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Fee Setting

Dear Dave
I am CEO of a $5million M&E firm. I just recently read your column in the December 2002 issue (I’m way behind in my reading!) and it struck a cord with me. The subject was finding the hourly cost of salary over the hours worked in a week. Does that presume we are ethically bound to sell our services for some sort of a “reasonable” markup over our actual hourly labor rates?

Unfortunately, I believe that kind thinking pervades our A/E industry and that is why fees are generally too low. It seems to me that the price at which we should sell our knowledge and expertise should have no direct bearing on what we pay in hourly salary. If I can sell, oh say, 80 hours of my experience in a week for $150 per hour, and it is worth that much to the clients isn’t that fair value received by my client? I’d like to know your thoughts.

Dear DG
You won’t get much of an argument from me. The column you’re referring to was limited in scope to a technical explanation of how to job cost payroll expense for accounting purposes when a salaried individual works in excess of the standard hours in a pay period.

Hourly is merely one of many possible ways to do business. Regardless of the particular method used to establish fees I can most emphatically tell you, that at the end of the day, the industry-average profit margin being achieved (high single digits – before year-end discretionary distributions and taxes) is not sufficient for the long-term health of the profession. The question, to me, becomes why? Is it a pricing problem, a symptom of faulty contracting methods, a service issue, an overall weakness in firm management or some combination of these and other factors, like too many firms chasing too little work?

Think of fee pricing as a continuum with the absolute breakeven cost to operate the firm at one end of the spectrum and what the market will bear at the opposite end. The trick is to find the optimal point along that continuum which results in maximum profits to your firm and yet attracts a sufficient volume of clients and work. Where that optimal point lies is different for each firm. A well-managed firm will eventually find its particular point over time through testing and experimentation and then consistently operate with that point in mind.

Financially, it is all about widening the margin between the cost to operate the firm and the fees the firm is able to command. The average firm, in tight markets, probably has little opportunity to simply increase its fees in order to improve its margin. There is nothing particularly unique about the typical firm or its services to enable it to charge significantly more than the next firm—the clients would simply go somewhere else. This firm would need to invest (and this takes profits to plow back into the firm) in enhancements to its management discipline, process, procedures and technology to lower its cost and generate more profits without increasing fees. To capture the benefit of these investments, the firm would need to be smart about contracting methods it operates under. For instance, this firm would generally want to avoid time and material fee arrangements (potentially giving the savings back to clients) and instead work under lump sum fixed fees or percentage of construction cost arrangements in order to realize the benefit from its enhanced productivity and reward itself for investing to become more efficient at doing its work.

To widen the margin on the pricing end of the fee continuum is generally a much tougher task. Short of changing clients or markets outright, higher pricing requires developing something truly special (again needing profits to reinvest) about the services you offer or the manner and method in which you deliver them. You need to create a demonstrable difference which a client can come to understand and appreciate AND be willing to pay a premium to obtain.

The old business adage that something is ultimately worth what a buyer is willing to pay and a seller is willing to accept applies to the A/E business as much as it does to any other form of enterprise. Creating the widest possible margin along the pricing continuum is the essence of astute business management.

Wahby and Associates