Practical pricing advice for consultants
Anjali Oberoi | Pricing a consulting service is a tricky affair. When pricing a physical product, you have at least one objective benchmark upon which to base yourself: cost. Add a reasonable margin on top of what you spent making the product, and voila! This approach is called “bottom-up pricing”. While it is rarely as straightforward as I made it sound, the point here is that determining a fair price range - or at least the minimum acceptable price - for a product is relatively simple.
Pricing is also manageable if you are offering a generic service whose processes and outcomes are predetermined, like say bike-courier, ayurvedic massage, or even legal advice for basic transactions. Minimal market research - a web search and a few phone calls - will give you a sense of the price range in your catchment area. And, the specificities of your service will help you decide where to be in that price range. For example, you might decide to price your massages on the higher end because you use organic coconut oils. That approach is called “top-down pricing”.
Pricing a consulting service is a whole different game whose winning strategy, neither quite top-down nor quite bottom-up, often feels elusive. If a significant portion of what you do involves developing client-specific goals and conducting an analytic or creative process, you likely relate to this observation.
Top-down pricing is hardly applicable because every consulting project is different. Conducting market research will undoubtedly deliver valuable insight on what your competition is doing, but will quickly turn into a wild goose chase if you are attempting to pin a market price on a new project.
The main challenge to bottom-up pricing is tied to the fact that labor is the dominant cost driver in consulting. Two levels of complication arise from that. Firstly, projecting the amount of labor needed to complete a project is hard, regardless of experience. Research tells us that human beings are prone to a strikingly illogical cognitive pattern: we can be fully conscious that most of our past forecasts of task times were overly optimistic, yet tend to believe that our current forecasts are realistic. Psychologists call this the “planning fallacy”. While this piece is not about why the planning fallacy occurs, the recommendations we propose below draw from the main theories on the subject. For now, let us just note that this fallacy explains consultants’ tendency to underestimate - often to a gross degree - the efforts needed to complete projects.
Additionally, the price of a consulting project is rarely settled without negotiating with the client. So, it is not just that your offer might be based on uber-optimistic forecasts; it is also that you will be pressured to lower it. And that’s where a second labor-related factor acts insidiously against your interest. Unlike most other resources, consulting labor is generally expandable at zero direct cost. There is an opportunity cost in working 12 hours in a day instead of 8, or working on weekends. However, as a consultant you are probably not thinking about your overtime in such financial terms. More likely, you consider your ability to stretch yourself simply as a risk mitigator - “Worst case, I’ll finish this presentation tonight after dinner.”
Think how peculiar this is in comparison to what happens in activities that deal with physical resources. Imagine you were a baker and received an order for two banana bread loafs. You couldn’t possibly stretch the dough portion for a single loaf enough to fulfill that order. And if you magically could, you would be more open to giving your client a large price discount. That is about what happens when you are a consultant. Your time is a bit like magic dough. Which sounds great until you remember that your competitors have some of that magic dough too and your clients know it. These dynamics create incentives for consultants to drop their prices or shrink project timelines, thus muddying the path from cost estimation to price setting even more. Next thing, you find yourself kneading alone on a Saturday evening while everyone else is having a pizza party.
Can consultants do something to make the pricing process more effective and less anxiogenic? Let us not beat around the bush - the risks I mention in this piece cannot be systematically eliminated because they are intrinsic to the nature of consulting. There are however, ways to mitigate them. For a start, here are three things you should do to counter the influence of the planning fallacy on your cost estimations:
Keep a record of past forecasts and actuals. You can click on the image to the right to download a basic Excel template for keeping a record of past projects. This file can be used in two ways: Firstly, to monitor the gap between the level of effort forecasted and actually spent on every past project; and secondly to get some top-down guidance on how to price a new project from looking at comparable past projects. For the latter to work, it is important to note down details: What were the objectives of the project? What was the fee you proposed? Did you offer a discount? How long was the project? How many senior/junior person-hours did you budget for? How many senior/junior person-hours did you actually spend? Etc.
Trust the numbers, and don’t ignore outliers. People have a tendency to rationalize past failures, and minimize or even ignore them while making new plans. This is one of the core reasons behind the planning fallacy. However you might explain that a project went haywire, make sure to record it accurately and to take it into account when you are measuring your historical forecasts vs. actuals. The point here is not to deny that an accident occurred and that you could possibly prevent it in similar circumstances in the future. The point is to recognize and account for the fact that accidents of such magnitude (“outliers”) do occur. Trust the numbers over your gut feeling.
Run your plan by a peer. One paradox of the planning fallacy is that it only affects oneself. As it turns out, we are much better at forecasting others’ task-completion times than our own. The upside of this is that if you have access to colleagues who understand the nature of your work, you can get valuable feedback on the plans you draft. Before you send a proposal to a client, run your numbers by a peer and ask “do you think this is realistic?”
Having mitigated the risk of under-budgeting your offer, you are still left with the structural disadvantage that consultants face at the negotiation table - call it the (un)magic dough factor. One way to deal with that consists of shifting the focus of your discussions with the client from price to work scope. Do not just describe your deliverable. Give your client the big factory tour. Talk about the experts you will recruit, the parties you will engage, the data you will collect, the analysis you will perform, and how you plan to approach ideation and concept development.
If your client is asking for a discount, they might just be out of budget, or thinking they could get a better deal with a competitor of yours. And, if it is the latter, you should give a chance to proving the added value of your specific proposition. Discussing only the fees means tacitly accepting that what you offer is a generic service, amongst several substitutes on the market. Focusing the discussion on the scope of work sends the opposite message: Not all consulting services are equal, and what you offer is unique. Truly, effective pricing and good branding go hand in hand.
* Illustration by Dannae Alvarez