The smart money series: 5 reasons why you should still have fixed-fee contracts

Work with care (LOC)A few weeks ago, we talked about the traps of fixed-fee contracts. In this post, let’s talk about why we should keep fixed fee contracts.

  1. Stable revenues. Fixe fee contracts are revenue the client has committed to providing you. Contrary to time and material contracts which can dry up with no notice, with fixed fee, the length of the project and the amount to bill is already spelled out.
  2. 2.       Predictable work. Fixe fee contracts – at least when they are scoped right – provide a detailed, precise description of the work to be done. This makes planning your workforce needs easier.
  3. Clients that trust you. From the client side, signing a fixed fee contract means they already know what the project will cost. They can allocate the budgets before the work starts. It creates a trusting relationship with the client, who wants nothing less than surprise fees in the project.
  4. Relationship builder. Doing a fixed fee project with a client creates a trusting relationship at first, and eventually can turn into bigger contracts or even a retainer-based contract. The fixed fee contract is a trial, a way for the client to get to know you, and vice versa.
  5. Practices good estimation skills. Because fixed fee is so final, doing those contracts helps getting better at estimating costs and profit margins.

What about you? What’s your take on fixed fee contracts?

The smart money series: 5 traps of fixed-fee contracts

mouse trapFixed fee contracts. We love and hate them at the same time. It’s not that they’re bad in themselves, rather they must be done right. When drafting a fixed fee contract with a client, here are 5 traps to avoid:

  1. The missing information. When doing a fixed fee arrangement, make sure to be as specific as possible on what is included in the contract, and what is not included. This can be the number of hours of work included, or the number of revisions allowed on a plan. Also, any extras should be specified along with the rate at which these will be billed. This helps settle disagreements.
  2. Is it finished yet? Be very careful how you define a work as completed. Is it after the required hours have been worked? Is it if the customer accepts the work? Is it based on specific requirements provided by the client? Being specific about when work is done helps curtail the “one more thing” problem with clients who always want more.
  3. Forgotten costs. When putting together the proposal for a fixed fee contract, it’s important to think about all your costs. That includes time spent by administrative personnel, or travel expenses, or even luncheon meetings. You should also think about technical support costs, and factor those in.
  4. What about after? The fixed fee contract should also include the cost of post-project support. Just like the cost of customer service is built-in the products we buy, so should we include it in our fixed fee contracts – unless we exclude it.
  5. How full is the glass? No one wants to think about problems we might have in a project. We all want to feel competent and able to complete our projects on time. However, when estimating a fixed fee contract, pessimism rules. Planning for the project to take longer builds leeway for us down the line.

What about you? What are the potential problems with fixed fee contracts?

Why keep a client that’s not profitable?

Pomerene Let’s look at product management for inspiration. Let’s say we are making widgets. If our cost for making the widgets is higher than the price we can sell them for, would it make sense to keep making the widgets? I think not!

Then why are we doing this in the consulting world?

We sometimes have clients who generate so much non-billable time that it eats up all the profit from the billable time we charge them. And yet, we keep those clients. Why? Could it be because we don’t know the client is costing us money?

We need to connect our costs to our clients. At the very least, we should record when we work for a client, even if it’s non-billable time. At the end of the year, we’ll be able to see if the billings for that client covered our costs, including that of non-billable time. If a client consumes a lot of non-billable technical support time, for example, then we can adjust the billable rate for that client for the coming year to compensate for the non-billable costs associated with a client.

Too often we only look at the billable work done for the client. This gives a biased outlook on the client’s profitability. If we include hidden costs such as non-billable work done for the client, then we paint a more accurate picture of that client’s contribution to the firm’s success.

The Small Business Profit Kit is Now Available!

Check for O'Toole - $22,500 (LOC)The new small business profit kit includes articles about business success and a simple method for determining billable rates for professional services businesses.

In this kit, we propose a cost-based approach along with simple sensitivity analysis tools that allow small professional services businesses to determine the fair price for their billable time. It is our hope that with our approach, professional services businesses improve their profitability and cost management.

Download the profit kit here

About Gut Feelings, And Why You Need Time & Billing Software

Learning how to determine latitude by using a sextant is Senta Osoling, student at Polytechnic High School, Los Angeles, Calif. Navigation classes are part of the school's program for training its students for specific contributions to the war effort (LOC

We had a client who signed on to us because he and his associate could not agree on what was most profitable in their business. While one thought one type of contract was most profitable, the other associate believed it was something else entirely.

The problem was: they were both basing their conclusions on their gut feelings, their instinct. And while instinct is indispensable in business, it may not be the best guide to assess business performance. Why? Because our gut feeling does not have a 360-dregree view of the business. It only has access to the data we pay attention to.

Sales Myopia

From the sales perspective, we’re focused on sales contracts. How much one client signs for over another. However, once the contract is being executed, it’s often out of our hands. Hence, we may not know that the client requires a lot of non-billable work, which drives profitability down faster than a mortgage crisis.

Project Manager Myopia

From a project management standpoint, we see how projects go: how fast we get approvals from the client, how well the project is scoped and how many (or how few) change requests we get. If the project budget and timeline are respected, then the project seems successful. However, if this client takes 90 days instead of 30 to pay invoices, and requires a lot of legwork to get contracts signed before the project can start, it may not be as profitable as it seems.

Administrator Myopia

From an administration standpoint, what makes a good client is accounts receivables. However, the speed at which a client pays does not necessarily mean profit. What is this client generates too much non-billable work? What is this client’s projects consistently go over-budget?

Our gut feeling doesn’t see straight

Because our personal perspective on the business is not as accurate as we would all like to believe, we need data. Cold, hard, heartless data.

Billable time: how much is your time worth?

Snorkeler at John Pennekamp Coral Reef State Park near Key Largo. At the Time of This Picture, Water Clarity Was Good, But Experienced Divers Say Clarity Is Far Less Than It Was 20 Years Ago Because of Dredging and Filling Operations by Land Developers.

Deciding how much to charge for our time is always a tricky thing: if we charge too much per hour, we will lose clients. If we charge too like per hour, we won’t make enough to cover our costs.

Too often, we choose how much to charge for our services based on industry standards, our previous job, or the competition. While those are worthy benchmarks to gage our pricing against, they may not be the best factors to use in building our rate sheet.

Here are a few questions worth answering before choosing a rate:

  1. How much revenue do you need? Work up your costs, such as office rent, administration expenses, wages, etc. Then, add your target profit before taxes. This should give you a good idea of the amount that must be billed in a year. Knowing your costs will also allow-you to compute your break-even rate – the rate at which you’re not losing money.
  2. How many billable hours can you and your team work? It’s naive to assume 100% of work time is billable time. Previous years can give a good idea of how many billable hours can be expected by a person and the organization as a whole.

Revenues

Once you know your revenue needs and your productivity, divide one by the other and we get our billable hourly rate. For example, let’s say we have the following costs:

  • A team of 10 employees that cost us 500 000$ per year in wages.
  • Office rent, equipment and administrative expenses cost us 60 000$ per year.
  • We aim for 15% before-tax profit, which amounts to 98 823 $

Our revenues should be at least 560 000$ per year (to break even), 658 823$ to make our target profit.

Now, let’s look at our productivity:

  • Out of our team of 10, we have 7 consultants who can produce billable time.
  • We estimate that our consultants should bill about 70% of their hours, which is 28 hours per week per consultant.
  • We estimate that each consultant will work about 48 weeks per year, leaving 4 weeks for vacation, holidays and other absences.

Our total productivity is

7 consultants
x 48 weeks
x 28 billable hours per week
= 9408 billable hours per year.

How much should we charge per billable hour?

To attain our profit goal, we need:
658 823$ / 9408 hours = 70.03 $ per hour

To break even, we need:
560 000$ / 9408 hours = 59.52 $ per hour

Can this work?

Once we’ve  made those calculations, the question remains: is this realistic?

  • Are those rates in line with your peers in the industry?
  • Are you more or less expensive than your competitors?
  • What happens if your team’s billable hours ratio is 60%?
  • What happens if your expenses go up? If one of your consultants leave the company mid-project?

Today’s economy has taught us the importance of hoping for the best while planning for the worst.

Hunting for project revenues: billable hours


While evaluating projects for the entinre department or the entire business, we can assess their importance regarding the business revenues. With a pie chart showing billable hours per project, we can see which projects make the most of our revenues.

From this information, we might want to ask ourselves if it’s ok that one project repesents 25% of our revenues? Would we want to depend on that project? Or even on a client that represents such a big chunk of revenues?

We can build the same type of chart do display billable hours per client, and see, just like projects, if we are repending too much on a single client for our revenue.

Of course, this has nothing to do with income, since there are nos costs involved here. We could build a chart showing project billings or client billings, which might give us better insight on the diversity of our business.

What do you think? Which metric do you use to asses your company’s health? Is it a billable hours ratio? Revenues? Profits? Percentage of profits?

It doesn’t matter which metric you choose. It should be easily available whenever you need it. Any manager in your business shuld be able to know, when they need to, iof their business unit or their department is meeting performance targets. Abak allows professional service businesses to know, in real time, the health of their projects.

Time Is The Product, Profit Is The Goal

Woman aircraft worker, Vega Aircraft Corporation, Burbank, Calif. Shown checking electrical assemblies (LOC)It seems in manufacturing, business managers are used to having metrics like product line profitability, expected revenue from sales, breakeven points, and the like. In professional services businesses, the same performance metrics can still be obtained, if we use time (and billable time) as our product, and resources as our product lines.

As we can see in the table below, the metrics really are the same; it’s just the name that changes.

Manufacturing Professional Services
Productivity
How much product was made.
Work in process
How many billable hours were worked.
Income by product line
How much profit was generated by sales of each product line.
Project/Client profitability
How much profit was generated by resources working on each project or for each client.
Budget control
How much spending is planned to produce each product line.
Budget control
How much work is expected to be done for each project.
Revenue by product line
How much revenue was brought in by sales of each product line.
Revenue by resource
How much revenue is generated by each person employed by the business.
Production line scheduling
Which product is planned for production, how much production time is available.
Resource utilization
Planned project assignments for each person employed by the business.

Project Cost & Profitability: Are You Turning A Profit?

Old Style Cash Register and Canned Goods in a Butcher Shop in New Ulm, Minnesota ..., 10/1974In the world of professional services, time is your product. There is no inventory, no production line, and no factory. It can be hard to know how well (or how poorly) you’re really doing.

  • Money might be coming in, but are your turning a profit?
  • Is Mr. Big Client really bringing in big profits?
  • Is Miss BigShot Employee really billing enough to be worth her salary?
  • Are you sticking to your budgets on project spending and billing?
  • How much can you expect to bill at the end of the month?
  • Does a big project really bring in more profit than a small one?

The only way to know the answer to these questions is metrics. Metrics are measurements that one can establish to assess their performance and progress.

It’s surprising how many businesses only know this metric globally, from the annual balance sheet. Projects should be profitable, and non-profitable projects should be identified as quickly as possible.

All expenses should be associated with a project. This includes resource costs (from time sheets, for example), expenses, vendor and contractor invoices, and overhead related to the project. When all costs are coded to the correct project, it’s easy to use invoices for the project and identify profitable projects.

Businesses should have a target profitability level per project and per client.

Project Revenue Expenses Profit (loss)
Project A 2500.00 2000.00 500.00
Project B 3500.00 2000.00 1500.00
Project C 4000.00 4000.00 0.00
Total 10 000.00 8000.00 2000.00

In the table above, we can see that even though Project C is bringing in more revenue. However, since only half of its time is billable, it is not turning a profit at this time. Project B, on the other side, is returning a higher profit, mainly because of its higher proportion of billable time.