When you are dealing with Consultants, Accountants or Law Firms, many times you will be working under a form of time and materials arrangement. As with every other type of time and materials arrangement, you need to be concerned that the proper structure is in place to manage costs.
In any time and materials type of arrangement, it is important to understand what type of expenses are included in the hourly rate and what may be billed as an expense. As there is no standard, the billing practices will vary from firm to firm, and what is included in one company's hourly rate may be a billable expense for another company.
For time and materials professionals services there are a number of ways in which firms may try to get a billing advantage. It's important that you understand the practices so you can manage your costs. It's also important to be able to compare the estimated cost of services between different firms. Here are some of the types of things which you should check:
Most firms will have multiple levels of professionals and support staff. Check
to see that the rate for each of the levels is appropriate for the type of work they
will be doing. It should be comparable to rates charged by competing firms.
I always do a rate sanity check by looking at the rate in terms of an annual salary (e.g. hourly rate x 2080 hours). I then divide that by a multiplier of 2.5 to see approximately what that means in terms of the annual salary for the individual and compare that against what I feel it's worth in the marketplace. My 2.5 multiple is an average which allows for fringe benefits, contribution to overhead and profit and down time of approximately 40% of the possible billable hours for real downtime, vacations, holidays and sick time. Here's how it works. If a consultant bills at $300./hr you multiple the $3000 x 2080 = $624,000 which is the annualized billing rate. I then divided by 2.5 which in this case equals $249.600. So If I didn't feel that someone charging $300/hr was worth a salary of 250,000 a year in pay, I would try to negotiate substantial reductions in the rate. If I thought the number of non-billable hours was a lesser percentage because they would have less downtime, I would negotiate harder.
A key to negotiating with them is basic supply and demand. If they are experts, or are really busy they may be able to command their price. If there is excess capacity or the work requires skills which are readily available, you can push much harder on the rates. Principals of consultants may sometimes link their rate to their self worth, so negotiating with them on their rates can be difficult, as you are attacking their perception of their self worth. If you face this there are several ways to go. One is to not go after their rate but focus on negotiating all the other rates. The other approach is to allow them to charge their rate but look for more from them to be included in that rate.
The more you negotiate the rate down, the more vigilant you need to be in terms of managing and checking the hours. It's like winning the battle and losing the war. If you don't manage the hours and costs, the gains you made on the rate will be lost in the hours and charges billed.
Check to ensure that the individuals assigned actually have the skills and experience to be classified to be billing at those rates.
Check to see if they operate under a "billing increments" approach. Firms may bill in increments of 5, 10, 15 or 20 minutes and that has a major impact on your costs. If a principal bills out at $300 per hour under a 20 minute increment system, anything they do will cost a minimum of $100. If they billed out at a 5 minute increment, anything they do will cost a minimum of $25. If you have an activity which may require a number of very short activities, the billing increment becomes very important.
Check their reputation for padding. Remember that their goal is to maximize the number of billable hours. It's also extremely important to check the bills to see that whoever is billing is appropriate for your work. Some firms and their employees have been known to bill time to any activity that they think will pay it just to maximize their billable hours.
Understand what is included in the hourly rates charged. Many firms will also have hourly billable rates for activities of people like records clerks, secretaries, proofreaders, copier operators etc. which become even more difficult to track
If they bill separately for support services, understand what the rates are for all of the different categories and ensure that the rates charged are appropriate for the work and the individuals are appropriate to be billed at those rates.
Understand what the overtime rates are for any non-professional staff members. There may be different rates for nights, weekends, and especially holidays. Make sure that an premium surcharge for overtime is appropriate to the firm's costs.
Understand what their billing practices are for other types of time like travel time, meals. When is the clock on and when is it off ?
Understand what their rates or surcharges are for incidental expenses such as phones, faxes, copies, travel, meals, services, couriers . This is traditionally a huge area for their making additional profit if you don't aggressively manage it. Copies which cost $.02 could be billed at $.50 per page. Also check their practices to see if any will drive your costs such as extra file copies or other record keeping practices.
Understand what surcharge or mark-up will be charged for subcontractors, specialists, which may need to be hired.
Understand what their travel policy is and what types of miscellaneous expenses they reimburse. They may have very expensive tastes when you are the one paying for it.
Understand what travel will be required. Understand whose responsibility it is to pay for any incremental travel for things such as their failure to complete the work on time.
Understand whether there are any other miscellaneous expenses which they may charge and what the rates are for them. E.g. Is there a charge to use their conference rooms, if parking is validated, is it later billed to you. Are there charges for things like HVAC charges for work to be performed at night, on weekends or holidays when systems are normally shut down. What are they ?
Ask them to define the circumstances where you will not be billed for their problems or errors. E.g. if it takes an extra trip because they failed to do something they should have, do you pay them for all of the time and expenses associated with that extra trip. E.g. If they forgot a document and needed to have it faxed to them will the bill you for the fax and the secretary's time to fax the document ?
Ask them to show you their billing process with samples of time records, and invoices.
While many of there tips also apply to any type of time and material work, they are especially important for managing cost of professional services:
Check to see that the rate for each of the levels is appropriate. In addition to checking the rate is is important to control the staffing levels and level of effort of each category.
Require a budget of time broken down by each of the categories which must be managed to, so your work isn't burdened with their highest priced principals unless they are needed.
Interview the individuals assigned and negotiate rates for those with skills and experience which are disproportionate to their billing rates.
Ask for rates to be adjusted or individuals replaced if during the work you discover that the rate was in-appropriate, or ask for an adjustment to cover their learning curve at the higher rate.
If they operate under a "billing increments" approach, negotiate the lowest possible billing increment or a reduced rate to offset the added costs which the billing increment will create.
To manage padding of hours, require a budget and weekly billing reports to see that who is billing to insure that their are appropriate for your work.
Do a spot check at their firm to see if the individuals billing are actually working on your work.
Define exactly what is included in the hourly rates charged by professional staff and what other hourly rates or reimbursable expenses are authorized.
Require a budget and weekly billing reports for any support services to see that who is billing is appropriate for your work.
Check the support individuals to see that they are appropriate to be billed at those rates.
Establish overtime rates are for any non-professional staff members.
Negotiate a reduced mark-up for their overhead and profit on overtime and holiday pay to something consistent with their real costs.
Include a definition of what time can be billed and what is considered overhead or a cost of doing business which must be included in the rate.
Negotiate as much as possible what is to be included in direct time.
Define what expenses are classified as reimbursable and which are included in overhead which is part of the hourly rate.
Include negotiated unit prices for all reimbursable standard expenses.
Include a negotiated percentage mark-up which is allowable over direct cost for all other reimbursable expenses.
Agree in advance on their practices to eliminate any practices which add cost and don't provide appropriate value in comparison to the cost.
Negotiate a percentage surcharge or mark-up for any subcontractors, specialists, consultants.
If their travel policy is too lose, negotiate the parameters or require them to travel in accordance with your company's policy for the same level individuals.
Set a budget for both the number of trips and amount of travel expense and require justification and advance approval to exceed it.
Establish a procedure whereby reimbursement of expenses is tied to performance such as all travel after the agreed completion date which is required to complete the work will be at their expense.
Protect against miscellaneous expenses by defining the allowable reimbursable expenses.
Require that all other miscellaneous expenses be treated as non-reimbursable, unless those expenses have been specifically requested and approved by you.
Tie reimbursement of both fees and expenses to performance. Establish a maximum fee amount for both.
Require fees and expenses be stopped or reduced in the event of either the failure to complete the work on time.
Require that fees be stopped or reduced if work is required to be redone to correct their errors.
Closely monitor all invoices. Require back-up documentation be provided with invoices.
Perform spot checks and audits.
Establish the required format and content for invoice.
Check and question invoices.
Show them that you are monitoring the situation and will be reviewing all of the billings, charges, time records etc.
Be especially vigilant during economic bad times where the incentive is to drive up billable hours, make profit from incidental expenses and even staff work with in-appropriate senior level staff to keep them billing.
Avoid situations where both sides have a financial incentive to complicate the activity (such as both companies have outside counsel in negotiations who are both on the clock).
Manage what they do and the level they do it to make sure that they don't "overkill" the situation to drive up their billable hours.
If you are able to establish a fixed scope of work for them to perform, aggressively push to get a fixed fee, or a guaranteed maximum amount for the work.
Never agree to compensate them on a percentage of cost of an item, especially if they have the ability to drive or influence the cost up. For example, Architectural consultants want to charge a fee as a percentage of the final cost. If you allow that you need to be extremely vigilant that what they design, the materials they select, the processes required, etc., don't un-necessarily drive up your costs.
Never agree to compensate them on a percentage of the savings or recovery unless you have a good understanding what that will equate to and feel that its reasonable for their services.
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