Fee Structure Negotiations

For many of our clients, Vantage Partners provides coaching and advice for dealing with tough sales negotiation and customer interaction challenges as they arise. This article is part of an ongoing series of occasional advice columns to provide some ideas and input to Sales teams on how they can best address these issues as they are negotiating with their customers/clients, or their customers’ or clients’ procurement teams. If you find this advice helpful and would like advice on how to handle your own Sales Negotiation challenges, or if you would like to suggest other challenges for us to cover in the future, please reach out to us here: https://www.vantagepartners.com/contact/

Professional service fee structure negotiations

Fee structures are fundamentally about risk allocation. Many clients understandably dislike a daily/hourly rate structure or a “time and materials” payment structure because they bear the risk of taking on large unexpected costs and the service provider has no incentive for efficient service delivery (indeed, the provider is actually rewarded for being inefficient). Many service providers have difficulty quoting a fixed fee for their services if the scope is unclear or may change over the course of the engagement, and find themselves resisting requests for fixed fees or daily/hourly fees with caps, because bearing the risk of having to eat extra time feels too great.

How might you respond when a client relentlessly advocates for a fixed fee structure? Vantage recommends the following five tactics as possible ideas for handling such requests:

Phase the project: Start with a fixed fee in the design phase and agree to quote fixed fees for subsequent phases after scope has been more clearly defined A common challenge service providers face is the fear that if they agree to a fixed-fee structure, they may get in big trouble when they later learn that the scope of effort required to meet the client’s needs is much greater than originally anticipated. Since it is hard to scope a project before it even begins, perhaps offer to begin work with a clearly scoped diagnostic/design phase with an understanding that that will enable you to later quote a fixed fee structure for subsequent phases of the engagement when you and the client are both more comfortable that you have a mutually understood and clearly agreed definition of exactly what the service provider will do and what the deliverables will be. 

Consider a blended solution: Offer to have some work streams on a time and materials basis while others on a fixed fee basis For newer products and services, service providers often have difficulty scoping because they are not exactly sure of the cost of time and materials associated with implementing the new product or service, and are thus not comfortable offering a fixed fee billing structure. However, for other products and services, service providers are more familiar with the types of costs associated with implementation. Thus, perhaps you might offer fixed fee billing for products and services where scope and costs of delivery are quite clear, and time and materials billing for other products or services where the scope will be more variable (perhaps with a “not-to-exceed” ceiling where you will not bill above a certain level without authorization for the client).

Get creative: Offer a time and materials billing structure with collars. If their interest is in making sure that you are incented to be as efficient as possible in getting the work done and in minimizing their pain if you take longer than expected, perhaps you might look for innovative schemes that offer a time and materials billing structure up to an estimate of the total fees, with a bonus for coming in below the estimate and the marginal cost of additional services gets more and more deeply discounted as you go over the estimate. For example, if you budget for a $1 million dollar engagement that is expected to take 10,000 hours (quoted at a blended rate of $100/hour), you might get $110/hour if you come in at less than 9,000 hours, but only $90/hour for the hours over the 10,000 mark, only $85/hour for hours over the 11,000 mark, and only $70/hour for the hours over the 12,000 mark. These kinds of risk-sharing and gain-sharing arrangements are creative ways to structure the risks and incentives that may meet both side’s interests better than a pure fixed fee or pure hourly/daily billing arrangement.

Change the players: Leverage your relationship with a more senior person at the client organization Sometimes it may be the procurement team who is pushing for a fixed fee (in part because they may be able to claim some kind of savings up on their “scoreboard” if the fee is fixed, but cannot take credit for any “savings” if the fee is variable). In cases like that, especially if your end client actually understands the difficulty in nailing down scope because their needs are evolving and the solution they really want is not yet crisply defined, you might be well advised to try to bring your end client into the conversation. It is certainly true that many procurement teams may seek to assert control and keep your end clients out of the contracting conversation. However, there still may be ways to get your end client more actively involved, even if it has to be behind the scenes to clarify their interest in, and business benefits from, a flexible service package that can’t be completely specced out at the outset.

Clarify Alternatives: Make clear the difference between a “BATNA” and a “FATNA” Perhaps the most common tactic that clients use is to threaten to walk away from the nego-tiation and go with the competition who is offering a fixed price, or in other words, going with their Best Alternative To a Negotiated Agreement (BATNA). However, we find that sometimes customers mix up their BATNA with their FATNA, a Fantasy Alternative To a Negotiated Agreement. There are two ways that potential Alternatives might not be fully realistic: 

• The switching costs may just be too high. Switching vendors midstream can be extremely costly — from the time it takes to evaluate new vendor proposals, to the cost of onboarding and integrating new vendors, to the risks that they may not be able to deliver the same value that you will. Thus, before you enter this conversation, have in your back pocket a simple bulleted list of the types of costs and risks your customers’ may face if they switched midstream.
• If the competitor’s pricing is too good, it may not produce the results desired. Low-ball bids can lead to bad out-comes for the client, either in terms of under delivery of the services they need, or substituting less qualified staff. Moreover, the low fixed price bidder may well embed a bunch of assumptions in their bid that they know cannot be fulfilled, so they expect to make their margin on costly change orders. Just as many homeowners who select the low bidder for a renovation project find the final cost after change orders is much higher than most of the other quotes they rejected, clients who pick the cheapest fixed price service provider often find there are many “extra” charges that they did not factor in when they made their vendor selection.

In closing — while you might ultimately decide to either build in a reasonable contingency and give your client the fixed price quote they request or flat-out refuse to offer a fixed price because the scope is just too unclear, be aware that there are several strategies you might try before you get to those results. Instead of treating a demand for a fixed price as a “win/lose” contest where either the client wins, and you lose, or you win, and the client loses (two bad results from a service provider’s point of view, since client satisfaction is usually a critical interest), think of it as a shared problem in sorting out a risk allocation system and in generating creative options that will make sense to both sides.