The 3 Consulting Fee Structures

There are three basic types of consulting fee structures. Each one comes with certain risks and potential rewards (or benefits). We emphasize “potential” because nothing is certain when it comes to project outcomes.
It is important for both the consultant and the client to understand how each fee structure works, and the risks and rewards for each type to determine which one is the best option depending on the circumstances. The three types are: 1) Bill rate; 2) Project-based / fixed fee; and 3) Value-based. Each one has its place, but, generally, the structures go in order of the lowest risk and potential reward to the highest risk and potential reward.

Bill Rate

With a set bill rate, the client pays a set rate per hour, day, week, or month for each consulting resource for a set amount of time. In other words, the consultant bills the client based on the amount of time spent at an agreed upon rate.

The bill rate will vary depending on the seniority of the resource and the reputation / expertise of the consulting firm. While this structure still involves scoping and anticipating outcomes, it is best applied when outcomes are unknown, specified as a range, or are more qualitative.

For advisory or staff-augmentation type roles, a retainer model may also be used, where the consultant and client agree to a prepaid time and rate for the consultant to be available based on the client’s needs, similar to the way attorney fees are often paid. This is more common when the consultant acts in an advisory role at the strategy level.

Potential Rewards / Benefits:

  • Cost transparency is high as rates are known
  • Project scope can be more flexible, as relationship can be focused around tactics rather than results
  • ROI potential for the client is lower, as outcomes are less defined
  • ROI for the consultant or consulting firm is the predictable margin on asset-overhead, such as salary or hourly pay.

Risks:

  • The client and consultant are incentivized differently. The client wants the work done quickly, but the consultant has a greater reward if additional time is added to the project.
  • Risk to the client is that the consultant may spend a notable amount of time looking for additional ways to help the client, which generates more billable hours.
  • Risk to consultants is low, since they are compensated directly for the time they spend on the engagement.

Although the bill rate is the traditional model for consulting fees, it is now losing ground to the project based/fixed fee service. A 2018 consulting fee study by Consulting Success found approximately 41% or respondents used either hourly or daily rate billing, while 31% used a project based/fixed fee structure. (1)

Project Based / Fixed Fee

In this model, the consultant determines a fixed fee for accomplishing a specific project goal. The fee is usually determined by estimating the amount of time the task is expected to take and multiplying that by the hourly billing rate unless the consultant has “productized” their project offering. Investopedia give a great breakdown of this method here. In this model, deadlines are established for the completion of the project and the milestones to ensure progress.

Although it is similar to the rate-based fee structure, it offers more concrete targets and milestones than the bill-rate model. Many clients prefer this structure because it clearly establishes the targets set forth in the contract. However, targets may change as new information becomes available, or if unexpected events occur.

Potential Rewards / Benefits:

  • The project outcomes and ROI are known by both sides
  • Clients are typically getting higher quality work from experienced consultants
  • The consultant can theoretically get the job done quicker and thus enjoy higher margins on time (assuming limited unforeseen circumstances)

Risks:

  • Scope creep has a higher negative impact to both parties
  • The risk is not eliminated for clients, but it is low since they are contracting for a specific outcome of the project. Risk is highly mitigated since the consultant and client have an agreed upon the result / benefit.
  • The consultant should be an expert in the project and outcomes (thus lowering risk), but there is an inherent amount of risk which cannot be planned for until integration into the organization

Value-Based Fees

Lastly, with value-based fees, the consultant fees are based on the results of the project. The greater the benefit generated for the client, the greater the benefit to the consultant or the consulting firm.

This type of consulting fee is generally reserved for niche or specialty work when the consultant or firm is highly experienced in generating the most value to the client in a specific practice area and the consultant has enough experience to bet on the results. There must be tangible and measurable results in order for the consultant to be properly compensated.

The down side is that it can be difficult to attribute the benefits to the work performed and to measure the metrics which the project must meet. A lot of definition is required up front to eliminate contention when results are met, and particularly if they are not met. The realization can also be longer as results take time to materialize from a project.

Potential Rewards / Benefits:

  • The ROI for the client is variable because if the end value created is low, then the investment should be proportionately low.
  • There is a high incentive for the consultant to deliver and participate in the upside of the value created. The greater the reward for the client, the greater the reward for the consultant.

Risks:

  • Risk is low to the client, as the bulk of the consulting fee will be taken from the benefit received by the client. However, risk may be higher to the client if time and resource allocation is wasted on something that has little benefit.
  • There is a high risk to the consultant since the fee is tied to the results delivered to the client. However, the consulting firm has a base fee lower than the normal rate to cover at least a portion of its fixed costs in addition to the upside.
  • The impact of scope creep is high, but the impact of the outcomes should keep everyone on the path.

Risk Versus Reward Graph

The figure below indicates the different fee structures and the level or risk and potential reward (ROI) associated with each one.

The potential ROI refers to the positive impact to the client and the fees to the consultant.

When to Use Each Fee Structure

Each fee structure works for different purposes. In general, the one with the lowest risk is also the one that has the lowest potential ROI, with the highest risk structure having potential for the highest ROI.

Bill rate is best used when:

  • Ongoing work is needed
  • The scope is not clear or is expected to evolve substantially
  • Tasks are not defined
  • Advisory work is the focus, i.e. providing guidance at a strategy level
  • Commoditized services are provided, and client is price sensitive

Project-based/fixed fee is best used when:

  • The scope is defined, and the objectives are agreed to
  • A project outcome is required, but tangible results are difficult to measure
  • A new client seeks to prove fit of the partner
  • More comfort is needed than just a typical bill-rate structure. I.e. the consultant specializes in topic at hand
  • A client wants a project completed by a certain date
  • A hybrid approach of fixed fee with an hourly rate addendum is needed for additional work that not included in the original scope

Value-based fees are best used when:

  • Metrics are measurable and attainable
  • Metrics can be set up front to understand what is being measured as success
  • Attribution methods for client benefits are agreed to
  • The parties trust each other and have good communication
  • Provider is a very niche consultant with proven results

There are many factors unique to each type of consulting fee structure. The more niche a consulting project is, the more often it will lend itself to a value-based fees project. Value-based fee consulting projects also work well when the scope and outcomes of the project are clearly defined, whereas bill rate structures provide a bit more flexibility. There is a time and place for every type, and a hybrid can be used for added comfort for both client and consultant.

 

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Sources

  1. Zipursky, Michael. Retrieved from: https://www.consultingsuccess.com/2018-consulting-fees-study.