Management Consulting Essentials: Pricing

This is the 8th post in a series of posts addressing the issue that too many independent management consultants are working too many hours for too little pay.

It is my objective to inspire as many independent management consultants as possible to exercise their profession and approach their clients in a different way.

See the end of this post for a summary.

Pricing

This series of posts has the title “increase your prices.” However, the pricing itself is just a single element in securing a high price for what you do.

There are two major parameters, which determine how much you can ask for a certain assignment:

1. The perceived value of the outcome for the client
2. The perceived substitution opportunities for the client

The value of the outcome

The amount a client is willing to invest in consulting is proportional with the perceived value of the solution. The value can be either minimizing risk associated with a new venture, avoiding costly consequences of certain activities, revenue opportunities from new initiatives and so on. All projects are initiated for a reason, but not all projects have clear and measurable objectives.

This issue is covered by post #6: The objectives

The substitution opportunities

The price a client is prepared to pay for consulting is depending on the perceived substitution alternatives available. If the project can be delivered by many other consultants, with whom the client has good experience, there will be a competitive pressure on your prices.

This issue is covered by post #1: Brand values & positioning

Pricing formats

You basically have two formats available as an independent management consultant:

1. The fixed price format
2. Time & material

Both formats can be combined with a performance element when this makes sense. I will deal separately with this issue after describing the two main formats.

The fixed price format

The fixed price format is preferred by many customers especially when engaging with a new consultant. It makes many clients comfortable when they know the price of the project and that they have budget coverage.

As an independent management consultant you use the fixed price format when you fully control the risk associated with the project. When the project prerequisites and the outcome can be defined very precisely and the effort required to complete the project is well within your control, then you can often set a price which is acceptable to the client and at the same time provides a very satisfactory remuneration for you.

Packaged services such a executive search, market research, strategy analysis, customer satisfaction surveys, reseller search and so on are predominantly delivered on a fixed priced basis.

Your average hourly pay on fixed price projects will normally exceed what you can ask on a time & material basis.

There are apparently independent management consultants who accept a fixed price format for projects where they cannot control the risk. Such situations are normally characterized by vaguely defined projects assumptions and unclear project objectives. This leads to very unfortunate situations where the consultant has to deliver many more hours than estimated or anticipated. Such hours cannot be delivered to other clients at a more acceptable price. The consultant risks being dragged into a vicious circle.

The best way to avoid high risk fixed price projects is to break them down into smaller sub projects. The first sub projects should be devoted to defining the project assumptions and project objectives more precisely. After setting the objectives and defining the project premises it will be more obvious and measurable what the next steps should be.

The time box

There are situations where a fixed price is required, but the project by nature is open-ended. In such situations a “time box” can be a solution. A time box is a fixed amount of hours, days, weeks or months. If the project has not been completed within the time box, the client and the consultant can negotiate how to continue the project.

The time box gives the client a fixed price, but leaves the outcome open.

Time & Material (T&M)

Most clients know that consultants charge more for fixed price projects than they can charge on a T&M basis. Clients therefore often ask their trusted advisors to deliver on a T&M basis.

There is a limit to how much you can charge as an independent consultant on a T&M basis. The CEO will typically divide his own salary package with 1.600 and it will be difficult for you to charge more than that. This is one of the reasons why small companies seldom can engage good consultants. Larger companies are prepared to pay higher consulting fees simply because their executives are used to higher fees themselves.

It is almost impossible for the independent management consultant to make a premium on the T&M format. However, there are obviously projects where no other format is applicable. Projects of an exploratory nature or ongoing process facilitation can basically only be delivered on a T&M basis.

T&M is never the preferred format for the independent management consultant.

Performance based pricing

There are obviously many potential clients who will try to push the risk associated with a project to the consultant. This is acceptable when you do consulting in areas where you have a better chance of managing the risk than the client has.

Let’s give a few examples.

Let’s assume that you work with reducing the expenses associated with certain operational activities. Your business model is to do an audit first. If you can identify a savings potential of amount Y, you are entitled to charge the client x% of Y for the audit. Your risk is minimal as you are doing this all the time and you know how to deal with all the “loose ends” of such an assignment.  You may even have a set of services for taking the savings home that the client also can pay for on a performance basis. Such a business model can be highly profitable for an independent management consultant.

IPO and M&A projects always have a retainer and a performance element. In this situation the client will be highly motivated to ensure the consultant gets the best terms and conditions possible. The performance element is not introduced to minimize the risk, but to maximize the outcome. A performance bonus is obviously also easier to award when it is being paid with someone else’s money, which is the case in the IPO/M&A situation.

You should never accept a performance based format in situations where the risk is high and basically outside your control.

Let’s assume that a potential client wants you to help him break into a new market. He offers you a high percentage of the revenue, which will be generated by your own effort. You don’t know the client very well, and he is not prepared to pay you for the learning curve activities required for you to understand the Customer Value Proposition, the nature of the Value Chain and all the other basics concepts.

Such a project is a suicide mission, which you should always reject. See this blog post to get a more elaborate explanation of why this format simply doesn’t make sense: Commission Only?

As an independent management consultant you have very few “swings and roundabouts”. Would a company devote a substantial portion of their resources to something, which is extremely risky? Something that may leave the company with no revenue if the project failed? Start-ups have to, but mature companies would never do so. Will you?

Price and value

The perceived value of something is reflected in the price. If you are unable to get a reasonable price for your services there can only be three reasons:

1. The perceived value of your service is low and/or
2. The competitive pressure is high and/or
3. The potential client doesn’t have any money

In the first two instances you need to work on your Value Proposition. In the third instance you need to walk away.

Pro bono

Doing pro bono work is something we all do from time to time. We obviously do so for other reasons than making money.  Do not mistake pro bono work with engaging in high risk projects, which are to yield a high profit some day. Those are two different things. We do pro bono work to help someone in need.

Summary

I meet and talk with a lot of independent management consultants.  99% of them are extremely busy.  They are so busy that they have little time to learn new approaches, keep up with the development in their area(s) and develop their business. Most of them even complain that they are too busy. They also use their busyness as an “excuse” for not being responsive and not meeting deadlines.

When I ask why they are so busy the unison answer is: “client projects”. My response is: “Fantastic, you must be making tons of money?” Answer: “Silence.”

The silence continues when I ask them: “When will you increase your prices and with how much?”

This series of posts will address the “many hours/low price” issue, explain the causes and provide recommendations for how you can remedy the situation.  Applying the ideas should enable you to work less hours, make more money and have more fun at the same time.

Other posts in the series:

Post #1: Brand values and positioning
Post #2: Networking
Post #3: Pre-qualification
Post #4: The first meeting
Post #5: Self assessment 
Post #6: The objectives
Post #7: The deliverables
Post #8: Pricing
Post #9: The proposal
Post #10: Negotiating the price and the payment terms
Post #11: Client reference
Post #12: The delivery
Post #13: The Quest for certainty