gets in the way of work, rather than facilitating it), this can often pose problems if your systems are not set up to expedite these processes.

And, as with fixed fee arrangements, although you won’t bear the direct financial risk for overruns, without tight project management and resource allocation, mistakes in this area are likely to damage your client relationship much more significantly than those on other pricing schedules. (After all, every mistake costs your client money, even if they’re the reason behind the delay.)

Shared risk or performance-based models

The rarest of the 3 major pricing models (accounting for no more than 4% of all projects in 2022). The shared risk approach, as the name suggests, splits the risk and reward of a project between the client and the service provider. This means that both parties will generally be expected to contribute to the funding of a project in some way. This exposes you to a much higher degree of potential downside – you don’t only stand to lose resource and time if things go awry, but actual capital that you could allocate elsewhere. However, you’ll also get to share directly in the upside that your work generates for the client.

As the arrangement suggests, shared risk contracts are best deployed for projects which have a relatively high “setup cost” but a highly variable upside. To make them an effective source of profit for your business, you’ll have to be good at estimating the time to value for projects, accurately forecasting resource needs, managing projects effectively, and have flexible workflows and excellent change control. (In other words, you’ll need to be equally good at the things that make for successful fixed fee and time and materials contracts.)

Managed services and subscription pricing

In this model, less mature than its counterparts, your client pays a fixed fee on a retainer basis either monthly, quarterly, or annually with the expectation that a specific quantity or type of work will be delivered. 
Clients and PSOs alike are being drawn to this model because it creates much more predictable cost structures on the one hand and predictable recurring revenue streams on the other. However, it carries a significant risk for you as a provider because it requires you to be even more adept at packaging, pricing, and delivering on your contracts. 
In many ways, you can think of this approach as a compromise between traditional time-and-materials pricing and fixed fees. It carries a mixture of both the advantages (in terms of being more predictable and easy to understand) and risks (in terms of requiring laser-focus on profitability metrics, project scope, time, and resource utilization control to ensure you capture the value of your work.)

How can Unit4 help you optimize your pricing

Regardless of your approach, the suite of capabilities conferred by a good professional services automation (PSA) solution, particularly with configuration, pricing, and quoting functionality, are invaluable in tracking and responding to the KPIs we’ve highlighted above and critical to supporting accurate estimates and time and cost capturing for billing on non-fixed contracts. Linking your CRM to your ERP to provide additional insight into the nature, failure points, and projected success rates of your projects is also critical. To see how Unit4 ERP can support your organization, check out its dedicated product page here.

You can also explore SPI’s findings on the financial performance and strategies of organizations like yours in this interactive eBook.