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Doing the Calculus

November 9, 2010 — Leave a comment

How do you  compute a fixed cost that is sure to be profitable?  I should start by admitting that everyone takes a loss at some point, but this is true for all types of pricing models, even straight time & materials.   However, the norm should be higher profit margins, not loss.  So how do you do it?  This topic deserves a book, which I may write one day, but for now, a few pointers (I am also contemplating a short video on the subject in the near future).

1. Complete the discovery process.  This means taking time to analyze the situation, talk with the appropriate people, really understand what they have in place, and what needs to be done.  You can short cut this process, thinking it’s too expensive, but you throw away two things by doing this.  First, you won’t have as much of an opportunity to sell your value across all key influencers and decision makers. Second, you won’t have the inside scoop on what the project entails, which later becomes your basis for building justification.

2. Based on your understanding of their need, the perceived value to the client, and market rate, come up with a price.  Let’s say this project is central to protecting their billion dollar secret process…what’s it worth to secure it if the likelihood is high?  This takes practice and guts.  I start with perceived value, consider pricing, then compare to market rates.  I don’t mind being the most expensive as long as I can justify my price through experience and testimonies.  Most of the time, value far exceeds T&M pricing.  Don’t be surprised if your project earns you $10,000 in one day vs. your $150/hr rate.

3. Once I have a price, I figure out how much time it will take.  Notice I did not compute my price based on hours. This is the big deception – the idea that a fixed price is your best guess at T&M, presented as a fixed price.  Now, if the cost of doing the job is way more than my price, I may have a problem.  Either I don’t understand what it’s worth, I don’t have an effective way of doing the job (like someone building a house without power tools today), or, what the client wants is not possible within a reasonable number.  Usually it’s number one.  I’ve been beaten down by discount shoppers more than once, but these are not my target clients, and they probably aren’t yours either.  Send them to Dell or CDW where they can cut out the middle man and do most of the engineering and support themselves.

4. Finally, I figure out other options.  I price out the best option, the least option with phases, and a middle option.  Options help the client visualize what they are getting, what lower cost options cut out, and they head off requests for discounts.  Example; If option 1 is 100,000 and option 2 is 75,000, I have already told them what they get for 75000, so there is not reason to select 1 and ask for a 25% discount.  It’s not an option.

© 2010, David Stelzl

Resellers, VARs, Solution Providers, and Channel Managers – this is an important lesson on the profitability of services.  While your (or your partner’s) services may be very profitable, they may not be as profitable as they seem.  As the market has commoditized, I’m seeing far more short product/install contracts…less consultative, long term engagements.  This is particularly  true in the mid and smaller markets. What is the result.

Listen and see how calculations on profit, gross profit, and net profit are sometimes confusing.  To the sales rep, all GP is good – you get paid, right?  To the person with P&L responsibility, the numbers don’t always add up…I frequently run into people who initially think they have strong services margin.  When I show them how to calculate it, we find profits to be much lower apart from the product sales.

© David Stelzl, 2010

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First, don’t miss today’s podcast at http://dstelzl.podbean.com/ – critical information on justification you need to provide before your projects can be approved.  This applies well to the topic of managed services and how you should go about creating the ongoing justification needed to maintain long term managed agreements.  A couple of key points made in yesterday’s teleseminar that deserve repeating:

  • Managed services is a necessary part of building your company going forward. Without it, further commoditization of your product set only produces less margin, and service billing rates for most companies have not increased much over the past 20 years. We were paying $150 in 1988 for network engineers in the southeast; the same fees we’re charging right now in many cases.
  • Valuation numbers for resellers depend on recurring revenue contracts. Ten years ago you might have sold you company for a multiple of revenue – today you might consider a small multiple of EBIT in most cases. Most acquisitions today are fire sales. Only recurring contracts or narrow highly specialized offerings can reverse this trend.
  • Educational based marketing is the number one way to sell this type of program. Most clients are not aware of the risks they are operating with today. Without education, you’ll never come to agreement over the value you’re providing.

In addition we covered how to build it, how to price, what products to use, who should sell it, how to sell it, and how to maintain it and grow it.  If you missed this program – make sure you catch the next one.  You can’t succeed in this economy without changing your game to compete.