Bald Dog

Vancouver, British Columbia
June 28, 2005
 - The Inherent Lunacies of Commonly Used Fee-Setting Techniques
 
There are many service professionals out there who offer a broad range of compensation strategies for their work, hoping that prospects will find one of them more attractive than others and then they are more willing to engage these professionals.

By Tom "Bald Dog" Varjan, Organisational Provocateur



There are many service professionals out there who offer a broad range of compensation strategies for their work, hoping that prospects will find one of them more attractive than others and then they are more willing to engage these professionals.



While some of these fee-setting methods are good for certain situations, some of them are plain duds and can land you in really nasty situations.



So, let us review here some pricing methods service professionals use, and we look at both the pros and the cons of each method. Some methods are great but the problem lies with their interpretation.



Let’s start with a common belief. Many professionals guarantee results and try to use this guarantee to entice clients from competitors. This is the same as guaranteeing to your spouse that your marriage is for life and nothing can end it except death.



Well, that is nice, but here is the other side of the coin. In a former life I used to work in jobs where my "clients" were dead (grave digger, embalmer and crematorium attendant). It was good because I didn't have client complaints, but was bad because they didn’t give me testimonials and references, so I had to become a good marketer.



Many of them had divorced several times by the time they kicked the bucket. That indicates that in spite of the fact that they once had promised "together forever" to their spouses, at one point the shit hit the fan and divorce raised its ugly head.



So, the essence is that we cannot promise definite outcomes, unless we control every aspect of the client relationship. And there are just a very few professionals who can do that. They are gravediggers, embalmers, autopsy doctors, and other professionals whose clients are fairly cold and fairly horizontal.



Personally I believe it is unethical to guarantee outcomes when you work collaboratively WITH clients.



It may work a bit better when you work as an outsourced labourer and are expected to produce results FOR your client.



So, let’s see these fee-setting methods.


Flat Negotiated Fee (Project Fee)


In this method professionals usually calculate how many hours it will take to do the job and how much they have to fork out on materials, and quote a price accordingly.



These people try to justify their fees for time and effort they invest in creating deliverables, as though clients cared about them. In a way this is a lumped hourly fee structure.



From the client's standpoint the "I run a team building workshop for you" is as useless as a fart in a windstorm. Clients want to reduce talent attrition, boost sales (strategy) and the way (tactic) to achieve it is improving team performance. But how you improve team performance is absolutely irrelevant. If it is a workshop, that is fine. If it is removing some team members, that is fine too. If it is feeding them some pancakes, that works too



If you can say that that let's work together to reduce annual talent attrition by 25%, that is a valuable proposition. Can you see the difference? If it takes 10 minutes to remove some prima donnas from the team and improve performance, why the cricket would you bother to run a workshop? The real performance improvement takes place right after removing the troublemakers.



You can't improve the overall performance of the fire brigade by running workshops on the physics of fluid dynamics. Hey, they don't need to know that aspect of water.



The problem is that with this approach you take the client’s focus from the improvement to the tasks: “I deserve my fees because I have been working like a dog for two weeks non-stop”.



Since this approach is about working hours, there is a tendency to include heavy reports and tonnes of unnecessary memos in the agreement.


Monthly Retainer


There is a huge misunderstanding here. For many service professionals, retainers mean a certain number of hours of pre-paid manual labour. However, I believe that buyers use service professionals for what they know – brain power, and not for what they can do in the form of manual labour (brawn power).



Just imagine a financial advisor. She takes care of your assets for a certain annual fee, but if you try to convince here that “Hey, I’m too busy, here is some money, go to the bank, stand in the queue and pay off my VISA card, since I pay you anyway”, she may recommend you a check-up from the neck up in the local mental hospital.



You must feel at ease with the fact that your value to your clients lies in access to your smarts. If you mismanage this part, clients end up demanding your being physically on site whenever they need you, and you will end up living the rest of your life on-call.



This can lead to scope creep, like “Since you are here and get paid anyway, why don’t you clean the toilets and make me some coffee?



Make sure you get paid in advance and provide unlimited access to you. Also, make sure you document in your agreement who exactly has access to you. There is no point in charging one single fee and allowing the whole department to call you whenever they feel stuff on something.



Again, your retainer fee is a compensation paid to your for access to your smarts and talents for a pre-specified period of time. The retainer is not a pre-paid hourly rate that is drawn against as billable time is dispensed. You are not a human vending machine.



There is no project in retainer agreements. There are no specific objectives. The emphasis is on having access to your smarts and counsel. The value of the retainer agreement is not a function of your physical presence either. It is the client’s responsibility to contact you whenever your advice is sought.


Fixed Fee With Exposure Opportunities


This is when clients say “Although we pay you only $XX but you will get $XX worth of media exposure.” This is retarded.



Imagine going to Safeway (Grocery store chain in North America, the UK and maybe elsewhere too) and refusing to pay full price, arguing that “I offer you exposure by carrying my groceries in your shopping bags”. What do you think would happen? The cashier would call the nearest lunatic asylum to book me a place.



Push back to buyers and tell them that unless they only want “exposure to value” not the value itself, they had better cough up the dough. Imagine, you go to a restaurant starving, order teriyaki elephant tail, and the waiter does a nice PowerPoint presentation on how teriyaki elephant tail is cooked. Then he happily brings you your discounted receipt. You have just been exposed to value but did not get it. How would you feel? Still starving? Then watch the presentation again and pay the discount rate again.



You offer real value, so you must only accept real dough. Wherever in the world you live, I find it hard to believe that the reining currency is called “exposure”. But check it with your mortgage company. I may be wrong.


Cost-Based Fees


There is a problem here. In this braindead setup you are supposed to be paid based on your costs. As a service professional, you can offer advice worth of thousands of dollars in ten minutes at very low costs. So, why should you be penalised just because your overhead costs are so low?



When you were in the phase of collecting your knowledge, you paid both for your schooling and your education. Nobody came to you saying, “Let me help you to pay your tuition because a few years later I want to hire you and need you to be as knowledgeable as possible”.



This is payback time. You have knowledge others want. Charge good money for it. $15,000 for a four-hour gig to restart a constantly-crashing computer network (lost productivity) is perfectly all right even if your cost is nothing. You pay your cost by keeping yourself on the top of your industry.


Contingency Fees


The mistaken idea behind this payment method is that every dollar your expertise brings to your clients’ businesses, they pay you a percentage.



Once I had a woman who wanted to hire me to help her with weight loss. (I am a certified personal trainer and work exclusively with businesswomen on a broad range of health, fitness and lifestyle issues. You can call it a paid hobby.) But instead of paying me my normal fees, she wanted to pay me for the lost weight. I told her that it was up to her how well she would adhere to the programme I design for her, and she would start shaping up accordingly. She insisted on the pay for lost pounds. So I had no option but to tell her that I could push her to the brink of certain death to achieve maximum weight loss, but that would not achieve what she was seeking. Although she saw the point and was willing to accept my normal fees, but I decided to reject her application. A troublesome prospect most often becomes a bat out of hell (homage to the great rock singer, Meatloaf) client.



How stupid do you think a mother would be if she paid a babysitter for the poundage of flesh she has to babysit? Just a thought.



Business owners all over the world are pounding on their chests that they have no money to waste and they only pay for performance. This statement is also bullshit. They have already wasted a boatload of money on their own stupidity and underperformance, called “figuring it out”, instead of hiring some help.



Imagine a business owner whose business has been underperforming for years as a result of his own incompetence and stupidity, but now – often in desperation – he hires a consultant and demands instant result. This reminds me of my discussion with the president of a Vancouver-based high-tech firm in 2002. The president wanted to retain me provided I could guarantee new money in their bank account within three days. He also emphasised that I would have to work all by myself because the guys were extremely busy and they didn’t want to be interrupted by minutiae like client acquisition. To my best knowledge the company doesn’t exist any longer.



Far too many business owners call in external advisors too late. Just imagine. What is the point in hiring the best ship consultants to save your sinking ship after she hit an iceberg and is already 9/10 under water?



My view on contingency payment is that I don’t want to take 100% risk and then be rewarded with a 10% of the rewards, while the business owner is having a great time, knowing that she abdicated all the responsibility to an external helper.



This also reminds me of how so many professionals live their lives. They are willing to sacrifice their own health for the sake of chasing more business, and from their 50s they spend all their hard-earned money on remedial measures to re-build their health. Does it work? No. You simply cannot put in what is not there. Once your health is gone, it is gone forever. It is so simple.



All right, business owners may cry that they are only willing to pay for results. Then how come that they have been being paid for years and years for their own stupid efforts of driving their own businesses to the ground? Maybe they should pay back all that money and now there is money for a competent advisor.



This method doesn’t work in consulting, which is all about collaboration. It is about WE create something amazing here, not YOU do this and I do that. The synergy lies in “we” not in “you” and “I”.



But for example if you do lead generation FOR a client and you are in 100% control of the whole lead generation process, then contingency may work out. Nevertheless, you still have to demand a certain “setup” fee payable in advance. Also note that you don’t get paid for the sales, but you get paid for the sales leads. Converting those leads into clients and customers is not your problem.



If you are a DJ and play a popular song, you have to pay royalty on the song even if the whole room is empty. It is your responsibility to bring in people with pulse and money not the musician’s.



The other place when contingency compensation works is joint ventures (JV). However, if you JV with a company, you are a partner. And advisor is an advisor, not a partner. The owner of the company must give you a non-executive director position, so you have a say in company matters. Insist that you must be involved in every single decision and you have unlimited rights to inspect the books. Remember, you are not a fully-fledged decision maker but not a passive observer either. 



You also create an agreement that you are not responsible for anything that is going on in the company, and you take no responsibility for the company’s debt either now or in the future. You just use your director position to make certain that some anal retentive cost conscious bean counter doesn’t undermine your lead generation initiatives by cutting budgets. Let me know if you need some help in this area.


Equity/Stock Position


I would avoid this method like the plague. Let’s face it. Some 98% of all businesses fail before their tenth year in business. So, if you enter a stock option agreement, you have only 2% chance of emerging as a winner being rewarded for your expertise. I may not be a mathematical genius, but even I know that if I have only 2% chance of reaping the rewards, I had better not take 100% risk. It is just not a sexy ratio.



Also, when business owners offer you something in the future, they try to abdicate the risk onto you. At the same time, just take a quick look at the cars they drive and the homes they live in. They don’t want to sell their cars in order to inject some money into their own businesses. They ask you to inject your own money as a “partner”. They are having a great time, while you are hoping and praying that you see some money for your work.



But then you could start the same business as a competitor, push that idiot out of the market and then you keep 100% of the profits. It is a lot better deal.



Especially high-tech leeches have been famous for this before the dot com blast, but even now. They know they can have a great life using some venture money. We just must make sure we don’t descend to the stupidity level of some “investors”, and don’t invest our hard-earned money and talents in these lunatics’ adventures.



But if you feel passionate about what the company does, go for it, but demand a non-executive director position on the board. Again, accept no responsibility against losses, but make sure your voice is heard and you are involved to a certain extent in running the show.


Commission


This is a fixed percentage of profits on specific sales and it sucks.



Imagine that your efforts result in $1 million in monthly sales. Great. You estimate a great commission cheque.



Then comes the business owner and announces that using this $1 million he wants to buy a new house and a new Ferrari. All in all, after all that hard work the $1 million is gone and you are there with pennies in your pocket because your commission is payable on profits.



And since you have no say in company matters, all you can do is to grit your teeth, tighten your belt ready to face some starvation and look forward to the next month, being terrified of the boss’ next whimsical decision.



Besides all that, this compensation method is highly unethical. It forces you simply to sell more not to improve the client’s condition.



Imagine that you go to the store to buy a simple computer for word processing, but the sales clerk is trying to sell you a top-of-the-range all-bells-and-whistles computer. He doesn’t care what you want or need. He cares about what he needs: More sales to be able to pay the mortgage.



Some people may say they don’t do this. Look, we are humans. If the road is clear and there are no cops around, we all exceed the speed limit. All in all, when the temptation is there, we can easily fall for it. So, the best bet is to remove the temptation itself.



Do you remember - from the movie The Exorcist - when the young priest, Father Karras is preparing to meet the possessed girl, and Father Merrin, an experienced exorcist, warns him, “do not listen to anything the demon says. He will mix lies with the truth to confuse you.”



The commission structure is the same. It mixes so many lies into the equation that the good intentions just vanish. Just keep away from commissions.



Oh, one more little thing. As a service professional you are supposed and expected to be unbiased. When your compensation is directly attached to the outcome, you will be everything except unbiased, thus you automatically become useless.



It reminds me of the police force in the old communist Hungary, where the cops were paid bonuses based on the fines they collected. Guess what. They ruthlessly fined every warm body with a pulse. And the sad thing was that they made up rules on the fly as they found it most beneficial to themselves. And when the poor victims tried to argue their sides of the story, the cops often just beat the crap out of them. It happened to me a few times too. Then they forced me to sign a document that I had fallen down the stairs. Then they dumped me in a dark alley and that was it. Sweet. I guess Gestapo-like law enforcement didn’t end after the fall of the Nazis.


Barter


In this setup you are supposed to exchange services, but there is a problem here.



Let’s say that you are a private tutor and your client is a car mechanic. So you teach his kid and he fixes your car. Is that fair? On the surface it is. But let’s dig a bit deeper.



The mechanic fixes your car, which is a rapidly depreciating liability anyway.



However you are tutoring the mechanic’s daughter, so she can get better grade, she can go to a better university, she can get better recognition as a professional, so she doesn’t have to slog her way through all the drudgery her parents went through. All in all, you offer the mechanic’s greatest asset (her daughter) an opportunity to become all she can be and achieve more then her parents have ever achieved.



Is this barter equal? Not exactly. Who is offering more value in this equation? I vote for the tutor in spite of the fact that teachers earn a tiny fraction of what car mechanics earn.



I know people who barter their professional services for computer parts, groceries and other tangible bits and bobs. That is, they commoditise their own services by bringing them down to the level of a bag of potatoes or a hard drive.



Can you imagine the lawyer saying, “Replace my computer’s hard drive and in return I review your document for the joint venture that can earn you millions of dollars down the road.” Something is seriously wrong with this picture.


Hourly Fees


This is concentrated stupidity of the highest degree. It is basically giving your life away piecemeal. And I don’t care how high your hourly rate is, it is just plain negligent to tie your income to such a finite entity as time. If your value is simply the function of the time you spend in your client’s company, you may just turn into a lapdog, and at least you will be more highly appreciated.



There are so many problems that it is just hard to express in one short article, but here are some.



First here is an exercise for you. Average North American consultants invoice some 1,144 hours a year. Multiply this number by your hourly rate, and what you are staring at is the absolute maximum you can earn.



Per Diem fees...




...inflict an artificial upper limit on your earning potential



...make your income subject to “going” or “competitive”(ly low) rates



...present you as an expense, an impediment



...damage your market positioning and create a space for price objections



...force clients to make too many budgetary decisions, and create too many yes/no situations



...do not require your clients to fully commit to the project, because they know they can end it anytime



...lock you into a “commodity trap”. You are just one of the crowd.



...take your focus away from creating and delivering value because you always try to sell more deliverables and tasks regardless of improvement in the client’s condition


Summary


The way I see the situation is that it is me who takes a risk by running in my own business. I am willing to take this risk knowing that I am the owner and the ultimate decision maker of this business. Whatever happens in my business, I am single-handedly responsible for the results.



But while I am willing to take this risk in my own business, I am not willing to assume risk in other people’s businesses. Yes, I guarantee my work but I cannot guarantee results, simply because I am not the decision maker.



Here are some questions to consider:



Can military generals guarantee victory? No.



Can airline pilots guarantee safe arrival? No.



Can surgeons guarantee survival for their patients? No.



Even Harvard Business School cannot guarantee that, after completing their MBA programme, you will have a guaranteed position at McKinsey & Co. or any one of the large accounting firms. But I have also heard that you have to pay the – obscenely expensive - tuition in advance with no guarantee for getting a job at all. How is that?



As a service professional, all you can do is to bring a lot of your past experience to your engagements to improve the client’s condition. The client must take responsibility for getting the greatest possible result from your advice.



In my view the best way of setting fee is based on perceived value. Yes, you can stick a price tag against tasks (conducting workshops) and deliverables (business plans), but they are just that, prices. Just as beauty is in the eye of the beholder, value is in the eye of the buyer. So, everything you do should revolve around perceived value as received by the client. Hint: It does not make 20 times more money to make a Ferrari as it takes to make a Ford.



Ford sells four wheels, some upholstery, an engine and a radio for $20,000. Ferrari sells success, style and prestige for $400,000. Go figure.



Organisational Provocateur Tom "Bald Dog" Varjan of Dynamic Innovations Squad helps professional services firms and solo professional to create more client value for higher fees using less of their time and effort. For his FREE Black Paper Ten Deadly Management (Mal)Practices That Bring Professional Service Firms to Agonising Death!" visit Tom's site at www.di-squad.com