What are you worth? Episode 2: Rate Models
One of the most important topics and often an area of insecurity when going for your first project: how to determine the right rate? This first blog will be dealing with the different rate models out there, discussing their pros and cons.
Setting the correct rate - Part 1: Rate Models
One of the most critical questions that arise and generate uncertainty when starting a new project is: How to determine the correct rate? This decision is fundamental, but it is sometimes difficult to choose which approach to take as it is open to negotiation. Setting the rates for your clients' projects can be considered complex. To do so, you must first understand some relevant aspects to go in the right direction. For that reason, in this series of blog posts, we will help you to 1) understand the different rate models, 2) know what your work is worth and set the correct rate, and 3) get the most out of negotiations. We will begin this blog by explaining the different fee models that exist, discussing their pros and cons so that you can evaluate the other options in detail.
1. Fixed project fee
The fixed project fee is the preferred option for traditional consulting firms and consists of agreeing on a payment for a given result. The price of the work is based on the value of the work you offer instead of the time it takes to do it. This model provides clarity from the outset regarding the cost of the investment for the work required. It is ideal for the more budget-conscious client, who knows they will not be in for unpleasant surprises.
However, as an independent consultant, this rate model can be detrimental to you. If you need to spend more time than expected on the project, you will not be rewarded for it, compared to working long hours during your stay in a company.
2. Fixed day rate
The fixed day rate is a widely used model that compensates for the time worked and not only for the result of the project. Daily payment is established for an agreed period to complete the project. The disadvantage is that if you have to work more than the stipulated number of days to complete the project, you will not be paid. It would help if you considered that the number of hours you work is up to you and allows you to adapt and modify the rate for larger or smaller projects. By billing a project with work per day, you will have the option to sell several days at a pre-established price (and even more economical for the client).
3. Hourly rate
The hourly rate is an even more flexible model that compensates the employee for the actual valuable time spent on the project. Therefore, payment is agreed upon for each hour of work on a given project. This option is ideal when it is difficult to determine the time to finish the job, as it provides excellent flexibility. The downside of this model is that clients may want to micromanage the hours you work for them, which can affect your enthusiasm, client relationship, and project results.
However, this can be solved by transparently communicating the time you have scheduled to dedicate to the project or letting the client decide if they need additional hours.
The performance-based rate or time-based fee model is advisable in some cases, especially when the project results can be easily measured, as in the case of mergers and acquisitions. In these cases, it is common to negotiate a percentage of the deal value, probably in conjunction with a fixed fee or time-based compensation.
To set the appropriate percentage, you consider the expected value of the operation in conjunction with your daily rate or the established hourly rate. You must consider that you share the risk with the client in this type of model, and if the expected results are obtained, it is beneficial for both.
Each fee model has its advantages and disadvantages, so there is no clear answer as to which model would be best for you as an independent advisor. But experience has taught us that unless you know precisely what you will do in your project and how long it will last. So, ideally, it would help if you stayed away from fixed fees unless you are getting a reasonable premium convenient for you. Suppose you are looking for flexibility and freedom. In that case, we recommend that you opt for an hourly rate, possibly combined with an additional premium based on easily measurable performance.
Be proactive and propose the rate model that you prefer to your client, stating that this is how you usually work. If they prefer a different mode, that’s the start of your negotiations!