Editor’s note: This article comes from Tom Watkins, a decision support analyst who responded to a recent IT Consultant article on accurately pricing intellectual property.
When consultants reach the end of the analytical processes they use to calculate how much they should charge clients for their work, they have to take intangible “fudge factors” into account. I consider five common issues when valuing my intellectual property (IP):
- What the market will bear
- The client’s level of desperation
- The number of alternative solutions
- The client's budget
- The possibility of reselling the IP
Let’s take a look at two crucial factors: the client’s budget and the possibility of reselling your work.
Second of two parts
This is the second installment in a two-part series that covers the variables that this consultant considers when pricing his services. The first half of this series discussed how market pressures, the client’s need for the solution, and the client’s alternatives have a hand in what consultants charge.
The client’s budget
If you recognize that a client’s budget for a project is fixed and they tell you, “That’s all we have,” you must size the scope of effort to fit the available funds. But if you think the client believes that a solution can be had for a predetermined amount, you have a different challenge. You must justify your higher bid to the client, and if you can convince the client that their budget isn’t reasonable, then you can raise it.
While there are many methods for this justification process, and you must carefully select which technique to use on a case-by-case basis, I have most often used a “risk analysis” approach.
I present an objective, mathematical analysis of the parameters of the project. Then, using a standard project management risk analysis of schedule, cost, and task integration, I try to create a convincing argument that there’s a cost savings to an increased level of effort. What client will persist if you tell him that his planned project has a 93 percent chance of failure while your proposed changes—at a slightly higher cost—will reduce the risk to only 37 percent?
Another approach is to let the clients decide that their own numbers are bad. In your discussions with the client, get them to estimate the risk they think there is to successive parts of the project.
Suppose you have a scenario involving just seven such assumptions, each of which has a 90 percent chance of being successful. The overall odds would actually be somewhat less than 50-50 (.9x.9x.9x.9x.9x.9x.9=47.8%).
When I have a very stubborn client who insists on his budget, I attack his thinking in deriving that estimate. Using some classic human decision and logic failings, I can sometimes point out the flaw in the client’s thinking. Here are a few methods I use:
Availability is a mental shortcut that occurs when people judge the cost, effort, or likelihood of some event or happening by how easily they can recall other examples of the same or similar things. The error is in what they think is “similar.” A DBMS program in Access is not the same as a DBMS application in Oracle SQL.
Representativeness is a mental problem-solving method that is a sort of shortcut the mind takes in dealing with complex real-world problems by assessing the evidence intuitively and comparing it to some mental model. This is similar to availability except that the recalled example is internally created, not a real-life example. The error can be in what and how they create that internal mental model of “what should be.”
- Risk aversion
The notion that people are "risk averse," as decision theorists put it, has become a part of many economic models. People tend to avoid risks when seeking gains but choose risks to avoid losses. People need a strong inducement to gamble but they will expose themselves to tremendous risks to avoid a loss. You can use this in your justifications to show that, for an added investment, the client can avoid the loss created by doing the project poorly. It’s up to you to point out the potential risks of not doing it right the first time.
- Prospect theory
The prospect theory—“losses loom larger than gains”—counters the risk aversion approach. The prospect of the gain isn't worth the pain of the loss. A loss seems less painful when it is an increment to a larger loss than when it is considered alone, and that is the key to using the prospect theory to advantage.
Framing is the principle that if a problem is framed, or presented in a different manner, the response will be different, even if the problem hasn’t changed. In general, the frame that takes the broader view of a situation is more easily defended. If you’re given a low budget, you can put it into the context of the entire corporate investment and ROI of the project. For example, I had a client that wanted me to set up a new financial management system for them because they had outgrown QuickBooks. Because QuickBooks cost about $450, they really growled when I suggested a package for $7,500. Their frame was QuickBooks, and my price was 16 times more than their last financial package. My frame was their $10-million-per-year business. I showed them that their new package was .00075 times the cost of their annual financial management responsibilities. They did it my way.
The nirvana of consulting: Opportunity for subsequent resale
Finally, there is the issue of the opportunity for subsequent resale of IP. I often try to find a situation in which I can get a client to pay for the development of a product that I can later resell to other clients. This is perhaps the nirvana of consulting: Get paid to create a product and then resell the product at virtually 100 percent profit to other buyers.
I frequently work for the federal government. I bid only my costs—no profit—to win the contract. I negotiate the proper IP rights and then do the work. At the end of the contract, I leave a happy client that got what it wanted at the lowest price on the market and I walk away with a fully developed product or service that I can sell many times over to other clients. I have virtually no sunk costs in the IP but usually have buyers for the IP lined up before the end of the first contract.
I have one such contract right now with a federal agency. I bid 25 percent lower than my nearest competitor and won. I negotiated the proper rights to the Web-based application software I’m creating for them. When I’m finished, I’ll be able to sell the use of the product to other federal and state government agencies.
I’m doing lots of add-on, out-of-scope work that I would normally not do, and will probably not make any money on this contract. However, I have already lined up another agency that will pay me to use the product. In that second contract, I will have no sunk costs and no development time other than some simple logo changes. I’ll be selling a service and not consulting labor, so my profit will be nearly 100 percent of the bid price.
My current client gets what it wanted at less than it would have otherwise paid, and the next client gets the same service but pays only for access and use, not for design, development, and testing. I don’t lose anything on the first deal and make profit on every similar contract thereafter.
It’s all subjective
To ensure that all these factors are considered in the costing of my IP and contract pricing, I use what I call a bid qualification form that includes subjective comparative quantifications and objective numeric gains, losses, and risks in a complex formula that also considers my risk tolerance. The overall objective is to maximize profits while minimizing risks. The balance between these two is almost never level, but you want to use everything you can to obtain the greatest gain for all concerned.
Raising the client’s budget
When potential clients have a preconceived notion of what a solution should cost, what methods do you use to change their minds? Send us an e-mail or discuss your strategies below.
The author, Tom Watkins, is the CEO of Management Technology Consulting Council, Inc.