What is a Professional Services Contract?
A professional services contract is a legal agreement between a professional services firm or consultant and a client, which defines the expectations of each party. It defines who will be at risk when the money changes hands and how the final project-based service will be provided.
Professional Services Contract Structures
Although a positive outcome is the goal of every client, the contract structure that supports the consulting engagement plays a significant role. As a result, the structure of the professional services contract utilized to pitch an engagement can easily make or break a deal.
Understanding the advantages and disadvantages of each of these six kinds of contracts for services is crucial:
- Materials and time contract
- Fixed price services contract
- Not to exceed (or materials and time with a cap) contract
- Retainer-based services contract
- Recurring service subscription
- Managed services agreement
This article will examine three of the most popular professional services contracts and provide examples of where each type performs well. We will then look at the three additional professional service contract examples that include additional elements to shift risk and up-sell existing work.
#1 - Time and Materials Professional Services Contract Structures
The most commonly used contract for professional service engagements is time and materials (TM), which permits firms to charge their clients for the amount of work they perform. In this type of contract, time is recorded for each worker and then invoiced at the agreed-upon daily or hourly rate. The employees will also keep track of the expenses they incur in the project and then pass them to the client for reimbursement.
#2 - Fixed Price Professional Services Contract Structures
Fixed price contracts are an increasingly popular contract for providing professional services. This is particularly relevant in a competitive market where clients can transfer some additional risk onto their suppliers. According to the latest SPI Research, nearly 39 percent of professional Services Benchmark projects are completed on a fixed-price basis.
The contract structure shifts the responsibility to the service provider since they've agreed to complete the project, regardless of how much effort it may require. For professional service firms that know how to run a fixed-price project effectively, the additional risk of a fixed-price project can deliver a substantial profit.
#3 - Not To Exceed Professional Services Contract Structures
If a time and material contract and a fixed-price contract were joined and had a child, the result would be a not-to-exceed (NTE) contract. These types of contracts can also be referred to as time and material with a cap and are designed to minimize the risk carried by the client, even more than the fixed term contract.
By following this model, a company will provide work on a time and material basis up to a certain point. Once this point has been reached, the professional service provider cannot invoice for additional work but is still required to complete the contract's deliverables.
The contract structure tends to be the worst of all possible scenarios for a PSO as the amount of revenue generated by the project can't exceed the negotiated cap if the labor investment proves to be greater than the original estimate, just similar to what would be the case under the TM contract.
If the labor investment proves to be lower than the estimate made initially, there is no benefit of being able to bill the client for the entire contract value, as there would have been with a fixed-price contract.
In this way, PSOs tend to use NTE agreements only when they need to, when deliverables are easily understood and predictable, and when there is a good chance that they'll be able to negotiate change orders or cap increases with their clients in good faith.
#4 - Retainer-Based Professional Services Contract Structures
It's not just for lawyers nowadays; retainers appear in every kind of professional service contract and agreement for consulting. In the context of professional services, retainers are typically employed when there is uncertainty over when the work will be done and when quick turnaround times are required. Retainer-based contracts' terms may differ; however, the basic principle is that the client pays an amount in advance to receive services within the specified time frame.
If the PSO performs less work than the retainer covers, the PSO will keep the balance. If the PSO does more work than the retainer will cover, the PSO will bill for any excess work on a time and material basis.
#5 - Recurring Service Subscription
Subscription-based services are quickly becoming essential to the professional services industry's arsenal. A subscription model could be a powerful option based on the types of services that a PSO provides. With this model, customers are charged an ongoing monthly cost for the delivery of recurring services. These deliverables may comprise access to the custom software program, detailed monthly reporting and analysis, or smaller deliverables accrued over time.
Since the beginning of this year, there has been a lot of discussion about the commercialization of services. The model of recurring service subscription is ideal for services that have been successfully productized.
#6 - Managed Services Professional Services Contracts
Managed services agreements are becoming a popular tool that traditional professional services firms and consulting firms employ. Historically, managed services providers (MSPs) sold managed service agreements focused on providing specific services over long periods. Examples of this include outsourcing IT services, maintenance of equipment as well as outsourced business tasks like payroll.
In a managed service agreement, the service provider will give specific guarantees regarding the availability, response time, resolutions, and general responsibilities. The client is likely to be charged a fixed amount for these assurances.
In the traditional professional service context, managed services agreements (MSAs) are now becoming increasingly popular as an addition to custom software development. Instead of charging customers to fix issues as they occur on a time-and-materials basis (which could be expensive and inflexible), the follow-on support options are offered as a packaged service.
Who's involved in the sale of a service contract ?
There are many different parties. The person who holds the service contract is the one who owns the contract. The customer may purchase the service contract from a dealer at the time of sale, following the transaction from the service contract provider, or with a used item purchased from the original customer of the contract.
The dealer can also be the service provider in certain situations, like used car sales. The provider will be the person who is legally accountable to the service contract holder for fulfilling the obligations of the contract. The service provider could employ a service contract administrator to manage tasks like handling claims and billing.
When did the Service Contract Act become effective ?
The Act was in effect from January 1st, 2012, and applies to service contracts entered into, renewed, or made available for sale from that date forward. A provision in the transitional section of the law permitted service contract providers to align their existing contracts to the new law before January 1, 2012. Service contracts older than this Act, if they are still in force, are subject to regulation as insurance.
