The Role Of Fees In Practice Development

Are you a consultant?  How do you develop your “Price”?

A `fee’ is the price that the client pays for the service and yet the word `price’ is rarely used by service practitioners. One does not ordinarily speak of the price of a semester of education, the price of a loan, or the price of a visit to the dentist. Some 15 different ways can be identified of describing `price’ in the service sector of the economy.  To some extent the nomenclature used for price give an insight into a profession’s own conception of its services while in other circumstances it is no more than a cosmetic embellishment to hide the reality of what in the final analysis is a commercial transaction.

The strategy of establishing soundly based charges for professional services is no more than the projection and direction of all issues within a practice in order to maximise profits, or achieve whatever other objectives are stated in the plan. It requires a realistic attitude to fees by those who are to establish them and this attitude must derive both from practice objectives and the personal aspirations of those who share directly in the success of the practise and those who hope to.

The adoption of pricing strategies in services, requires a lot of skill and knowledge.

Before considering just what a consulting practice can do to improve its performance through increasing the demand for its services and by obtaining a higher level of profitability or its concomitant, higher billable time utilisation, one fact must be made abundantly clear. There should be no confusion between fee or price strategies and price cutting: they are not the same thing. Indeed a fee strategy may demand exactly the opposite to reductions – that is increases. In every type of transaction and not just professional and other consulting services, it is better for competition not to be based on fees. This can be, and usually is, destructive to the organisation and may well be harmful to the purchaser of the service. But to say that fee reductions as a competitive response are usually destructive is not implying that they should not be flexible. The use of carefully designed and sensitively implemented fee strategies, designed for specific objectives and profit maximisation, is an effective and indeed creative method of competing both within and external to a profession.

Costing

If the use of pricing/fee strategies in professional and consulting services is virtually non-existent, it is in part due to the inadequacies of most costing methods for services which still operate on a ‘faith, hope and 100 per cent’ basis. The vagaries of costing the output  activities have caused many to adopt empirical and ad hoc approaches.

One result is that while professional service organisations can usually determine the profitability of the practise as a whole, they cannot often calculate the profit or loss contribution of individual assignments, clients, individual professionals or even services. This, in turn, means that the development of a fee strategy is virtually useless because the components which lead to the subject for the strategy cannot be accurately identified.

Service organisations’ managements cannot be in full control of their operations unless they do develop a reliable system of ‘service’ or project cost accounting. Accountants and management consultants throw up their hands in horror when they find that their clients do not know with any exactitude the cost of the Products (the term includes both goods and services BTW) they are selling. Nevertheless, these and other consulting service providers have often either neglected or ignored this problem in relation to themselves, relying on the total profitability of their operations to ensure continuing activity.

This situation is as inefficient as it is unnecessary, since a service organisation can and should be able to identify costs. The reasons for the neglect are numerous and require study as a first step to rectifying the position.

Service organisations continue to use traditional goods (tangibles) cost techniques which are inappropriate when it is appreciated that ‘Product’ of the service organisation is usually difficult both to describe and measure; costs are primarily ‘people’ costs which will typically account for 70 to 80 per cent of total operating costs and perhaps 50 to 70 per cent of gross income; other costs are people related (e.g., occupation, travel, telecommunications); the output of personnel is both difficult to measure and highly variable in amount and quality and not just from day-to-day but from hour to hour and because the client participates in production the professional’s output may be inhibited or extended by the quality of the client contact.

In relation to practice development a far more relevant approach is one which first divides costs between chosen activities designed to increase awareness of the organisation and its services and to create favourable images. The second types are those incurred in presentations and negotiations with individual clients. These costs can be evaluated at three levels:

  • Upper cost – income sacrificed by the professional with a full work load plus expenses caused by the practise development activities.
  • Lower cost – for professional staff not otherwise fully occupied in their discipline. Only expenses are incremental items.
  • Middle cost – principally the professional’s staff remuneration plus expenses.

The upper and lower costs seem to be relevant alternatives in the short-term and the middle cost in the long-term. In the short-term the evaluation of the cost is a function of the work-load during a certain period. In the long-term it is a matter of estimating the necessary marketing resources required to maintain the professional organisation at a certain size. The service organisation can have a high or a low workload. But the work-load can also be evenly or unevenly distributed on individuals. It can also be dispersed or concentrated in time. The volume of proposals can be low or high, the number of prospects can also be low or high.

In every individual case there may be present instead of the extreme of high or low, a particular level of operation, somewhere in between. Moreover, in any particular defined period of time, a particular and individual mix may provide optimum operating conditions.

In a situation where all the factors go in a positive direction it is reasonable in the short run to use the upper cost. In a negative situation the opportunity cost is zero. In the short run the lower cost should therefore be used. If positive factors keep prevailing it is possible for the professional organisation to expand, if the negative ones prevail, it must contract. In a mom balanced situation, the middle cost is reasonable, it is to keep a certain volume of work.’

The significance of these factors within the context of fee strategy is simply that no fee can be set or adjusted with any certainty of it successfully achieving whatever the objective may be unless the cost of the inputs to the service itself is known. The development of a fee strategy which has any real meaning is out of the question without basic knowledge of the nature of the organisation’s costs.

Considerations in establishing a satisfactory and acceptable fee structure

The moment the service organisation or practitioner looks at the techniques which enable it to devise and operate a fee strategy, it finds itself faced with a dichotomy. These are the approaches offered by theorists engaged in developing a simplified model that helps to understand complicated reality and the approaches of marketing specialists discussing pricing on a descriptive level explaining what businessmen do, or say they do. Neither procedure is satisfactory. Any model is limited in use by psychological aspects–that is the psychology of service provider as well as the client. Either concepts or techniques alone are insufficient and probably misleading. A combination and balance is needed, but difficult to achieve. This situation should be recognised in considering the strategies suggested.

Fortunately commentators on pricing and fees have been more sensitive to the needs of service businesses than in many other marketing activities, so that the service provider does not find himself having to translate from the standard concept that “Services Are Different”. That is, from tangible product (goods) to intangible service.

Developing fee strategies is an exercise which must be undertaken in two dimensions. First, it is necessary to think in terms of establishing the right fee and, second, of using the correct methodology to arrive at it. The latter is perhaps an even more crucial exercise in a service business than in most other enterprises. Correct fee levels for consulting  organisations are perhaps more important than for goods oriented organisations because of the economic structure of the service business. Employing as they do relatively little capital implies that pricing and time utilisation are the primary elements of leverage in achieving profitability.

Consulting services despite, or perhaps because of, the knowledge gap between practitioner and client are in many instances far more `value sensitive’. Fees, over an extremely wide range of services, are rarely the critical factor in deciding to appoint an organisation or sole practitioner.

Six basic methods for arriving at fees:’

Cost-based fees

A conventional method of arriving at fees by summating the chargeable cost. The fee is arrived at for various levels of activity and time utilisation which will yield the desired profit. Cost-based fees, although very commonly used, do have the disadvantage that cost does not necessarily lead to an effective and acceptable fee. Basing a fee on costs plus a desired profit takes no account of competition nor demand. The fee can impact heavily on itself since it can attract or inhibit demand at a level which affects costs.

Competitive salary-based fees

A variation of the cost – pricing system based on the average or competitive salary levels for the consultants involved and charged for the time utilised. This method means that fees are determined by the major cost centre which for the organisation is personnel, not materials, machinery or stocks.

Contingency payment

This is essentially the service equivalent of piecework rates in manufacturing or commission for salesmen. The fee for services performed is contingent upon a certain act being performed or by accomplishment. This is a method used by estate agents, some contract R & D, application engineering and operational research consultancy and in some counties by lawyers undertaking litigation work. A variation of contingency pay pricing is the ad valorem method of calculating fees – that is based on values involved in the service. The contingency and ad valorem is only a description of a method and does not describe just how the actual fee or percentage is calculated, which may be arrived at by the other methods listed.

Fixed fees

This is a uniformity within a profession achieved by a controlling or strongly influencing body. This body might be the government (fees payable to both its own professional advisers and those funded by the government such as legal aid), professional associations, insurance organisations (medical fee rates). Fees may and frequently are fixed informally as in some types of consultancy fixed fees which are the results of a fee decision not a method of reaching one and whatever the level fixed it may well have been set by one of the other techniques described.

Contract fees

This is a method of arriving at a fee by negotiation with a single organisation; for example, rebates for insurance services such as reimbursable provisions on contracts covering group insurance. This method of fee setting is also common in some branches of management and engineering consultancy.

Value-based fees

Or what the market will bear. Other methods are only rough guides to value. Value pricing assumes that buyers will respond to fees in accordance with the value they place on the service. The problem being that a new client may have very limited appreciation of the “value” (even to them) of the service.  This is very common.

Psychological factors

The deficiency of all the methods other than value-based fees is that the mechanistic approach ignores what is perhaps the most pervasive factor in client decisions relative to fees, that is their perception of the expectation being purchased. It is impossible to discuss fees without considering the psychology of the client. The price [fee] setter should therefore never forget that especially in the absence of previous experience, the potential customer [client] will frequently decide in favour of the more expensive quotation … [and will] seldom accept a low price [fee] as a valid excuse for shoddy work: Given little or no knowledge of the service, the organisation or practitioner, the difficulty of competitive comparability, the client will use the fee level as a guide to expected quality and efficiency, however inadequate such an indicator may be. As with any products, services perceived as under-priced are viewed with suspicion and the client will seek the safety of the middle to top range.

Clients for all professional services tend to have psychological blockages on many aspects of the service-fee relationship. While, for example, they are reasonably happy to pay for collateral evidence in the form of documentation there is a resentment of charges for ‘advice’ in the form of telephone conversations. Consequently the wording of invoices takes on a considerable importance in making fees acceptable and thus in client retention and in stimulating referrals. The essential requirement is to notify the client on the invoice of everything that has been done.

Did you find this article useful?  Please let us know

These are outline notes from a MAANZ course.  If you are interested in obtaining the full set of notes (and a PowerPoint presentation) please contact us – info@marketing.org.au

Also check out other articles on http://smartamarketing2.wordpress.com

MAANZ International website http://www.marketing.org.au

Smartamarketing Slideshare (http://www.slideshare.net/bmonger)


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