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  • 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
    • Fixed-fee
    • Use-based pricing
    • Licensing
    • Hybrid
    • Free

    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.

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