Contract Pricing

Quick Quiz

By Barbee Davis, MA, PHR, PMP

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My company wants me to head a project to set up a consulting business using our current employees. I have been told to price services so that we make at least a 5% profit on the hours our people work. How do I calculate my profitability?

1. Find out what your competition charges and undercut them by $5.37 per hour.
2. Use a Cost Plus contract, then use international billing standards to pick your price.
3. Use a Time and Materials contract and calculate profit using current salary numbers plus a materials fee.
4. Use a Firm Fixed Price contract and add 5% to your actual costs.

C. Use a Time and Materials contract and calculate profit using current salary numbers, plus a materials fee.
Reputable consulting firms have a variety of ways to calculate their prices depending on their industry and the amount of risk they assume under the contract. For a new venture such as yours, one way that works is to use a Time and Materials (T&M) contract and understand how to do the math to be sure you meet your profitability goals.
Time and Materials means you will bill your customer a standard hourly rate for the services you provide in each of several labor or role categories, and you will also bill for the cost of materials plus a disclosed amount for your profit on the materials.
For example, you are preparing a contract that calls for 50 hours of developer work and 100 hours of testing work. (Substitute the types of worker roles for your industry and the math will still work.) You also will provide $750 in testing software and $250 in training manuals for the end-users plus a 3% fee for these materials. You know the per-hour range for the developers and testers in your organization, so you test out a per-hour fee of $80 for developers and $45 for testers to see if it brings you your profit goal of 5% or more.
($80 * 50 hrs.) + ($45 * 100 hrs.) + ($750 + $250) * 1.03 = Contract Amount
     ($4,000)      +         ($4,500)       +        ($1,030)               = $9,530 Contract Amount
Contract Revenue for Developers = $4,000
Contract Revenue for Tester          = $4,500
Total Labor Revenue                         $8,500
Now you look at your actual people and see that the first developer, Venkat, makes $82 per hour (more than the contract amount) and the second one, Alezia, earns $70 an hour (less than the contract amount). Each of them will work 25 hours of the 50 hours needed. The tester, Luis, is paid $42 per hour and can fulfill the entire 100 hrs. you promised your customer.
$82 * 25 hrs. + $70 * 25 hrs. + $42 * 100 = Actual Cost of Labor
     ($2,050)    +      ($1,750)    +  ($4,200)  = $8,000 Actual Cost of Labor
To figure profitability, take the difference between the Total Labor Revenue and the Actual Cost of Labor and divide it by the Total Labor Revenue.
($8,500 - $8,000)/ $8,500 = Profit Margin on Labor
          ($500)          / $8,500 = 5.9% Profit Margin on Labor
If the answer doesn’t meet your goals, adjust the amount per hour you will charge the client for labor. Of course, you will want to check the market to see if you are overpricing your services. You do have the risk that Alezia, the lower-priced developer, will be promoted or quit and you will have to replace her with a higher-rate person. Or Venkat might have skill sets that require him to contribute more than half the planned hours on the project. But currently you do have a profit margin that will exceed your goal, allow a risk margin, and also make a contribution to the overhead for the project.
To add in the profit on the materials:
$500 Labor Profit + $30 Materials Profit/Contract Amount = Total Profit
                         ($530)                                 / $9,530                   = 5.6% Total Profit
Move ahead with confidence that your contract processes and employee risks allow you to make the 5% profit goal set out in your project charter.
Barbee Davis, MA, PHR, PMP, is a reviewer for the global PMI Registered Education Provider Review Team. She owns Davis Consulting and is a published author, speaker, writer of training materials and an innovator in presentation skill workshops for corporate trainers. She holds a Black Belt in MS Project and teaches at the university level.
Barbee’s latest book, Quick Quizzes for Project Managers, is now available for ordering. Her book, 97 Things Every Project Manager Should Know, includes practical tips from experienced project managers around the world. Ms. Davis is available for speaking engagements and encourages your questions or comments.