Consultancy firms are redefining the way they price their services. Driven by changing customer expectations, consultancies are increasingly replacing traditional ‘fixed-price’ and/or ‘time-material’ costing methods for performance-based pay methods, or a hybrid form.
In recent years the external landscape of the consulting industry has undergone significant change, eroding the lifeline of some fundamentals which have been in place for over a century. One of these areas is pricing. For decades it was arguably one of the most rigid aspects of a consultant’s business model: clients could either hire advisors for an hourly or daily rate or agree a fixed price for a project. Yet against the backdrop of changing customer demands, in combination with the pressure they face to cut costs and their ability to more effectively measure the impact of consultancy services, gone are the days when a consulting firm could charge based on its track record only.
In 2011 Kennedy already earmarked ‘performance-based pay’ as one of the key trends in the consulting industry, and since, its use has continued to grow, both internationally and in the UK. In the lower-end of the market uptake has accelerated, but also large established firms such as A.T. Kearney, Bain & Company, The Boston Consulting Group and EY have acknowledge that they have increased the use of variable performance. In a more recent research the US-based analyst firm asked consulting firms to indicate the key criteria they use to determine ‘performance’, with a mesh of different constructions the result. In some cases performance is pegged to ‘hard’ results such as shareholder value, the realisation of cost saving or revenue growth, or FTE reductions, yet in other cases firms opt for a host of different ‘soft’ targets. Examples include an improvement to the culture at the client firm, higher job satisfaction of employees, higher knowledge levels and the ability for client teams to apply best practices in future projects.
Despite the hype in the industry surrounding performance-based pay – also known as risk and reward or contingent fees – the deployment of the model is still relatively low. Only around 12% of projects are performance based, up from 8% a decade ago, says the MCA. And often the outcome based fee is only an element of the wider fee structure of the consultancy program. For instance, when Coventry Council hired iMPOWER to consult on reducing costs to their transport programme for special educational needs children, the contract terms allowed for 50% of the fee to be performance based, contingent on achieving a 25% reduction in costs. “There are a small number of cases where 100 per cent contingent can work,” says Michael Robinson, UK head of Management Consulting at KPMG.
The success of performance based pay is typically dependent on several contextual factors, such as the type of project, the expertise area and the industry. Its application is generally trickier for high-impact strategy work, as consultancy recommendations find themselves part of a landscape filled with uncertainties, compared to operational improvement projects – boosting the efficiency of a manufacturing plant by 10% is less prone to external influences.
Fees based on outcome are also not without risks. Since the implementation phase is also contingent on the client working with the consultancy firm to bring about changes, the consultancy firm needs to be sure that their client is ready, willing and able to change before such an agreement can be entered into with some high degree of success. Secondly, it requires a high level of sophistication on the part of both the consultant and the client, in particular in the area of benefit tracking and data analytics. And thirdly, it requires detailed KPI-setting and contractual agreements upfront, often slowing the proposal / negotiations phase, and later on in the project risking the focus to be shifted towards ‘target realisation’ instead of realisation of wider, often changing client / project goals.
Change to business model
Looking ahead, the popularity of performance-based pay within the industry is not surprisingly predicted to increase in the coming years. With competition in the market intensifying – the number of consulting firms in the UK has grown by more than 25% to ~140,000 in the past 5 years – and clients increasingly critical on external spending, consultants will be ‘obliged’ to jump on the bandwagon, and at least experiment with different fee models. For the business as a whole, the changing pricing mechanics will have implications. Internal processes and systems will need to be customised to allow for the greater flexibility in pricing, and in addition skills required for performance-based pay will have to be embedded within the organisation, in particular across Manager-up levels. This in turn will also have an impact on talent management in the long term, says Jason Gordon, the partner leading value-based billing at Deloitte: “All these changes do have impact on talent management, recruitment and the traditional pyramid shape of consulting firms.”
Quote's of Michael Robinson and Jason Gordon obtained from the recently released 'The Business of Consulting', a special report from the Financial Times.