Pricing Models
When design firms sell work, there are several very different
ways to structure the compensation. The most common formats
are:
Time and materials
This is the simplest approach although it's not the best. When
working on a project, you track the actual hours and bill them to
the client at agreed-upon hourly rates. In addition, you track
out-of-pocket expenses and bill the client for reimbursement.
Travel-related expenses are usually reimbursed at cost, but all
other expenses should be subject to a standard markup of 20
percent. Why is that? It's to compensate you for the administrative
time involved in making those purchases and paying those vendors,
plus the fact that your own cash has been used, which otherwise
would have been invested and earning interest. A time and materials
relationship involves a certain amount of trust. The client must
have confidence that you won't leave the meter running needlessly.
To explain how the time has been used, you must provide a detailed
recap of all activity on a regular basis, usually at the end of
each month. A time and materials relationship is the easiest to
understand and document, but the big drawback is that your billings
will not reflect the ultimate value or impact of your creative
services.
Fixed-fee
A fixed-fee contract is usually a much better approach for
design firms, but it does come with some risk. Before starting work
on a project, you agree on a flat amount that will be charged for
services. This creates the opportunity for you to make an
entrepreneurial profit or loss, depending on how well you estimate
and manage the work. The goal is for your total price to reflect
the real value of the work to the client, as measured by the
positive impact that it will have on their business. At the same
time, your total price must be competitive within the marketplace
for design services. It's important for your fixed fee proposal to
be very specific about the exact scope of work-what is included and
what is not included. This is because clients will almost always
make additional requests after the project has started. You can
only identify those requests as being outside of the original scope
if indeed that scope was well defined in the first place. When an
additional request is made, you'll have to decide whether you have
the time and resources to take it on. If so, estimate the
additional time and expenses involved and send a change order
document to the client. A change order is in fact a small
additional proposal that must be approved and invoiced separately.
It is outside of the original contract. Because of this, many
change orders are shot down. This is fine. It means that the
process is working and the profit margin that you built into your
original proposal has been protected.
Use-based
Use-based pricing is common for photographers, copywriters and
illustrators, particularly if their work is being used for
advertising or marketing purposes. The price is determined by the
ways in which the finished work will be used or reproduced. Talk
with your client about the usage rights that they need, then sign
an agreement that specifies:
- The category of media to be used (magazine cover, billboard,
etc.)
- The total number of items that will be produced (for example,
if your work is being used on printed materials, the agreement may
specify the size of the print run)
- The geographic area of distribution (North America only, Europe
only, etc.)
- The time period of use (for example, a six-month campaign)
If the client later decides that additional rights are needed,
they will have to come back to you and negotiate additional
payments.
Licensing
Licensing is common for industrial designers or for anyone who
has an image or design that can be applied to manufactured items.
In a licensing relationship, the creative professional is the
licensor, providing an original design. The product company is the
licensee-they provide everything else, including manufacturing,
marketing, inventory control, distribution and customer service.
Compensation to the designer is in the form of a royalty, which is
a percentage of the money received from net sales of the product
(gross sales adjusted for any returns or discounts). In most
product categories, royalties are based on the wholesale price. In
publishing, however, royalties are usually based on the retail
price. Standard royalty rates can vary quite a bit based on the
product category (furniture, gift items, stationery, etc.). They
may be as low as 3 percent or as high as 15 percent. Sometimes the
percentage paid will increase when the product exceeds a certain
sales target (for example when a book sells out and needs to be
reprinted). Licensors with successful past products are in a good
position to negotiate higher royalty rates on future projects. Some
agreements guarantee a minimum total that will be paid to the
licensee over the term of the agreement. A portion of your royalty
may be paid up front as a non-refundable advance (for example, this
is often the case in publishing).
Hybrid
On a large project, a hybrid approach to compensation sometimes
makes the most sense. It's not unusual to see several different
types of compensation included in one deal. For example, an
industrial design firm might be paid a fixed fee for the initial
phases of a project, followed by a royalty to be paid after the new
product goes into mass production.
Free
Finally, you also have the option of giving your work away. Just
be aware that there is “good” free and “bad” free. An example of
“bad” free is speculative work. Spec work is when a client asks you
to generate a few sample ideas without actually hiring you. It's a
kind of test drive-they want to see the visual approach that you
would take. For designers, this short-circuits the normal creative
process because it requires you to jump right to form-giving
without first completing adequate research, analysis and strategy
development. This means that even if the client does later hire
you, it's highly likely that you will need to discard the sample
work and start again in the proper way. Spec work can cost you
quite a bit in payroll and out-of-pocket expenses. It's important
to weigh these ramp-up costs against the potential gain of later
landing the account. For a graphic design firm, that potential gain
might be zero. Clients in the U.S. do not usually sign long-term
contracts for graphic design services-the relationships tend to be
on a project-by-project basis. In addition, labor billings on a
typical print project are often less than $10,000. If you do
several thousand dollars worth of spec work, it's unlikely that
you'll be able to recoup that from the first paid project, and
there is no guarantee that the client will ever give you a second
project. (In the advertising world, spec work makes a bit more
sense because the relationship potential is so much higher. An
advertising agency might spend $100,000 or more on a major pitch
because it could lead to a one or two-year contract to manage a
significant amount of media billings.)
A “bake-off” is a variation of spec work where the client
approaches several firms and offers each of them a very small
amount of money to produce sample creative work. Again this
short-circuits the design process and burdens you with expenses
that are difficult to recoup.
In contrast, “good” free is doing pro bono work. Pro bono
publico is a Latin phrase that means “for the public good.” It
refers to services that are donated to political, social, or
religious organizations. Many designers generously provide their
creative services in support of causes that they are passionate
about. In the United States, there is a tax aspect to this that you should
be aware of. In order to report this type of contribution on your
tax return, the client organization must have federal non-profit
status and you can only deduct actual out-of-pocket expenses. You
cannot deduct the value of your labor.
[Editor's note: please see the AIGA Design Business and Ethics series
for a more extended discussion of the ethical and business issues
associated with speculative work.]
Trade-offs
When negotiating compensation issues with clients, many
designers keep a simple formula in mind: “fast, cheap, good-pick
two.” You won't want to describe the situation to your client in
such a blunt way, but these are in fact the essential trade-offs on
creative projects. For example: on a pro bono project, you won't be
paid, yet you'll want the finished work to be as good as it can
possibly be. The trade-off is that the project will probably take a
little longer to complete. Paid clients will always be given
scheduling priority-after all, it's their projects that pay the
rent. Because of this, pro bono projects often move to the back
burner. In contrast, let's say that a large corporate client comes
to you with a fast-track project that is of great importance to
their business. It has to be fast, and it has to be good. Chances
are that it won't be cheap.
Terminology
When discussing potential projects with clients, be careful
about terminology. When you use a term, it's important to know that
both you and the client understand it to mean exactly the same
thing. As a reference, here are standard definitions for some of
the terms that frequently come during negotiations.
Estimate
An estimate is tentative and non-binding. It is a projection of
the approximate costs that you anticipate on a project. The total
is usually described as a rough “ballpark” figure or presented as a
high/low range.
Quote
A quote is much more precise. It is a firm offer to perform
specified services for a fixed price. For example, printing
companies submit quotes based on the exact specifications provided
to them by clients.
Bid
This term is normally used when a client is seeking competitive
prices from several different suppliers. Many corporations have
strict guidelines for the competitive bidding process.
Letter of agreement
This is a written recap of items that have already been agreed
to orally. It's a bad idea for any creative firm to begin a project
solely on the basis of an oral agreement-always protect yourself by
having a signed document. A letter of agreement is better than
nothing, but it's smarter to submit a complete proposal.
Proposal
A proposal is a detailed project document that defines the scope
of work, the process, the schedule, and the total price (usually in
the form of a fixed fee). It normally includes legal terms and
conditions as well. It is a discussion document where the designer
puts forward a recommended course of action for the client to
consider. Many proposals go through several rounds of changes and
negotiations before they are finalized.
Not-to-exceed
Watch for this term on documents that come to you from the
client-particularly on corporate purchase orders. It indicates the
maximum amount that can be paid for a project, including any taxes,
shipping or other last-minute charges. You will not be able to bill
for anything beyond this total without going through a lengthy
re-authorization process.
About the Author:
Shel is a graphic designer who is active on the business side of professional practice. He has solid experience managing the operations of leading creative firms and guiding them through periods of accelerated growth and rapid change. He has served as director
of operations for MetaDesign San Francisco and as vice president of operations for Clement Mok. He provides management consulting services to a range of creative firms in both traditional and new media. Shel has served on the national board of the Association
of Professional Design Firms and as the president of AIGA San Francisco. He has written and lectured on many topics related to design management and teaches Professional Practice at the Academy of Art in San Francisco, the California College of Arts, and the
University of California.