Consulting firms often use this second ratio and apply differential rates to different categories of consultants. A typical time utilization rate is 80–90 per cent for operating staff, 60–80 per cent for senior staff (supervisors, team leaders) and 15–50 per cent for higher management staff (partners, senior partners, officers). Operating consultants can achieve high utilization rates thanks to the marketing, planning and coordination done by their senior colleagues. Data from various countries indicate that single practitioners who take care of their own marketing and administration achieve utilization rates of 55–65 per cent, since many of them have to spend as much as 20–25 per cent of their time on marketing (see Chapter 29).

30.2 Costing chargeable services

Fee per unit of time

The time unit used by most consultants in calculating fees is one working day, but some consultants use weekly or hourly rates. The basic consideration is simple: every fee-earning day has to earn a corresponding proportion of the total budgeted income. This, of course, is an average figure. The actual fee will be influenced by other factors, as will be shown in section 30.3.

Let us use the hypothetical example of a consulting unit described in section 35.2 and assume that the time budget of the 20 operating consultants in that unit is 190 days each and that the six senior consultants should achieve 130 chargeable days each. To keep things simple, the unit’s director and the two trainees attached to the unit do not do any directly chargeable work. Let us assume, too, that the unit’s target income is $3,898,000, which corresponds to the operating budget (total income) shown in table 33.1 (Chapter 33). The average daily fee rate will then be:

Fees for various categories of consultant

Charging the same daily rate for all consultants irrespective of their experience and seniority would be a wrong policy. Many clients would insist on having only senior consultants assigned to their projects if they could get them for the same price. In contrast, some tasks that can be done by less experienced consultants would become too costly. Most consulting firms therefore apply differential fee

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rates for different categories of consultant. The difference in fee rates charged for various categories of consultant can be quite large (1:3 or more).

In our hypothetical case the rate for an operating consultant may be set at $800 and for a senior consultant at $1,100. This will permit the unit to achieve the same total income, assuming that the projected time utilization is attained by both categories.

Fee/salary ratio

Another ratio used by consulting organizations (the so-called “factor” or “multiple”) compares the salaries paid to the fee-earning consultants with the total fees earned as follows:

Total fees earned

= Factor

Salaries

The value of this ratio in most consulting firms is between 2.5 and 4.0, but higher ratios are not uncommon in large firms. Tables 33.1 and 33.2 (Chapter 33) show an expense structure of a hypothetical consulting firm and provide data from which the factor can be calculated.

A single practitioner can often achieve a lower ratio by operating with lower overhead expenses. For example, if he or she spends 27 per cent of the 225 days available (i.e. 60 days) on marketing, administration and other non-chargeable activities, total annual income may be $150,000 (salary $85,000, social charges $20,000, various overhead expenses $30,000 and profit $15,000), to be earned in 165 chargeable days. The per diem fee is thus $910, while the “multiple” is 1.76 (i.e. 150/85).

30.3 Marketing-policy considerations

Even if time-based fees are applied, the actual fees are not the result of a simple arithmetical operation apportioning the total income to be earned to the projected fee-earning days. Some other factors need to be taken into consideration.

Consulting fees are simultaneously an instrument of general, financial and marketing management policy. Consultants have to keep in mind not only how much the service sold costs them and what income they must earn but, at the same time, what fee is appropriate in a particular market and how much the clients will be able and willing to pay for the service provided.

Normal fee level

A “normal” fee level may be well established and generally known, and may even be recommended by a professional association (e.g. as minimum and maximum fees). Fees higher than the suggested maximum would then be acceptable only

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for certain special services, or might have to be justified in detail. In some countries legislation protecting free competition forbids the setting of any compulsory or recommended fee levels by professional associations or other bodies. However, statistical data and informal advice on fees may be available.

Fees charged by competitors

As in other areas, the consultant should find out how competitors calculate fees, what pricing policy they follow and what the clients think about their fees. It is equally useful to find out about the fees charged by other colleagues in the profession, who are not competitors.

Fees for different market segments

Different segments of the market served may require different fees. For instance, lower fees may be charged to small enterprises and non-profit-making social organizations than to important multinational or national business corporations. Some consultants follow this policy, while others consider it inappropriate.

Promotional fees

A promotional fee (say 10–15 per cent lower than a normal fee) is sometimes used in launching a new type of service in order to stimulate clients’ interest. It is understood that it will be increased to a normal level at the end of the promotional period. This is acceptable if the clients are aware of it. It is unprofessional to interest clients in a new service and then increase the fee without warning.

Subsidized fees

Governmental consulting services may be able, or even obliged, to charge lower fees to some or all clients. This is possible thanks to government financing, whose purpose is to promote consulting and make it available to clients who would be discouraged by high fees. In some countries even private consultants may be able to work for low fees thanks to government subsidies under special schemes for assisting small enterprises, encouraging businesses to move to new geographical areas, helping underprivileged social groups to start new businesses, and similar. Alternatively, the consultant may charge a normal fee but the client may have the possibility to apply for reimbursement or a subsidy (see section 24.5).

Fees determined by clients

Government agencies or other clients may have established maximum fee levels and are unable to go beyond these in recruiting a consultant. Some consultants accept these imposed fee levels in working for clients from whom they get, or hope to get, a fair amount of business.

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Congruence of fees with the consultant’s image

The level of fees charged and the fee-setting technique used are elements of the consultant’s professional image. Thus, a consultant who is positioned as a high-level adviser to top managers on corporate strategy issues would consistently charge higher fees than one involved in routine reorganization of office operations.

30.4 Principal fee-setting methods

Management consultants use several methods of setting fees. This reflects differences in the jobs they do and the views on appropriate ways of remunerating professional services.

Fee per unit of time

The traditional and probably still preferred method is to charge a fee according to the time spent working for a client. The unit of time used is one working day (eight hours) in most cases, but it can be one hour, one week, or one month (in long assignments).

As mentioned in the previous section, differential fee rates are normally used for different levels or ranks of consulting staff. The ratio between the fee charged for a senior expert and that for an operating consultant can be as high as 3:1. Research assistants and junior (entry-level) consultants are likely to be charged for at a lower rate than operating consultants (usually 30–50 per cent of their rate).

Easy and clear fee calculation and billing are major advantages of this technique. The clients are billed after agreed periods of time (e.g. monthly) for the time actually worked by the consulting team in the previous month. Many consultants consider this to be the only correct way of charging for professional work.

Yet objections have been raised to the notion of fees per unit of time. The client is billed for the time used and not for the intellectual input made or work accomplished. He or she might even be billed for time totally wasted, and therefore has to trust the consultant’s professional integrity and competence. Or he has to control the progress of the assignment in considerable detail to be sure that he is paying not only for the time used, but also for the product as agreed in the contract.

Some clients object that this sort of fee encourages the consultant to take more time than necessary and to try to prolong every assignment. This does occur occasionally. However, it can be avoided if the client examines the consultant’s proposal thoroughly, defines the maximum duration of the assignment in the contract, participates actively in the assignment together with the consultant, and monitors the progress made and results achieved.

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Flat (lump-sum) fee

In this instance the consultant is paid for completing a precisely defined project or job. The advantages to the client are obvious. He or she knows how much the whole job will cost, and can also have an idea of the amount of time to be spent on the project, hence the daily rates used in costing the assignment. Finally, the client may be able to withhold payment, or the last instalment of it, if the job is not completed according to the contract.

In agreeing to these conditions, the consultant must be sure that the project will not cost more than the agreed fee. He or she cannot accept this form of fee if completion of the job depends more on the client’s than on the consultant’s staff. Thus, a flat fee may be charged for a market survey, a feasibility study, a new plant design or a training course, but not for a reorganization which depends much more on decisions and action taken by the client than by the consultant.

It does happen occasionally that a consultant who first agreed to do a job for a fixed price needs more time to complete it and prefers to do it for free rather than to ask for an additional payment. The reason may be that the consultant did not plan and manage the job properly. Or the assignment has taken more time for unforeseen reasons; it is vital to complete it, but the client’s financial position permits no overrunning of costs. This could mean that on such an assignment the consultant will make no profit, or may even fail to recover costs.

A job can also require less time than has been quoted. This can occur if the assignment is not precisely defined and the consultant has made a generous time allowance to reduce risk. Occasionally a smart consultant may submit an excessively high quotation knowing that an uninformed or very busy client will have little insight into the project. In such cases the client will pay too much.

These and other drawbacks of a simple flat-fee arrangement have led to the development of several alternatives:

●in preparing the contract, the client and the consultant examine, in considerable detail, the consulting time and other resources required, and the risks involved;

●to protect the client, a lump sum is set as an upper limit that will not be exceeded: within this limit, if the consultant takes less time, the actual fee is paid on a time basis;

●to protect the consultant, a contingency provision is included in the contract (to be used if unforeseen conditions or events occur);

●competitive bidding is applied and the consultants are asked to justify their fees in detail; the client then analyses several bids and reviews them with the consultants before choosing one of them and approving the fee.

In current consulting practice, flat fees and their variations are becoming increasingly popular. They are the preferred formula in public sector and international technical assistance contracts, where often the direct client or the

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agency sponsoring the project want to have a guarantee that the allocated sum of money will not be exceeded. In addition, the client may be ill equipped for handling details and monitoring the consultant’s work on a daily basis. Consultants, in turn, like these contracts because of the increased flexibility and freedom in organizing their work.

Fee plus royalty

In a growing number of cases, consultants spend time with clients to introduce, adapt and transfer an existing knowledge product (system, methodology, model, training material or similar) of the consulting firm. In these cases, various combined fee-setting formulas may be appropriate, which include separate payments for authorization to use the intellectual product provided and for the work involved in helping the client to use it. As a rule, this fee structure would apply to copyright-protected intellectual property, or patented business or consulting methods (see Appendix 5).

Fees contingent on results

Fees contingent on results – the so-called “contingency fees” – have one or both of the following characteristics: (1) the fee is paid only when specific results are achieved; and (2) the size of the fee depends on the size of the results (savings, profit) achieved.

In theory, this could be an ideal way of remunerating and motivating consultants: the consultant is not paid for spending time at the client’s offices, or for writing reports, but for achieving bottom-line results. Initiative and creativity are encouraged. The client pays only if the results are real and measurable, and the payment is in proportion to the results obtained.

In practice, however, a host of problems arise:

●The consultant may be tempted to focus on easy short-term improvements, producing immediate savings, and neglect measures likely to produce benefits in the long run (such as preventive maintenance, staff development, or R&D). Excellent short-term results may even be the cause of future losses.

●It is often difficult to identify and measure real results achieved by the consultant’s intervention, and separate them from other results achieved by the client.

●If results are not easily measurable, the client’s and the consultant’s assessment of the results may be very different (for example, they may have different quality standards), in which case disagreement and conflict are difficult to avoid.

●Sometimes the projected results are not achieved through the fault of the client, or owing to environmental forces that the client does not control, and the consultant cannot do anything about it.

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●It is not easy to decide when the consultant should be paid if the results can only be measured long after the end of the assignment.

●If the client company is in difficulties, the projected results may never be attained and the consultant will get no fee whatsoever.

Contingency fees have been one of the most controversial issues in management consulting. For many years they were banned by the consultants’ codes of ethics. This ban has been lifted in most countries and contingency fees are no longer regarded as unethical. This, however, does not remove the technical problems involved in their use.

Some management consultants (as well as chartered accountants) continue to reject contingency fees. Other consultants use this method of payment if they feel that they can accept the risk involved, that the client will get a substantial and measurable economic benefit, and that contingency payment is the most appropriate acknowledgement of the consultant’s contribution to the improvement of the client’s business.

The use of contingency fees is more common in the United States, where it has increased over the last few years, than in other countries. Most American consultants do contingency work at least some of the time. This is often explained by the more entrepreneurial attitudes of American consultants.

Equity participation

In searching for new and flexible fee arrangements convenient to certain sorts of client, some consultants have started accepting equity in payment for their services. As a rule, part of the payment would be due in cash and part in equity. This formula has been used in working for promising high-technology firms requiring substantial management and business development consulting assistance, but unable to pay the full cost of this assistance on account of a cash shortage. It became very popular during the Internet and e-business boom of 1998–2000, which saw the emergence of new formulas of consultant association with the creation of new firms and initial public offerings.

This is a sort of contingency payment since the value of equity will reflect the results actually achieved by the client firm. The consultant intervenes in a similar way to a venture capitalist. Indeed, some large consulting firms have started to provide venture capital as a line of service, in conjunction with working closely with the client during critical periods of creation and growth of the firm. Some consultants have established separate organizations for venture capital activities remunerated by equity. They undertake not to sell the equity thus earned without the agreement of the client. In these cases, the consultant is taking a considerable risk and is putting great emphasis on implementation and on results that will influence the market price of equity at a time when equity can be sold.

The use of this remuneration formula can thus act as a powerful motivator. It can fairly reflect the real value of the knowledge input made by the consultant to

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a young business or a restructured ailing business. Conversely, it can jeopardize consultant independence and objectivity, lead to various conflicts of interest, and tie the consultant excessively to market and stock-exchange performance of one or a few clients. In choosing this formula, consultants are making a strategic decision on what sort of professional business firm they want to be.

Percentage fee

A percentage fee is a kind of contingency fee, tied to the value of a business transaction, such as a merger, an acquisition, a property deal, a joint venture, a bond issue, or similar. Traditionally, real-estate agents and investment bankers have charged percentage or success fees for their services in these transactions. Percentage fees are common in architecture and civil engineering, where the consulting engineer’s remuneration is often calculated as a percentage of the total project cost plus reimbursable direct cost.

A management or business consultant acting as an intermediary and facilitator, helping a client to negotiate a merger or an acquisition, may work for a percentage fee. Whichever side of the table the client sits, he is interested in negotiating an arrangement which is most favourable to him and acceptable to the other party.2

A typical example of a percentage fee is the Lehman formula, or the 5–4–3–2–1 formula, which continues to be the standard method of structuring the intermediary’s (broker’s or finder’s) fee in mergers and acquisitions, although various modifications of the basic formula are in use. The classic Lehman formula is based on the acquisition price and uses a descending percentage scale as follows:

5 per cent of $1 to $1,000,000

4 per cent of $1,000,001 to $2,000,000

3 per cent of $2,000,001 to $3,000,000

2 per cent of $3,000,001 to $4,000,000

1 per cent of $4,000,001 and up.

Thus, the consultant’s success fee for the sale of a $5 million company would be (0.05+0.04+0.03+0.02+0.01) $1 million = $150,000. An alternative formula is 5 per cent of the first 2 million dollars, 4 per cent of the next 2 million, and so on. Another variant in use is 5 per cent of the first 5 million dollars, 2.5 per cent of the next 10 million, and 0.75 per cent of any amount in excess of 15 million. A fixed percentage fee (say 1 to 3 per cent) is also practised, as well as various bonus formulas, in which a bonus is paid, in addition to the normal fee, if the selling price obtained exceeds a certain limit. The bonus can be calculated as a percentage of the whole transaction or of the part of the price in excess of the agreed amount.

Some consultants prefer different fee formulas so as to be sure to earn something even if the deal fails. For example, a retainer or per diem fee may be

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