The 4 Consulting Fee Types: Which ones to use and when

Determining how much to charge a client is no easy task!

Not only do you need to come up with the fee in the first place, but you don’t want to risk overcharging or undercharging and losing the sale, or worse still, squandering the profits in the delivery phase.

Despite the many variations, there are only 4 different consulting fee types around which all others are based.

You could argue that there are only 2 - Fixed fees and Variable - however the different fee types described here require more thought than simply fixed or variable. They are a combination of the way the fees are packaged, and the scenarios in which they are deployed.

In this article I’ll explain the different fee types, and reveal the following 3 things:

1. Which one has the greatest profit potential
2. Which one is the most common - and why it should’t be!
3. Which one clients prefer the most

Consulting Fee Types

The diagram below details each of the 4 fee types, along with the 4 dimensions of a fee. (For the benefit of those reading on a mobile device, this diagram is described in detail below)

It's a lot to take in, which is perhaps why many consultants don’t go beyond Time & Materials. But before we get into the different fee types, let me explain this model a bit first.

On the left are four categories. which represent the 4 dimensions of a fee, as follows:

• Engagement Type
• Pricing Model
• Revenue type
• Profit Model

Engagement Type

In a consultancy there are two types of engagements:

1. Project: The client engages you to complete a discrete project
2. Service: The client engages you to fulfil an on-going need through a service

Pricing Model

The Pricing Models is the core part of your pricing strategy and includes the following options:

1. Time & Materials: Fee is based upon an agreed day or hourly rate. Billing is for the exact amount of time worked plus any material expenses. Different resource grades typically attract different rates.
2. Fixed Fee: Fee is based on the cost of the total days estimated effort, then the addition of markup (Cost Plus) or a fixed sum (Value based). The client pays the same fee regardless of how much effort you expend.
3. Risk/Reward: The client agrees to pay a base fee, plus a risk/reward element based on the outcomes achieved. The Risk/Reward element can be fixed or variable, and it can be based on elements of project tolerance (Time, Cost, Scope, Risk, Quality, Benefits), or it can be specific project outcomes. The Risk element eats into your profit on the project. 
4. Retainer: A fixed fee, paid annually or monthly. The model secures your availability to the client. It is on a ‘use it or lose it’ basis. There may be provision for additional fees on a T&M basis.

Revenue Type

An engagement produces revenue which is either predictable (fixed) or unpredictable (variable).

Profit Model

The Profit Model concerns the approach taken to determine the profit on the engagement at the point of sale. There are many different pricing models, but the two most common in a consultancy are:

1. Cost Plus: The fee, whether variable or fixed, is based on your costs to deliver (resources mostly) + your markup.  
2. Value-Based: The fee is based on your estimate of costs + an additional sum based on the value to the client of the outcomes that you're providing.

Let's now explore the different fee types in more detail. Each fee type is explained below using a SWOT Analysis (Strengths, Weaknesses, Opportunities and Threats), along with examples of when to use each fee type.

The Fee Types are:

1. Time & Materials
2. Fixed Fee
3. Risk/Reward
4. Retainer

More commonly known as T&M, Time & Materials is the most common Fee Type. Why? Because it's the easiest to apply by the consultant. That doesn't mean it's the most preferred by the client. In fact, for most projects it's not preferred by the client as there's no clarity of total cost to them. That represents risk. The client will be concerned that costs spiral, and/or they simply run out of budget. 

Aside from the risk stated above, the primary problem with T&M is that it doesn’t offer your business the ability to plan its revenue and resources. And you’ll be working like crazy to bring in the revenue.

It’s exactly because of T&M billing that lawyers are renowned for the long hours that they work. To make this fee type work in the legal sector it is necessary to drive people extremely hard, often aiming for upwards of 40-50hrs per week in billable time. That means all of that other non-billable stuff - another 10-20hrs - needs to be fitted in too!

T&M also drives client disputes over bills. In the legal sector - which is the biggest purveyor of T&M fees - the average bill is discounted by 6% in response to client disputes.

Whilst T&M offers the most simplicity, it does not create the best foundation upon which to grow a successful consulting business. And it doesn’t really offer the mid to large corporate consulting client what they want either. 

Next up is the Fixed Fee approach. There are, however, two variants of the Fixed Fee based upon your profit model. It is important to understand each as there are some important differences.

Fixed Fee (Cost Plus)

This model is a step up from T&M and the most commonly applied type of fixed fee. With this pricing model you estimate how much time and effort a project will take, then you apply your markup to provide the client with a single, fixed fee.

Since starting my own consulting firm I've never used T&M fees, instead preferring to use Fixed Fee (cost plus) as they're the easiest form of fixed fee and well suited to the strategic engagements I undertake. 

In my consulting experience, I've won fixed fee engagements from a few thousand pounds to well-over a million. So, fixed fees are very versatile!

Fixed Fee (Value-Based)

Ah, the Value-Based Fee. Stuff of legend. In fact, value-based fees are stock advice in pretty much every book you can buy on running a successful consulting business. The trouble is, it's much easier said than done, and a value-based fee doesn't suit every engagement type. 

With a value-based fee, rather than basing your profit on your standard target markup, you base your profit on the value of the engagement to the client.

Or more precisely, you base your fee on the cost to the client of the problem that they are facing. As you can imagine, that requires an in-depth discussion with the client to extract that cost, which may not be immediately obvious to them. 

To close a sale on value requires an open discussion with the client about the cost of their problem, and the investment required in you to resolve it. It also required the consultant to shift mindset from one of selling hours, to selling an outcome.

The risk/reward model can be seen as a variant of the fixed fee (value-based). It’s a great model, but in most consultancies it is rarely applied. It is much more common in construction industry related consultancies. 

The primary challenge is that there needs to be maturity in understanding between the client and the consultant.

The final fee type is the Retainer. A retainer fee is deployed where a client secures a portion of your time for their exclusive use. There are many different services that a consultancy can create to encourage retainer fees. 

The best part of a retainer fee is that it represents recurring revenue to your business. This makes a significant difference in the overall value of your business.

Conclusion

So which fee type is best?

The answer is... you've guessed it - it depends. On a whole number of variables. 

The most common fee, especially for small and startup consultancies, is T&M. However, that really isn't the best approach (unless you make the markup very high) as it can result in overwork, under-delegation, and doesn't give the client much budget certainty. 

Fixed fees are preferable to your business, and most preferred by clients. 

If I was looking at it purely from a business management perspective, I'd love a business full of nothing but retainer revenue. That way my business would be totally predictable. It would ultimately be a subscription business. 

However, the consultant in me sees that all a bit.... well, boring! Whilst I do love certainty, I also love the challenge of a project. That's why I believe a consulting business should have a mix of retainer and fixed fee engagements. 

If you can achieve a value-based fee, you'll get the greatest profit. But if not, settle happily for a cost-plus fixed fee. Just be sure to increase your markup in light the efficiency you create as the team gets more skilled.

Risk/Reward opportunities are rare, but are also probably the most exciting. The thing I like most about them is that it drives the delivery team to perform efficiently and optimally. 

Probably the most important aspect that runs across all of these fee types is the importance of accurate time recording and scope management. If you don't have time recording in place, then it's irrelevant what model you follow as you're likely haemorrhaging money through over-delivery.