PPP Notes - Services and Compensation

(These notes are compiled from AHPP) 

ARCHITECTURAL SERVICES AND COMPENSATION

 

• The Common Challenge for Architects
• Identifying and then receiving appropriate compensation for services they provide their clients.
• Historically
• Architects/their works were commonly supported by the state. 
• The church supported the majority of architects during the Middle Ages.
• During the Renaissance the concept of patronage of architecture extended to wealthy families and private businesses in leading European cities.
• Now
• Over the last two centuries the roles of architects, practitioners in new engineering disciplines, and construction contractors have become more separate, and project engagements have become the standard for everyone in the industry.
• Early project-based fee structures were widely based on percentages of construction cost, and the AIA and other industry groups once promoted standard fee percentages.
• FEE-BASED STRUCTURE
• Complexity, scale and uniqueness of twentieth-century building projects led to the adoption of cost-based fees for design services. 
• This approach emphasizes recovery of costs – labor and expenses – incurred in performing the architect’s services.
• Invites detailed negotiation of the projected effort, staff salaries, overhead rates, fee multipliers, and profit margin that the architect is allowed.
• LIMITATIONS OF FEE-BASED STRUCTURE
• Many architects recognize the opportunity to make maintaining long-term client accounts (rather than individual project engagements).  For this, flexible compensation terms are devised to cover many different services, individual projects, and locations.
• More projects involve delivery methods beyond design-bid-build.  They typically include a third-party construction manager / design-build responsibility.  They also require new combinations of architectural services and fee considerations.
• Architects are increasingly sensitive to business risks imposed by different service approaches, and are seeking appropriate rewards in contract and compensation terms.  If an architect shares direct risk for construction cost, he/she might negotiate an incentive fee derived from savings under the project budget.
• Architects/clients are developing a clearer sense of value based on the contribution of architectural services to the success of a client’s enterprise.  Sophisticated clientele realize an architect can speed the process while saving money.

 

• THE ARCHITECT’S SERVICES
• Most clients’ needs do not begin with programming and design and end with construction.
• Architects must now address the entire facility life cycle that concerns their clients: planning, change management (including design and construction) and facility operation.
• Architects can serve their clients continuously long-term relationships – sometimes with traditional design services.
• Diversification of services has led to increased specialization among individual architects, firms, and consultants.
• Options for Defining Services
• First step in structuring architectural services – and their appropriate compensation – is determining the scope and specificity of a client’s service requirements.  May be defined very precisely or very loosely, depending on the clarity of the client’s goals.
• CLIENT-GENERATED WORK SCOPE:
• Detailed service requirements as part of a REQUEST FOR PROPOSALS (RFP) soliciting architectural services.  This approach is employed for repetitive/standard assignments, managed by client’s own personnel, for the purpose of comparing competing proposals.
• OWNER-ARCHITECT AGREEMENTS:
• Standard service agreements are useful in defining architectural services, primarily for relatively traditional design and construction projects.  Particularly true for AIA standard forms.
• CUSTOMIZED WORK PLANS / SCOPE DESCRIPTIONS:
• For a set of special services, it is up to the architect to create a customized definition, after extensive consultation with the client, as the basis for a service and compensation agreement.
• Consider:
• Client goals
• Service tasks and expected work products
• Key review and decision milestones
• Schedules of tasks, phases, and milestones dates
• Requirements for information or services provided by others
• Allowances for changes or events outside the architect’s control
• Exclusion and additional services available
• THE VALUE POSITION
• A traditional emphasis on cost-based project compensation has contributed to a low level of profitability among architecture firms as an industry.
• Many architects have been conditioned to accept pretax profits – this cannot be sustained long-term.
• Cyclical nature of design and construction investment has exacerbated this problem.
• Architects today have a new awareness of the value of their services in relation to those of other professionals, and the distinct benefit their clients derive from their architectural services.
• RELATIONSHIP TO FIRM MARKET POSITION AND STRATEGY:
• The most successful firms have adopted overall business strategies and market positions based on services provided.
• Firms perceived as the best or offering something unique in serving client needs will be in demand and will be paid a premium for their services.
• Conversely, undifferentiated firms will be evaluated on price alone.
• Several clients seek to engage firms on a commodity price basis, which will be unprofitable to the firm unless it can deliver its work at a lower cost.
• Some possible dimensions for firms include:
• DESIGN PREEMINENCE:
• A firm honored for the signature quality of their design work.  Can be regional, national or international in scope.  Clients value name-value association.
• BUILDING TYPE EXPERIENCE:
• A firm with successful experience in the facility types that concern them.
• PROJECT LEADERSHIP CAPABILITY:
• As clients seek simpler and more efficient ways to manage facility projects, they look for firms to lead the delivery process – through program management, construction management, or design-build services.
• UNIQUE SERVICE METHODS:
• Firms offering value through special services that improve quality, speed, and accountability in the planning, construction, and management of their clients’ facilities.
• Other firms offer unique computer-aided design (CAD) and computer-aided facility management (CAFM) capabilities.
• RISK ASSESSMENT IN PRICING ARCHITECTURAL SERVICES
• Architects must be sensitive to business risk (a financial loss outside of one’s control).
• Few “typical” assignments; each one must be evaluated in terms of special risks as compensation and contract terms are proposed.
• Goal is either to find ways to eliminate sources of risk or else to receive fair compensation for changing conditions that are outside control.
• A FUNDAMENTAL RISK is a misunderstanding of what is included in an architect’s services, particularly under a fixed-fee contract structure.
• Some specific risks include:
• CLIENT DECISION MAKING AND APPROVALS:
• The architect should understand the structure and pace of the client’s decision-making process.
• SCOPE CHANGES:
• If an assignment is expanded or substantially altered during the design and construction process, the change creates more work and cost for the entire project team.
• THIRD-PARTY PROJECT MANAGEMENT:
• If a client has engaged a third-party program manager or construction manager to lead a project’s design and construction, the relationship can be more complex.
• FAST-TRACKING AND CONSTRUCTION-DRIVEN DELIVERY SCHEDULES:
• Accelerated construction schedules drive the demand for design decisions and an architect’s bidding and construction documents. 
• CONSTRUCTION COST RESPONSIBILITY AND CONTINGENCY STRUCTURE:
• Architects are usually held accountable for designing to a client’s budget based on the architect’s budget review and estimating services.  Risk is compounded when the architect is asked to rely on estimating by others (third-parties or construction managers).
• EXPECTED STANDARD OF CARE IN DESIGN / COORDINATION:
• As instruments of service, architect’s technical documents are never perfect or immune to differences in interpretation.  A small percentage of the total cost can be related to the coordination issues or omissions.
• FINANCIAL RESOURCES AND PAYMENT TERMS
• Architects should confirm their clients’ financial resources and intended payment practices related to any project assignment.
• COMPENSATION OPTIONS
• FIXED (STIPULATED SUM) FEES:
• A fixed fee is a firm compensation amount related to a particular scope of service.  Convenient / appropriate when services precisely defined.
• Greatest profit potential to the firm.
• Important to include a contingency within the fixed fee to cover the foreseeable risk.
• HOURLY BILLING RATES AND FEE MULTIPLIERS:
• Most flexible fee option for architects and clients.  Generally preferred when no exact service scope can be defined.
• Often used for preliminary phases of project assignments that are later converted to fixed fees.
• Can utilize fixed dollar rates (e.g., $125 per hour) in which rate is calculated to cover direct salary cost, fringe benefits, overhead and profit.
• Some clients prefer to negotiate a fee multiplier, which is applied to salary cost incurred by the project team.  One is a multiplier of direct salary expense (DSE) and the other of direct personnel expense (DPE).
• Disadvantages include limited profit potential in that a planned profit percentage is earned only as staff effort and cost are applied to the work.  Can be made worse if client chooses to implement a “ceiling.”
• COST PLUS FIXED FEE:
• Hourly fee option in which a client is billed for the actual cost of an architect’s effort – base salaries, fringe benefits, and firm overhead – on a rate or multiplier basis, and a fixed fee is negotiated.
• Useful when a client does not want an open-ended fee arrangement but there are many unknowns and it is difficult to establish a stipulated sum at the outset.
• UNIT COST METHODS:
• Compensation based on cost per square foot, room, store, building or other unit.
• Office planning and interior design are often priced per square foot and the same units are used in lease rates and tenant allowances in commercial buildings.
• Requires accurate and timely data on the cost of providing the services for each unit.
• PERCENTAGE OF CONSTRUCTION COST:
• Tying compensation to the construction cost of the project and not to the scope or cost of the professional services provided.
• Method is rarely used as a compensation basis today because of its inequities for clients and architects.
• Fallacies include the assumption that construction cost is directly proportional to the architect’s effort.  It also allows construction market conditions to benefit a client but penalize and architect, or vice verse. 
• Lastly, it can penalize an architect who invests in reducing construction costs.
• REIMBURSABLE AND NONREIMBURSABLE DIRECT COSTS:
• While staff labor represents the majority of an architect’s cost of service, there are other direct costs that are related to the work and not covered in a firm’s overhead. 
• These include travel, long-distance communications, mail and courier services, printing, photography, computer services and output, and materials or equipment dedicated to the architect’s effort.
• Direct costs may be reimbursable or non-reimbursable.
• SERVICE AND PRICING STRATEGY:
• No single best strategy or compensation approach.
• 6 processes do work well for many firms, however:
• CONSULTING WITH THE CLIENT ABOUT NEEDS/PRIORITIES:
• Most important step is knowing the client – understanding his/her needs, expectations, style, and concerns.
• Discover a client’s “value drivers,” paramount concerns that, if addressed properly, can ensure an architect’s selection and a higher level of compensation.
• This step is more difficult when an architect is asked for service proposals through a formal RFP process.  In this case, opportunity for direct discussion of the client’s goals may be limited.
• IDENTIFY SERVICE STRATEGY, TEAM, WORK SCOPE:
• Once needs are understood, develop an overall service strategy to address them successfully.
• Helpful to use a description of the architect’s services using the standard form of agreement (AIA B141).
• Consider:
• Is the effort limited to design and documentation services?  Or is it a long-term agreement where multiple services can be authorized over time?
• Which services and key people are appropriate?
• What consultants and outside resources are necessary?
• How will the architect relate to the client, users, public agencies and other team members in terms of communication?
• ESTIMATE THE COST OF PROVIDING THE SERVICES:
• Unless open-ended in an hourly billing arrangement, tt is important to estimate the actual cost of providing the services (including the firm’s staff, outside consultants, and direct costs) as the starting point for compensation.
• Architect should determine the hourly rate or multiplier that will represent actual cost, including salaries, fringe benefits, and firm overhead.
• EVALUATE RISK FACTORS AND APPLY CONTINGENCIES:
• The architect should evaluate the potential risks and decide what additional compensation is appropriate to offset them.
• May be specific dollar amount, a markup of hourly cost rates, or an increase in the base fee multiplier.
• ASSESS THE FIRM’S VALUE POSITION AND ADD THE APPROPRIATE PROFIT TERMS:
• Finally, the architect should assess the special value of the firm’s services to a client and determine the most favorable fee and profit structure for each case.
• Three considerations:
• The firm’s minimum profit targets.
• The value of the firm’s services in the marketplace.
• The value of the project to the firm.
• The target profit levels will determine the architect’s fixed-fee, fully loaded hourly rates, or fee multiplier.
• COMPARE THE PROPOSAL WITH PAST EXPERIENCE:
• Compare a new client or project opportunity with the firm’s past compensation experience.
• Most firms take an early educated guess about basic design service fees as a percentage of a project’s estimated construction cost.
• It is still wise to review proposed compensation terms with several firm principals or project leaders before completing the service proposal.
• Finalization
• When the scope of services and compensation terms are finalized, they are normally included in a written proposal document presented to the client.
• Different forms typically are used: letters with attachments, completed owner-architect agreements (AIA B141), or more elaborate formats prescribed by a client’s RFP.
• At a minimum, the service proposal should contain the following elements:
• A description of the professional services covered by the proposal.
• A time schedule for the services proposed.
• Identification of the architect’s key team members and their relationship to the client’s own staff and other project participants.
• Proposed compensation terms, including the basis for reimbursable expenses and additional work.
• Assumptions and qualifications upon which the proposal is based.
• The proposed form of agreement for the client’s review and approval.
• BILLING AND COLLECTIONS
• UNDERSTANDING A CLIENT’S ACCOUNTING PRACTICES
• Discussing preferred billing and payment terms in earliest consultation with a client about goals, needs, and service scope.
• Asking:
• “We prefer to bill for services every (_) weeks.  Is that acceptable?”
• “Is there a particular schedule to which invoices should be submitted?”
• “What documentation is required with our invoices?”
• “Who will review our invoices and approve for payment?”
• “How quickly will payments be processed once invoices are approved?”
• APPROPRIATE INVOICING AND PAYMENT TERMS
• Most architects invoice their clients for services monthly or every four weeks, depending on their internal accounting practices.
• Thirty days is a general standard for invoice payment.
• Some architecture firms, however, average collection periods of sixty days or more.
• SPECIAL RISKS AND RESPONSES
• Uncertain credit:
• Architect has a right to ask about a client’s financial resources to support a specific project assignment.
• If financial capacity is in doubt, the architect should consider declining the engagement.
• Fee retainage:
• Contracts that allow retainage (amounts withheld from professional service fees until the completion of a project or work phase) dilute an architecture firm’s financial performance and increase it’s risk.
• Slow payment:
• Clients who describe a slow and complex payment process, or decline to commit to any specific process present serious risks for architects.
• PAYMENT PATTERNS AS PERFORMANCE FEEDBACK
• As is the case with buyers of any goods or services, payments made by architecture clients often reflect their perceptions about the quality and value the firm is providing.
• Regular invoices provide a natural opportunity for the architect to ask – on paper or in person – for a client’s assessment of the firm’s performance.
• If payment patterns change, it’s usually a sign that the perceived value of the service has changed.