Performance Pricing: Betting on How Good You Actually Are
Imagine for a second that you’re a successful engineer and mechanic with a steady trickle of customers – much thanks to your excellent skills with engines and people. You’re also the only mechanically skilled person in your family, for which you’ve become their go-to-person when cars break down.
One beautiful spring day with blue skies and fluffy white clouds, your cousin Eric calls you. Eric is usually short on money but rarely on ideas.
“Remember that old car I have in my garage?” Eric says. You indicate that you know the vehicle he refers to. It’s an old race car that he bought off the Internet some years ago, against your advice.
“Some rich guy I met will pay me 10,000 if I can beat the speed record on that straight on the highway,” he continues. Apparently, it’s an old classmate of Eric who left town, made a fortune on stocks, and is now back and looking for ways to spend his gains.
“I know I can do it. But there’s a catch – I need to patch up the engine, and I don’t have the know-how. If you help me, I’ll split the winnings.”
Your cousin just asked you if you’re interested in performance-pricing your services as a mechanical engineer.
How Performance Pricing Works
As we can see from the brief story above, performance pricing involves two things:
A pre-defined price or share of something (usually a result).
A condition for payment.
In the case of Eric’s car, it involves half of the winnings if he wins the bet.
Other performance-price contracts could stipulate a share of some result such as earnings or savings. I once heard of a guy who helped improve the efficiency of a rail network in return for a share of the savings. He earned tens of thousands of euros as a result. The rail company wasn’t expecting that and growled a bit about it but eventually paid. That leads to one of the drawbacks of this type of pricing which we will discuss in a bit.
Performance-pricing isn’t that different from gambling. The difference is that you can, in fact, control the outcome to an extent. But you’re still leaving many things to chance and there’s always an element of risk involved.
Who Uses Performance Pricing?
“Ambulance Chasers” Who Use Contingent Pricing
Contingency pricing is a very common form of performance pricing. Some lawyers practice this form of pricing which means they get a share of the reparations or compensation contingent on some condition – usually the plaintiff being awarded something. This is controversial and by many considered unethical as they argue that it can shift the attorney’s priorities in a way that doesn’t align with the interests of the client. Lawyers that do this systematically are sometimes, and rather unkindly, called “ambulance chasers” since they actively seek legal cases in which damages can be sued for, and shared between plaintiff and attorney.
Real-Estate Agents Who Get a Percentage of the Final Price
Realtors often use a similar model in which they get a percentage of the sale price of a home. At a cursory glance, this makes sense. But it’s not without problems for the seller.
It turns out that a commission based on sale price will not encourage a realtor to work harder to get higher bids. The reason for this is that their share of the increase in final price doesn’t compensate them enough for the work needed to get it.
This was discussed in a bestseller titled Freakonomics. A book I highly recommend. If you’re a frequent reader of this blog, check it out. I’m sure you’ll love it.
Startups Without Cash That Buy Services With Equity
Another form of performance pricing is when the buyer offers equity in return for services. Many developers and designers are familiar with this idea. It’s one way that budding startups try to finance the buying of professional services. We will discuss it in more depth in a bit.
These are just some examples. There are, of course, countless other professions that are paid contingent on a condition or as a share of something.
6 Reasons Why You Should Consider Performance or Contingency Pricing
1. You’re Sure That Your Work Can Make a Measurable Financial Improvement
If your work leads to something that can be easily identified or measured, performance pricing is an option. The keyword here is “measure.“ Most people aren’t used to measuring the results of what they do. Getting around to thinking this way can be a challenge. Especially since these metrics need to be linked to a financial improvement: reduced costs or increased earnings.
The reason why this is so important is that it affects directly how much you’re paid. If you cannot show that you’re achieving savings or earnings for the client, why should they pay you at all?
Metrics Can Give a False Sense of Objectivity
Measuring can also create a false sense of certainty. Metrics are inherently biased and aren’t as objective as some people tend to think.
In the book Weapons of Math Destruction, author Cathy O’Neil explores the various ways that poorly-designed software-enabled metrics cause injustice and reinforce segregation. Meanwhile, the hapless users of the software live under the illusion that the metrics are fair. It’s a computer after all, an “objective” machine, they argue.
Measuring the “Unmeasurable”
Provided you can theoretically find a way to measure the results fairly, you need to define how it’s done. Data can take many forms. It doesn’t have to be quantitative – as in hard numbers that are fully comparable. It can also be qualitative as in the case of collecting written feedback using a survey. Deciding this is no small task. People spend years of their lives learning the fine skills involved in research design.
In most cases, measuring is easy. But in some cases, it’s extremely difficult. If you can’t measure the results of what you do easily, performance pricing might be more trouble than it’s worth.
2. You Trust the Client Unreservedly
A performance-priced project is a promise. The client vows to pay you under certain terms. That requires you to trust the client to make good on their promise to you. Even if the person you’re currently dealing with is trustworthy, people change jobs. Companies hire new people and even CEO’s and COO’s quit or are replaced. The longer time a performance-priced contract lasts, the higher the risk.
A few years down the road, collecting on that promise could mean a painful and time-consuming legal battle with a company much larger than yours. One that your small company isn’t prepared or able to endure.
Cheating small businesses on what they’re owed is an old and time-honored practice of large corporations. Apparently, it’s a crime without any real consequences considering how high some of its worst perpetrators have managed to rise.
Escrow Services Protect Both You and the Client
A way around this is to put the money in escrow. That way, the escrow agent will hold the money and pay it out if certain terms are met. However, these arrangements are likely costly and take time to set up.
Also, the idea might also chill a well-working relationship and expose a lack of trust. Feeling some distrust towards someone you haven’t worked with before is normal, but manageable most of the time. After all, most contracts last months and you often have some leverage. You can usually refuse to work until payment is done.
Not so in this case. With payment years ahead and a lot of work being needed to be done on faith, it shouldn’t wait. It needs to be addressed from the start, which might ruffle some buyers’ feathers.
3. You Can Afford the Result Not Materializing
With a bet like a performance contract, there’s always the risk of the results not being what you hoped. A contract such as this can pay multiples of what you’d earn going at your usual rates. But you also risk getting nothing in the end.
A common piece of advice to people who gamble is to never bet more than they can afford to lose. The same applies here. Never do this out of desperation.
You should only attempt a performance price if you can afford to lose the money and see other advantages. A performance-priced contract could help you gain a new client. It could also enable you to work with an existing one in a way that aligns your goals and fosters deeper collaboration.
4. You Can Agree With the Client on Objective KPI’s and Metrics That Reduce Costs or Boost Earnings
Even if you can define metrics that are fair and objective, they also need to make sense and be logically linked to financial improvements. Reducing pain is almost always better than improving gain for a client. If your project is to improve an e-commerce store, reducing the number of abandoned carts is one metric that has a clear financial advantage.
One way to go about this is to discuss metrics first, before anything else. Once the metrics are clear, the tasks and work needed will follow. You can use a method such as impact mapping to make this kind of analysis once the client is on board and the contract is signed. The analysis is valuable in itself and not something you should do for free.
For any larger company, decisions such as these need to be communicated and agreed on internally. Whatever metric you choose, be prepared to help the buyer explain the rationale to their superiors and colleagues.
5. You Believe It Will Benefit Collaboration and Create a Sense of Partnership
One of the most appealing aspects of working with goals and performance-based prices is the idea of being aligned with the client. By making their win your win, the collaboration will be improved. There’s nothing wrong with that notion. It may very well be so. But it doesn’t happen in a vacuum. You must establish trust first.
If you’re unsure whether working this way will, in fact, align your interests and improve collaboration, I suggest taking a step back. My experience is that performance-based pricing only improves collaboration if there is any trust in the first place.
6. In the Case of Equity, You Know You Will Be Considered a Shareholder
Startups, high on ideas and low on cash, see equity-financing in the form of performance-pricing as a great way to bring in professional help now and pay later. The problem is, few of them realize a freelancer, agency, and consultant paid in equity is, in fact, a shareholder. He or she will have a say, just like every partner and equity holder.
Not only that, as a holder of equity, you are also a defacto investor. That means that you have the same voting rights and right to insight into the business as any other person or company that has fronted money (or the equivalent in services).
I strongly recommend bringing this up early in case a startup comes knocking on your door. The ones that are worth having as clients will respect your position and work to produce the legal documents needed. Those who start wriggling when you mention this you can safely ignore – consider them a problem avoided.
5 Reasons Why You Would Avoid Performance or Contingency Pricing
1. The Results of Your Work Are Hard to Measure and Define
If you cannot find KPI’s or metrics that are linked to financials, hard to define, or agree on, consider it a huge red flag. Abort if possible. If you cannot find common ground about this, chances are this performance-based partnership won’t make it out the door.
2. You Need Money Right Now, Not Later
If you’re strapped for cash, betting your time and efforts on a risky performance scheme isn’t a great idea. “But I don’t have anyone knocking on my door anyway” you might object. That doesn’t matter. Your time, energy, and resources are your own.
Everything comes with an alternative cost. The time and sweat spent on pleasing this client for a possible paycheck down the road can be used right now to find clients and market your services.
3. You Fear that Performance Pricing and Terms Can Result in Disagreements and Disputes
Another red flag is if you fear that the performance terms might lead to resentment, dispute, or conflict down the road. After all, not all clients are honest enough to cough up the cash, even with the results in clear sight.
4. Your Fear the Client Might Suffer From One-upmanship
I’m sad to know that some have a zero-sum-game approach to business and to them “your gain is my loss.” Sharing the result of something created together is a form of defeat for those who think this way. To them, business is a competition and one-upmanship is part of it. If they can cheat or otherwise screw you, they will, and then brag about it.
5. You Cannot See This Client in Your Future
Engagements that are tied to long-term goals are long-term by necessity. At the same time, we live in a time of rapid changes. Companies pivot, people change interests, and trends come and go. These things will affect you and your client too. You need to factor those aspects into the decision to go ahead with a performance-priced project together.
Conclusion: Performance Pricing Works If There’s Mutual Trust and Win-Win Mindset
In summary, performance pricing can be a great option assuming you and the client are on great terms, and trust and rapport have been established already.
At the outset, there needs to be mutual respect for the position of either party for performance pricing to work. Your client shouldn’t get cold feet when you ask for something as reasonable as the terms of the equity promised.
What’s fundamentally important is that you and the client are aligned for a long engagement. It must make sense for both of you to depend on the other, for potentially months or sometimes years to come.
Want to Learn More About Performance Pricing?
Here’s a great summary of one agency’s experiences working with revenue-sharing and performance pricing contracts. If you’re considering performance pricing, make sure you read their recommendations first.
What Are Your Experiences of Performance Pricing and Performance Contracts?
What worked well? Were there things that didn’t work as you expected? What would you have done differently? Please post a comment and share your experiences. I read all the comments.
Coming Up Next: Value-Based Pricing
Our favorite way of pricing. If you assumed we’d already written everything possible on the topic, you thought wrong!
This post originally appeared on the Bondsai Blog, the blog of Leancept's personal CRM, now known as Elately.