Some consultants always charge a flat hourly rate or per-project rate, with no room for negotiation. Others are so loose in their rates that no one, including the consultant, knows what the final price tag will be.

In my experience, I’ve found that different projects call for different pricing schemes. But how do you know whether you’re offering the right one?

In two earlier columns, I discussed some of the pricing scenarios consultants can use. Here, I’ll explain the rest of the pricing structures, then wrap up with a discussion about fitting the price structure to the project.
The topic of pricing schemes was just too big for me to tackle in one column. To get the whole picture, read my first installment—which covered time and materials pricing as well as retainer pricing—and second column, where I explored fixed pricing.
Not-to-exceed pricing
Although they are often viewed as two different pricing plans, not-to-exceed is actually another form of fixed pricing. Too often, consultants will engage in not-to-exceed pricing informally, as it’s sometimes viewed as a mix between time-and-materials and a fixed bid. In order to get the business, I’ve seen consultants say things like, “I can’t see this going over X dollars,” only to have the client turn around and try to enforce that ceiling contractually. Not-to-exceed is actually more dangerous for the consultant than fixed pricing—it protects the client on the upside, but gives you no premium for that ”insurance” if you come in below the bid. At Cap Gemini, a global management and IT consulting company where I worked as a principal consultant, fixed prices could be used under a strict set of guidelines, but not-to-exceed prices were forbidden for that reason.

Phased pricing
Phased pricing is my preferred method of pricing. In this structure, we bid on the phase of the project that is currently at hand, and agree to bid on each successive phase as it becomes more visible. Sophisticated clients understand that, without doing the analysis and due diligence, it’s just not possible to estimate fairly what it will take to deliver the complete project. Likewise, it’s difficult to estimate the implementation cost without having done the design. Consultants who follow a structured project methodology are at a distinct advantage when trying to sell the client on this approach. We can walk the client through our process—from conception, through data gathering, to design and implementation, and through system operations—and help them understand the difficulties of committing to an effort level prematurely.

The phased pricing approach also gives qualified consultants an opportunity to differentiate themselves from those “ad hoc” consultants who just make it up as they go along. Although some clients feel exposed by this type of pricing, I find that a comparison to an architect building a building or a doctor making a diagnosis often clarifies the issue for them. Everyone instinctively understands that an architect can’t tell you the price before you decide whether you’re building out of mud or marble.

Performance-based pricing
Many clients now want to build in incentives for consultants to overachieve against their budgets or schedules. Some, taking a page from the outsourcer’s book, also want to impose penalties on consultants who fail to deliver against their commitments. By fixing rewards to specific elements of the deliverable, such as timeliness or quality, clients can certainly get our attention. Many consulting practices get great results with this method, as it helps prioritize the customer’s critical success factors, and can generate substantial additional revenue for consultants who bring added efficiency to their projects.

In my practice, I stay away from performance-based pricing scenarios for a couple of reasons. First, I want my clients to believe that I’m always focused on delivering the highest quality, fairest, and most timely result I can deliver, and I fear that reward schemes can give clients the idea that I need to be “bribed” to deliver at my peak. Because IT projects are so sensitive to politics, changes in technology, and other vagaries, I’m also very reluctant to accept a project with performance penalties. I short-circuit this approach with a simple policy: I guarantee all my work. If a client doesn’t believe he or she received value from my participation, he or she doesn’t pay. I’m not recommending this for all consultants, but I find it clarifies my practice in many ways. It helps me focus on projects that have a high likelihood of success, and forces me to do the unpleasant work of surfacing issues that could potentially damage the project.

Equity pricing
In my work with entrepreneurs and Internet start-ups, I’m often asked if I would be willing to take equity in lieu of cash for my efforts. In my recent interview with Chuck Krutsinger, COO of Interlink Group, Inc.—a Denver-based application development and Internet infrastructure consultancy—I asked Chuck his opinion on this concept, and I think his response says it all.

“Taking equity in lieu of fees is like buying into that company,” Krutsinger said, “and you’d want to do a lot of due diligence before you did that. More than anything, it would just complicate the process. It could become an impediment to sales, to check to see if the equity is worth what we think it’s worth. We’ll probably see some that are no-brainers, but those are the companies that would be less likely to give equity away.”

Unless you are experienced as an investor or as an analyst of a start-up’s prospects, taking equity is a risky proposition. If you decide that the potential upside is worth the risk, I’d recommend a split structure that allows you to see some cash while you’re delivering services and still gives you an opportunity to participate if your client’s business takes off. It often sends a good message to the client that you’re “in the boat with them” when you take on a bit of risk by taking some payment as equity. Equally important, however, is that the start-up believes in its own future enough to dole out some cash for your valuable services. In the gold-rush mentality that’s surrounded the Internet, many start-ups would be glad to tap your knowledge and expertise for free, with a slim-to-none chance of you ever seeing a dime for the equity you accept. In this Internet economy, where there’s no business without information technology, your contribution is a critical element to the start-up’s success, and legitimate entrepreneurs should be prepared to compensate you appropriately for your contribution.

Fitting the price to the project
So, after all this discussion, how does a consultant decide which pricing structure fits which deal? My rules of thumb follow.

  • Time and materials: Good for most types of projects. Be careful to build in the customer assurance factors such as regular progress meetings and budget updates so the client feels in control of his or her spending.
  • Retainer: Best for maintenance, support, or ongoing administration deals. Too sporadic for concentrated project work. Beware of becoming a “garbage man”—make sure the tasks you will and won’t perform under a retainer are clearly delineated.
  • Fixed price: Safe only when you understand the client, their corporate culture, and their technical environment. Also requires skill in creating detailed task plans, in estimating, and in assessing risk levels. Try to steer clients toward phased pricing instead.
  • “Not-to-exceed” price: Most dangerous pricing of all, as it shifts the majority of risk to the consultant with no upside payoff.
  • Phased pricing: Best overall solution. Requires that consultants use a structured delivery methodology, and that they educate the client in the difficulty of premature commitments.
  • Performance-based pricing: In engagements in which the client is willing to pay a premium for extra focus, effort, resources, or quality assurance, this can be a lucrative bonus for consultants. Beware of penalty clauses except in the most familiar and controlled environments.
  • Equity pricing: Risky unless you’re experienced at assessing the prospects of a venture. Can be good for relationships as it projects the willingness to take a risk for a stake in the client’s future. Best to split fees between some cash and a token slice of equity.

The emphasis on pricing in this piece leads me to reiterate the most important message a consultant can communicate to his clients: the value he brings to the table. In every marketplace—from books to shoes to IT services—the pendulum is swinging from a focus on price to the concept of total cost of ownership and customer value. The most critical skill a consultant can have when attempting to develop a relationship with a client is not a grasp of different pricing schemes, it’s the ability to articulate, and then to deliver, on the extraordinary business value of information technology.

Rick Freedman is the author of The IT Consultant: A Commonsense Framework for Managing the Client Relationship and the upcoming The Internet Consultant, both by Jossey Bass. He is the founder of Consulting Strategies, Inc., a training firm that advises and mentors IT professional services firms in fundamental IT project management and consulting skills.

After reading Rick Freedman’s take on the various pricing scenarios, have you changed your mind about how you’ll set your own in the future? Which works best for you? To share your opinion, post a comment below or send us a note.