business advice | Dec 12, 2018 |
What's the best approach to payment schedules?

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Dear Sean,

I’m negotiating payment terms with a prospective client for a large residential construction project. The work could take 18 to 24 months to complete. For longer projects like this, I typically require a larger payment up front, with the remainder broken down into two to three additional payments; for this project, I proposed a schedule based on an initial fee, then 12 equal monthly payments, based on the suggestion of another designer.

Here’s where it gets tricky: The client has rejected both of those options. Instead, they want to pay a percentage of the total project cost to start, then break the project down into smaller scopes of work and pay for each part upon completion. I’m not sure how I feel about that pricing strategy—what would you suggest?

Sincerely,
On the Money


Dear On the Money,

With large, long projects like the one you describe, the critical risk you face is time. To understand this risk, however, you have to evaluate the project from the top down rather than from the bottom up. The bottom-up perspective is based on the assumption that if you receive X percent from the project, and if you get Y number of projects, then you will be able to make Z. The top-down approach, on the other hand, starts with the following questions: How much do I want to make—and how much do I want to work—in a year? For example, if you would like to make $250,000 at the end of the year, have expenses of $230,000 and would like to work on 10 projects per year, each project has to pay you $40,000. If the project lasts 18 months, then $60,000. How you go about getting the $60,000 is another story, but knowing that $60,000 is the right number is where you need to start.

A quick way to figure this out is to calculate how much a project is going to require of your business to reach your goal—in other words, the percentage of your time the project will take up each month. In this example, you need $40,000 per month to cover both your expenses and your projected profit (if you’re following along, here’s the math: $250,000 in annual profit plus $230,000 in annual expenses, divided by 12 months). Next, determine the average percentage of time needed for the project, fully understanding some months will be much busier than others. If you say that this project will take up 25 percent of your time, that’s $10,000 per month. So your fee, based on what you need and how much you want to work, would need to be $180,000 for the 18-month project.

Why focus on time? It’s simple: You need a mechanism to get paid for delays. If the project extends to 24 months through no fault of your own, you need the additional $60,000 to continue meeting your revenue goals.

Most pricing strategies don’t allow for this: Flat fees per phase make delays irrelevant to the payment amount; additional hours will never be enough to equal $10,000 per month; and since the budget will probably increase enough to justify the added expense, charging a percentage is out too. What will certainly never work is to randomly assign payment schedules—as both you and your client suggest—that do not match the process you are about to undertake.

Starting with the idea that $180,000 is the right number based on time and amount of your bandwidth necessary to complete the project, your work is to set out relative value of each phase with requisite payments for each phase in accordance with that value. For argument’s sake, let’s say your design and project management (including installation) skills are equal, but design takes three months and project management takes 15 months. Your fee would then be broken as follows: $30,000 for design and $150,000 for production. If there is a delay not of your doing, the cost is $10,000 per month. Calculate it as a percentage, a flat fee, a phase fee—it does not matter. At the end of the day, your numbers are based on what you need, not what you can get. Start there and the rest will flow accordingly, leading you to a place where the duty to control time is yours and yours alone.

One last note: It is entirely antiquated to have any money due to you upon completion. The reputational risk you face for not doing great work dwarfs whatever carrot you might need by way of the withheld payment. Pre-internet you did not face this risk, but today everyone has a megaphone, and a disgruntled client screams loudest of all. Never ever permit any fee to remain until completion; the practice needs to go the way of the dodo bird, as it serves no one—least of all your client.

____________

Sean Low is the the go-to business coach for interior designers. His clients have included Nate Berkus, Sawyer Berson, Vicente Wolf, Barry Dixon, Kevin Isbell and McGrath II. Low earned his law degree from the University of Pennsylvania, and as founder-president of The Business of Being Creative, he has long consulted for design businesses. In his Business Advice column for BOH, he answers designers’ most pressing questions. Have a dilemma? Shoot us an email—and don’t worry, we'll keep your details anonymous.

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