It happens thousands of times a year…rate x time. A billing manager reviews project hours, applies a rate card and generates a client invoice…rate x time = fees. Pursuit teams push for higher hourly rates and increased leverage, while clients compare rate cards and proposed hours to market competition. Many project pricing discussions focus more on project inputs than the outcomes expected by the client, and proposed pricing structures are often similar across providers (rate x time, rate x time, etc.). Within this pricing context, using alternatives to traditional time-and-materials pricing may better align economic incentives, clarify engagement value and allow more creativity in the way clients are served. Considering alternative financial arrangements such as quality holdbacks, timeline incentives or value-based pricing should be standard practice when setting project price.
Traditional Price Structures
Traditional time-and-materials pricing can work effectively if proper oversight is in place, and it may be the best option for projects when the future level of effort is unclear, scope is subject to drastic change and cost markups are reasonable. It may also be the only option in a marketplace limited to a small number of powerful sellers or where a client desires a loaned staff arrangement. However, traditional pricing structures have inherent economic conflicts. Sellers want increasingly more time and more materials at an increased markup. Buyers typically have overall budget and timeline constraints, and client management increasingly wants value-for-money that cannot be demonstrated through hourly fees.
Alternative Price Structures
In contrast to traditional price structures, the following pricing components may be utilized to develop a more creative and aligned pricing package:
Simple Fixed Fee: Price is established for the entire project based on a package of services or deliverables.
Deliverable-Based Fee: Prices are set for key project deliverables or specific work products. Client payments are based on the successful delivery of each agreed item.
Quality Holdbacks: Quality checkpoints are built into the payment structure. Additional fees are earned based on client satisfaction or other agreed criteria.
Timeline Incentives: Payments are linked to key milestones in the project calendar in order to emphasize project speed or critical deadlines.
Value-Based Pricing: Payments are calculated as a percentage of specific value delivered such as cost savings, working capital improvements or other value-based targets.
“In this business with me, I do not buy a service. I buy a result.” –Arcángel de Jesús Montoya
In addition to competitive market position and revenue/margin targets, risk and value should be specifically considered when evaluating potential price structures. Key risk considerations may include: How predictable is the work and associated fees? What is the potential upside and downside? Who benefits? Who is penalized? How will scope changes be accommodated? What level of flexibility is needed? Key value considerations may include: Why is this project happening? What is the overall project objective? How closely are activities tied to outputs and outcomes? How does the client prioritize cost, quality or time? What specific role does each provider fill?
Alternative Pricing Pros
- Desired outcomes are clarified up-front
- Fees are more rigorously tied to value provided
- Upside can be built into fee structure potentially leading to premium rates
- Pricing structure can be more flexible and often more differentiating
- Client and provider economic incentives are more closely aligned and may lead to closer collaboration
Alternative Pricing Cons
- Pricing structure may incentivize certain behavior to the detriment of others (e.g., focus on speed might hinder quality, or vice versa)
Actual fees may be difficult to forecast and subject to variations
- Upside may indicate monetary incentive rather than client’s best interest
Increased level of risk assumed for slippage and/or rework
A push to move beyond traditional time-and-materials project pricing is well overdue. In addition to conflicting economic incentives of buyers and sellers, the use of hourly fees provides little visibility into value and demonstrates a general lack of project understanding. In contrast, alternative pricing models can better clarify desired outcomes, accelerate tactical decisions and align economic incentives. Think beyond rate x time.