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Sep 1, 2022Navigating the landscape of contract types for professional services can be a complex task. There are a multitude of contract types including fixed fee, hourly, recurring, and non-billable, among others. Each has its unique application, nuances, and best-fit scenarios. The challenge is not just in understanding what these contracts are, but also in discerning when they are best utilized.
To tackle this intricate subject, we’ll leverage our experience at BQE Software, with our firm management software specifically designed for the A/E and professional services industries. In this comprehensive guide, we'll unravel the specifics of the twelve principal contract types, explore their ideal application scenarios, and take a deep dive into their subtleties.
Embark with us on this journey of discovery to understand the ins and outs of contract types for professional services, ensuring that you are well-equipped to maximize your business potential.
For clarity and easier comprehension, we’ll initially group these contract types into four main categories: Fixed Fee, Hourly, Recurring, and Non-billable. This broad classification will aid us in understanding the larger dynamics of contract structuring.
Following this, we’ll delve into each category, exploring each type in detail to unpack the twelve primary contract types for professional services. Through this process, we’ll not only decode what each contract type entails but also provide valuable insights into when they should be ideally used.
First, let’s group these contract types into four major areas:
Contract types are generally broken down under fixed fee, hourly, recurring, and non-billable.
Most of these are pretty straightforward.
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A fixed fee contract, as the name suggests, is a type of agreement where the service provider charges a predetermined, unchanging amount for the services rendered. In essence, this contract establishes a set price for a specific project or task, regardless of the time or resources the service provider invests. This type of contract provides clarity and predictability, fostering a sense of certainty for both parties involved.
The fixed fee or fixed price contract is ideal in situations where the scope of the work is well-defined and the parameters of the project are clear. It is particularly useful when a professional services firm can accurately estimate the time and resources needed to complete the project. For instance, a design agency might use a fixed fee contract to create a website or a branding package, as they can confidently predict the effort required. This contract type is beneficial for both the service provider and the client, offering the provider assurance of payment and the client a clear understanding of costs upfront. However, it is crucial that the service provider has a comprehensive understanding of the project's requirements to avoid underestimating the workload, which could lead to decreased profitability.
The "Hourly Not to Exceed" contract type is a hybrid model that combines elements of both hourly and fixed fee contracts. In this arrangement, a professional services firm charges the client based on the actual hours worked but sets a maximum limit on the total cost. Essentially, the firm bills by the hourly rate, but the total charges will not exceed a predefined cap.
This type of contract is particularly appealing when there's uncertainty regarding the scope or complexity of the work, but the firm still wants to provide some assurance to the client regarding the maximum cost. It allows for flexibility in billing, accommodating unforeseen challenges or complexities, but also protects the client from unexpected overages.
For instance, an IT consulting services firm might use this contract type for a system upgrade project, where the exact number of hours required may be difficult to pinpoint due to potential technical challenges. It provides an attractive middle ground, allowing the firm to bill for actual hours worked while giving the client peace of mind with a cap on the total cost. It requires a careful balance and clear communication to ensure that the set limit is fair and reflective of the potential work involved.
A percentage contract type is a somewhat flexible arrangement where the fee for the professional services is determined based on a percentage of a specified value, such as the total cost of a project or a fixed contract amount. Unlike a strictly fixed fee, the actual fee can fluctuate in accordance with changes in the underlying value to which the percentage is applied.
Professional services firms often employ this contract type when the scope of the project may vary or when the total cost might change due to unpredictable factors. It is particularly useful in industries where the project costs can be influenced by external variables, such as market prices or unforeseen circumstances.
For example, a construction management small business firm might agree to a fee based on a percentage of the overall construction cost. If the client opts for more expensive materials or additional features, the firm's fee would proportionally increase. This arrangement aligns the interests of the service provider with the client, as it ties the compensation directly to the scale and complexity of the project. It offers a degree of flexibility that can be mutually beneficial but also requires clear definition and understanding of the base value and percentage applied.
Another easy example is if you have a contract to work on a home that was in a fire. Your normal contract amount for the rehab job is $100,000, but your client received an insurance settlement for only $75,000. So, you agree to work on a percentage, based on the settlement. Now you must increase employee utilization rates by 25% to retain the same profitability.
A "Recurring with Cap" contract type is an arrangement where types of professional services firms such as a law firm or even a software development business charges the client a fixed recurring amount, usually on a monthly basis, until the total payment reaches a predetermined cap. Essentially, it's like a fixed fee contract divided into even installments, with a clear ceiling on the overall cost.
This contract type is commonly used when a project spans over a longer period and involves consistent ongoing work. It allows both the service provider and the client to manage cash flow better, spreading payments over time. A professional services firm might choose this contract for a long-term consulting engagement or a multi-phase development project. The recurring payments provide steady revenue for the firm and make budgeting easier for the client, while the cap ensures that the total costs stay within an agreed-upon limit. This approach fosters a sense of predictability and stability in the financial relationship, but it requires a clear understanding of the scope and timing of the work to ensure that the cap is set at an appropriate level for the value provided.
All fixed fee contract types in BQE CORE will track your billing, compared with the contract total. Once your billing hits that ceiling, all billable time will be automatically marked non-billable. You can override these settings on a project by project basis if you need to.
Hourly types of service contracts have no fixed contract amount. You work, you track the hours, and you bill the hours. You can record a contract amount for reference in BQE CORE, but if you choose hourly as the contract type, the contract amount has no implications, as it does with fixed fee contracts.
When should you use it?
When is the client willing to agree to it? As much as this seems attractive like you’re covered because you get paid for the time you work, you could actually be losing money. As your firm gets better at the work, and you get more efficient, it takes fewer hours to get the job done. Now you’re getting paid less while the deliverables have not changed. Clients are getting the same value. You are getting a cut in pay, for being good at your job.
A "Cost + Percentage" contract type is an agreement in which the professional services firm charges the client for the actual costs incurred during the project, plus an additional percentage of those costs as a fee. Essentially, the firm's compensation is tied directly to the costs of the project, allowing them to cover their expenses and earn a profit through the additional percentage.
This contract type is often used in scenarios where the exact costs of a project are uncertain or can vary widely due to the nature of the work or fluctuating prices of materials or resources. For example, a construction or engineering firm might employ this contract for a project where there might be unforeseen challenges or the need for specialized materials that could affect costs. By tying the fee to the actual costs, the firm ensures that they are compensated for the real expenses incurred, plus a set margin for their services.
The "Cost + Percentage" approach provides flexibility and can help align the interests of the client and the firm, as both parties will be motivated to control costs. However, it also requires clear communication, transparency, and diligent tracking of all costs to ensure that both sides have a mutual understanding of what constitutes a legitimate project cost and what the final bill might be. It may be best suited for clients and service providers who have a strong working relationship and a shared understanding of the project's complexity and potential risks.
This is just like Cost + Percentage but based on a fixed fee instead of a percentage.
A "Cost + Fixed Fee" contract type is an agreement where the professional services firm charges the client for the actual costs incurred during the project, plus a predetermined fixed fee. Unlike the "Cost + Percentage" model, where the fee is a percentage of the costs, here the additional fee is set in advance and does not fluctuate with the project costs.
This type of contract is typically used when there's a need for flexibility in covering unpredictable or variable costs, but both the client and the service provider want to have a firm understanding of the profit or management fee involved. It's commonly employed in industries like construction, engineering, or consulting for complex projects where the exact costs may be hard to estimate in advance.
The "Cost + Fixed Fee" model provides transparency, allowing the client to see the actual costs and understand the specific fee being charged by the firm. It can build trust, as the firm has no incentive to inflate costs (since their fee remains constant), but they are also protected if the costs turn out to be higher than anticipated. However, success with this contract type requires careful definition of what constitutes a cost, meticulous tracking of all expenses, and clear communication between both parties. It may be best suited for intricate projects where both sides are looking for a balance between flexibility in covering costs and predictability in fees on a certain time frame.
Most firms find the Cost + methods are overly complex. I would much rather simply bill a flat fee and come up with a payment schedule. My favorite kind of payment scheduled is 100% up front. If that doesn’t work, then 50% up front, and 50% on completion. Simple.
A "Recurring" contract type is an agreement where the professional services firm charges the client a fixed amount at regular intervals, such as monthly or quarterly, for ongoing services. This continues indefinitely until the project is completed or until either party chooses to terminate the contract, depending on the terms.
This type of contract is often used for services that require continuous, regular attention, such as maintenance, support, monitoring, or long-term consulting engagements. For example, an IT services firm might have a recurring contract with a client to provide continuous network monitoring and maintenance, billing the client monthly for the service.
The "Recurring" contract model offers several advantages for both the service provider, subcontractor, and the client. For the firm, it provides a steady and predictable revenue stream based on your timelines, making it easier to manage cash flow and plan for future business activities. For the client, it offers the convenience of regular, scheduled payments and ensures continuous access to the necessary services. This model fosters a long-term relationship and aligns the interests of both parties, as the service provider is motivated to keep delivering value to maintain the ongoing revenue, while the client benefits from uninterrupted service. It's essential, however, to have clear agreements on the scope of work, deliverables, and conditions for termination to make this type of contract successful.
This is your classic retainer type contract. Your clients pay a fixed, recurring amount, each month. It is also clear what they are getting from you each month, X number of videos, weekly calls, reports, etc…
This is really a fixed fee contract on a recurring basis.
This is a recurring contract, where you bill your expenses back to the client, over and above the agreed upon recurring contract amount.
When should you use this?
This is used in the same scenario as a recurring contract, but where you know you will have significant and unpredictable expenses associated with doing the work. Imagine if you were asked to speak at an industry event. This is the kind of contract you would use. It’s based on a daily fee, plus travel expenses. Then you would be at their disposal--as many talks or panels as they want you to participate in.
Let’s say you have a fixed fee pricing model or plan with a cap on the number of hours. That’s really just an hourly model, but let’s ignore that for the moment.
In these types of contracts, there is often a clause that says something like, “. up to 10 hours per month, plus $150/hour thereafter.” This is recurring plus hourly.
When should you use this?
When you want to offer what looks like fixed fee pricing, but you want to hedge yourself against people taking advantage of you.
This brings us to our last group of contract types.
"Non-billable" contract terms refer to activities or components within a project that are not charged directly to the client. These might include internal administrative tasks, auditing services, marketing efforts, training, or other activities that are essential to the business but don't constitute a direct part of the service provided to a specific client.
For professional services firms, tracking non-billable time is essential for understanding the full cost of running the business and the time invested in non-revenue-generating activities. While these tasks are not billed to the client, they play a crucial role in the overall functioning and growth of the firm, and understanding them can help in assessing productivity, planning capacity, and determining overall profitability.
Oftentimes we start working on the project before it becomes a project. From taking the prospective client out to dinner to spending hours preparing a proposal, there may be significant time and expenses spent on a client before they ever become one.
This is good information to have.
Using the marketing contract type on a project in BQE CORE’s time tracking feature allows you to track exactly these sorts of things.
This is how you can set up a project or projects in order to track time and expenses spent on your own firm. All your admin costs and anything you will never bill to or associate with a client can go into a project like this. It’s a great way to create a cost center, to track the costs needed to determine your burden rate.
You want to choose your contract types wisely. When using the best contract type for your professional services firm, you can receive the most profits from your projects.
BQE CORE was designed for the A/E and professional services industries to make managing your firm as easy as possible. With robust features that include project management, time and expense tracking, billing and invoicing, and HR, you can manage your projects in real-time and reap the rewards.
