Negotiating payment as a contractor (issues, tips)

Last week I shared the advice I gave to a friend who was quitting his day job and wanted to do more freelance/contract work. This week I'll share a bit of practical wisdom on negotiating payment that I figured might be useful those of you who are just getting into contracting.

The problem: contracting clients will often ask you to quote fixed bids for contracts.

Potential issues:

• The client doesn't really know in advance what they want.
• After you agree to the terms they want to amend/change the specification of work that needs to be performed.
• Client doesn't agree with you that you satisfied the contract, doesn't pay in full or at all.
• The client knows what they want but you don't fully understand what it involved so your internal estimate of how long it will take is highly inaccurate and the fixed bid you provided reflects that. If it's much higher, your bid won't be competitive. If it's lower you just committed to a contract that will effectively pay you much less than you expected. You won't be happy due to the low pay and the client may not be happy because it takes longer than the implementation timeline you provided.
• Trying to prevent these issues by doing more preliminary research increases your overhead before you even get the job. Reaching a workable understanding with a client that doesn't fully understand what they want or what it involves can require a significant amount of unpayed work, which on close inspection may not be so different from providing your pre-client what is essentially free consulting.

The ideal solution is very simple: you trust the client, the client trusts you, and you get payed your hourly rate for the work performed.

Unfortunately most contractors don't live in an ideal world, at least not before they establish a portfolio of good relationships with good clients.

So much for the problem. Here are the tips:

• Add a mark-up (e.g., 20%) to the hourly fee. You want to leave room for negotiating. Often the person who you are negotiating with will have to report to his superior how much he managed to negotiate down your fees, and it's in your interests to help him look good.

  Also, the first price you quote subconsciously anchors the perception of quality. This is backed up by research and it seems to happen even to experienced negotiators that are aware of the anchoring effect. So a developer initially quoting $120/hour and then negotiated down to $100 is perceived as a better value for the money than a developer that initially quotes $100 and refuses to be negotiated down.

  It turns out how good people feel about the price they pay has more to do with the subjective perception of how much they save than with objective value they received. See groupon.

• Hybrid hourly/fixed bid: you do your best to estimate how many hours the project will take. You'll get better at this with experience. Add a reasonable buffer (e.g., 20%) to account for the unexpected. If you finish early, you only charge for the hours worked, the client saves money and is delighted. If the project overruns by more than 15% of the budget you estimated, your rate drops to a third of the "regular" rate. This way you continue to get payed so you're not working free for projects that "go bloody" but the client knows you have a strong incentive not to run up your hours.

• Advance payment, in installments: 25% of the estimate as an up front retainer, 25% for milestone A, 25% for milestone B, 25% for milestone C.

  This is sort of like breaking down the project into 4 smaller sub-projects, except it's a bit more efficient as you only have to understand the requirements and negotiate once.