Cost to deliver elements and price points for professional services

Cost Estimation and Pricing in Professional Services Delivery

An introduction to a big picture representation of calculating the cost to serve and identifying three

price points

John Phillips - au.linkedin.com/in/johnphillips11kps/

http://au.linkedin.com/in/johnphillips11kps/

Worthy but boring title? Is it worth me looking through this presentation?There is a wealth of research, data and special interest groups on pricing strategies and approaches related to products.

For example, industries such as Fast Moving Consumer Goods, Consumer Electronics, Automotive and Utilities have a rich vein of research and management consulting material available on pricing strategies and their impact.

Professional services industries are less well served, and in many instances, pricing in professional services hasn’t progressed beyond charging for chunks of time worked.

This presentation deals with more complex opportunities where we want to deliver an outcome that may involve many people, subcontractor, payment milestones, risks and financial provisions.

If that interests you, then its worth looking through this presentation.



How can I get a handle on how important this is?

Everyone gets that price is important, but sometimes we need a reminder of how important even

small improvements can be.

One simple, real-world business based example was provided by Compustat and McKinsey, where a

1% increase in average price can realise an 8% improvement in gross profit.John Phillips - au.linkedin.com/in/johnphillips11kps/


Alternatively, you can quote Warren Buffet

“The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, then you’ve got a very good business. And if you have to have a prayer session before raising the price by 10%, you’ve got a terrible business.”

It should perhaps be noted that the source of this oft-repeated quote was Warren Buffet’s explanation during the Federal Crisis Investigations Committee’s early 2011 interview when he was being asked about his investment in Moody’s Corp. Bloomberg’s piece proposed that, for Warren Buffett, it seemed that pricing power was more important than good management. If possible, I’d rather have both!


http://www.bloomberg.com/news/2011-02-18/buffett-says-pricing-power-more-important-than-good-management.html



So what does the big picture look like?

Looks complex. Let’s build the picture up and explain each element as we introduce it



Reminder: we assume that you’re building an estimate of the cost to deliver and outcome

Typical scenarios might be work in the engineering services industry, communications technology and information systems industry, construction industry etc.

Key elements are:

– A definition of the scope of the work that is good enough to allow an estimate

– Something that your company has the skillset to do, in whole as the prime contractor, or in part as a team member

– Something that’s worth doing - that delivers value to the customer



First we build up our estimate of the cost to deliver the outcome

That’s this ‘stack’ part of our model



Labour

Labour costs are the costs of our own effort in delivering the outcomeIn our model, labour costs are the total effort multiplied by the cost rate for each person.

You’ll need to consider the impact of inflation if the time to deliver the outcome is considerable (months or years say), and/or if the delivery period covers a known salary uplift.

We like to separate out the basic cost of employment for each individual from the overheads associated with their office location.

We do not include contingency in the base effort estimate – that comes later.



Labour

Overheads

Overheads are non-direct labour operating costs that we need to recoverWe like to separate out the overheads that need to be recovered from the basic labour cost so that we can allow for projects that have significant on-site effort and/or clients that pay for accommodation and other costs. It also means that low-cost / overhead centres can be more easily seen and taken advantage of.

The overheads we consider are typically location based costs associated with each resource and other operational costs and the total cost is derived from effort x overhead. Remember inflation here too.



Labour

Materials and Expenses

Overheads

Materials and Expenses are things that we need to buy or pay for to deliver the outcome

These costs can be expenses such as flights, hotels, taxis, meals. We might need to purchase items like computers or software, or even large material items to complete the delivery.

We separate out materials and expenses as the nature of their procurement and reimbursement are generally quite different.

Remember inflation here too.



Labour

Materials and ExpensesSubcontractors

Overheads

Subcontractors are those other companies, or individuals that we need to add to the team

Subcontractors are companies and/or individuals that we need to add to our team for their specific expertise and to make our offer more attractive to the client. Their costs may be fixed (through agreement), or variable and based on agreed rates. The difference is important to the risk profile of using subcontractors.

Remember inflation here too.



Labour


Overheads

Cash Flow Charges

Cash flow charges consider the cost of the working capital forecast for the projectAny of us that have been responsible for a business, our own or someone else’s, will understand the importance of cash – money in our bank. The concept here is that being paid 180 days after we’ve incurred the expense is not as good as being paid 30 days after the expense, and certainly not as good as being paid before the expense is incurred. Cash Flow charges are based on the monthly Working Capital forecast for the project and use a monthly interest / charge rate to encourage positive cash-flow (the monies we’ve been paid exceed the costs we forecast at each point of the project)



Labour


Overheads

Financial Provisions

Contingency

Cash Flow Charges

Contingency is the amount of extra cost that we think we may incurThere are sophisticated approaches to considering risk and contingency. Here we are noting that for any outcome where there is uncertainty, we need to consider what the risks are, what their impact would be, how we might mitigate them, and what we would need to do if they occur.

The end result is that we have some risks we can’t avoid and that we should have an appropriate amount of contingency to cover.

Total cost of contract delivery



Labour


Overheads


Contingency

Price FloorMinimum commercially acceptable margin for contract

Price Ceiling

Competitor’s price points Negotiating

Margin

Price Target

Client Value Proposition


(determined by value to client of contract delivery)

(determined by delivery scope, approach, operating costs and minimum margin)

(determined by pricing strategy and company’s value proposition to client)

Simple pricing model for a single valued price and a fixed scope of supply

Cash Flow Charges

Next we look at four price points



Labour


Overheads


Contingency



Cash Flow Charges

First we need to know what our price floor is – the lowest commercially acceptable marginThe price floor is determined by the minimum commercial margin that makes sense to achieve for this contract, based on our understanding of the cost to deliver. You can think of it as “what do I need to get as a minimum return to make this worthwhile (and not be better off keeping the money in the bank)”



Labour


Overheads


Contingency


Price CeilingClient Value Proposition


Cash Flow Charges

Then we need to know what its worth for the client – this gives a price ceiling

Here we want to know why the client want’s this outcome achieved. What’s it “worth” to them? What commercial (or other) gain to they seek to make on completion?

Knowing this gives us a theoretical price ceiling - it would make no sense to charge at or above this ceiling as it leaves the client with no return on their investment.



Labour


Overheads


Contingency


Price Ceiling

Competitor’s price points Negotiating

Margin

Price Target

Client Value Proposition


(determined by pricing strategy and company’s value proposition to client)

Cash Flow Charges

And then we should think about where our competitors will price, and why

Its likely that our competitors will have prices that vary from each other, sometimes dramatically.

Each will be based on a combination of their understanding of the outcome sought by the client (the scope), their cost to deliver that outcome, what they think their unique value proposition is, and perhaps whether they’re feeling lucky or aggressive.

Knowing as much as we can about where they might price helps to shape our decision to compete.



Labour


Overheads


Contingency

Price Floor

Price Ceiling

Price Target

Cash Flow Charges

Our target price considers our own pricing strategy and what we know of our competitors

Our chosen price target is determined by our value proposition to the client. It should reflect our understanding of their price ceiling, our price floor and be consistent with our own pricing strategy (are we a premium provider, or a high volume low margin body shop?).

Note that while we would like to know our competitor’s pricing strategy, ultimately we should care more about our own. Our potential price should be determined by our unique value proposition to our clients – why they choose us over our competitors and how much they are prepared to pay.



So that’s the big picture explained. Now let’s see one example of how to use it…



We can use the picture to see the choices we need to make under different circumstances

Nominal situation – we determine a price within client expectations, the competitive

environment and our value proposition

Rare but still all too common situation - the client's expectation of price is below our cost to deliver. Things to consider:- Can we use a different delivery approach?- Can we deliver something different (scope)?If neither work, then we should qualify out.



That’s all folks

Hope you enjoyed the slides.



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Cost to deliver elements and price points for professional services