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Consulting Business Models

There are two primary business models in the consulting business, time and materials and fixed price services.

TIME AND MATERIALS

The time and materials business model is where the ICT supplier is paid based on the amount of time that is spent by the ICT supplier’s personnel working on the customer’s projects irrespective of the outcomes that are produced. This is an input based business model where the customer pays the ICT supplier based on the amount of time spent rather than the output of that time.

Within the time and materials business model there are two sub-types of business model:

(a) working under the “direction and control” of the customer;

(b) not working under the “direction and control” of the customer.

The first sub-type of time and materials business is where the customer engages a person to do certain work and provides that person with instructions as to which tasks to do, and when and how to do them. The customer supervises the work and is responsible for the quality of the output. Care should be taken where the ICT supplier is a sole trader (or a sole employee of a shelf company) to ensure that the legal relationship is for the provision of a service rather than an employment relationship. For more details see the AIIA.biz Expert on Employment Law.

The second sub-type of time and materials business is where the customer engages a person to do certain work and that person works unsupervised, usually using the person’s own methodology and tools, and the person determines which tasks to do, and when and how to do them. These types of arrangements are more common for the more specialised types of work and for professional consultants and advisers.

FIXED PRICE SERVICES

The fixed price business model is generally where the ICT supplier provides its personnel to create an agreed outcome for a defined price in a defined period of time. The ICT supplier is paid based on the achievement of the outcome irrespective of the amount of time or other inputs that are needed to create that outcome. This business model is significantly more risky for the ICT supplier as the ICT supplier bears the risk of having underestimated the amount of time and/or other cost inputs that are needed to generate the output.

In particular, where the business model is a fixed price business model there are significant risks to the ICT supplier. The principal issue is to define the deliverable with sufficient accuracy to enable both parties to know when the deliverable has been provided. Under the fixed price business model it is the ICT supplier that bears the risk of having properly estimated the amount of time and other resources that it will take to supply the deliverable. The ICT supplier will generally charge a “risk premium” to take and manage this risk. Accordingly, it is essential that the deliverable is clearly defined, together with any assumptions that the ICT supplier has made as to the resources that it will need to achieve the outcome.

Most ICT projects require a significant contribution from the customer, both in terms of creating and agreeing the original specification for the deliverable, in contributing to the acceptance testing of the deliverable and assisting in migrating any data. All these items should be carefully documented in the agreement so that the customer has an obligation to provide these resources at the correct time and to the correct standard to ensure that the project runs smoothly.

A significant number of fixed price ICT projects involve disputes between the ICT supplier and the customer, primarily over issues of what is in-scope and what is out of scope. This is because the ICT supplier and the customer have completely opposite interests. The ICT supplier has an interest in creating as little functionality as is the bare minimum to ensure that the deliverable meets the agreed specification (because any additional functionality incurs costs for which the ICT supplier is not being paid). Whereas the customer has an interest in obtaining the richest functionality and performance from the ICT supplier because the customer is paying a fixed amount for the deliverable and so having a richer, higher performing deliverable for the same price is in the customer’s interest. Consequently, it is imperative to not only be able to clearly identify the scope of each deliverable but it is also necessary to identify what distinguishes a time and materials contract from a fixed price contract, so that the appropriate estimating and risk management procedures can be put in place prior to entering into the agreements.

KEY CHARACTERISTICS

The characteristic of a time and materials agreement is simply that the ICT supplier is paid for all time that it is engaged in the customer’s project.

Wherever there is a restraint, condition or cap placed on the customer’s obligation to pay for the time that is spent by the ICT supplier, it is prudent to consider this to be a fixed price business model with the appropriate reviews and risk management.

We recommend that an agreement is reviewed as a fixed price agreement where it includes any of the following characteristics:

1. There is a requirement for acceptance tests for the deliverable, with the customer not being obliged to pay for the work done unless the deliverable passes the acceptance test.

2. There is a fixed or defined time by which a particular outcome has to be achieved.

3. There is a fee arrangement under which there is an upper limit placed on the amount that can be billed, particularly if there is an outcome that has to be delivered within the upper limit. This type of business model is called a “capped time and materials model” and is in fact the worst of both worlds for the ICT supplier. This is because the ICT supplier is paid on a time and materials basis but in fact takes the risk of a fixed price contract. The ICT supplier does not get the “risk premium” that the ICT supplier would usually require when entering into a fixed price agreement. Essentially, the customer gets the benefit of the ICT supplier performing its services efficiently by paying on a time and materials basis, yet also gets the benefit of the ICT supplier underestimating the task. This is because the customer’s exposure to pay the ICT supplier is limited by the cap on the time and materials.

ABOUT BUYING CONSULTING SERVICES

including on-selling those resources to your customer.

An ICT Supplier often engages a contractor to provide ICT services; either to provide services for in-house use or to use the contractor on a project with the ICT supplier’s customer. In doing so the ICT Supplier should take particular care to ensure that it has a contract with the contractor, as amongst other things the contractor, and not the ICT supplier, will be the owner of any software or documentation that is created by the contractor. In fact all the issues that are mentioned in the Software Business section as being concerns for buyers of the ICT supplier’s consulting services will apply to the ICT supplier when it is buying services from a contractor.

The ICT supplier should take particular care on the following issues:

How does the ICT supplier control the amounts charged by the contractor?
When is payment to be made?
How are expenses charged?
Who owns the intellectual property in the deliverables? Can the deliverables be sub-licensed to the customer, and if so, on what terms?
Whether the liability of either party is capped, and if so what, if any, are the exclusions?
Whether the ICT supplier can terminate the contractor’s services for convenience, and if so, are there any financial or other consequences?
If the contractor is being hired to provide services in connection with a contract between the ICT supplier and its customer, what rights and obligations does the ICT supplier have in its contract with its customer, and how do those rights and obligations compare with the ICT supplier’s rights and obligations in the contract with the contractor.

Next, learn about Acceptance Testing.

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Master Time & Materials Consulting Agreement Fixed Price Software Development Agreement Master Design Services Agreement Master Website Development Agreement Contractor Agreement (for sell through)

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