Practice Note PN 3.

209

The Dangers of Fee Cutting

PURPOSE OF THIS PRACTICE NOTE

This note uses case studies to illustrate the consequences for architects of charging inadequate
fees for the services being provided.
1.0 INTRODUCTION
To provide a professional level of service, the architect should be adequately remunerated and,
while there are no mandatory or minimum fee scales, architects should assert their right to fair and
reasonable compensation.
2.0 CASE STUDIES
The following case studies discuss genuine incidents but, individually, do not represent any one
case.
2.1 Case Study 1 - Growth by fee cutting
Firm A was a medium-sized practice that decided the way to success lay in increasing the number
and frequency of commissions, so that it could achieve its growth target.
It adopted an aggressively consistent policy of winning work by offering reduced fees while
simultaneously priding itself on maintaining its high quality standards.
Initially, the losses were disguised by the large jump in cash flow and, by the time the insidious loss
record was evident, the practice had no option but to maintain its fee structure to ensure that the
workload was continued at the high rate.
Having exhausted the firms reserves, the partners were compelled to finance debts by borrowing
against their own assets to secure the necessary overdraft. It did not take long for the bank to
assess the firms potential and increase overdraft rates as a precaution against probable
delinquency.
The more perceptive senior staff foresaw the consequences and sought more secure positions
with other practices and the firm was then saddled with the higher costs of recruitment and the use
of contract staff.
Inevitably, the bank foreclosed. The partners lost all their assets and a once proud firm with an
enviable reputation simply disappeared.
Cause: low bidding in pursuit of jobs at any price.
Effect: bankruptcy.
2.2 Case Study 2 Design reduction
Although they set out to gain more work by cutting fees, the directors of Firm B were craftier than
those of Firm A. They kept sight of the fundamental need to maintain profit levels and decided that
this could be achieved only if the design content of each commission was reduced to the
necessary minimum. It was also decided that a good deal of costly and time-consuming checking
could be eliminated.
The consequences of inadequate attention to detail and the deterioration in design quality became
evident as defects, which appeared further down the track. Some clients could be fobbed off with

New Zealand Institute of Architects Incorporated

Published:
March 2009

Status:
First Edition

Notes:

PN: 3.209 Page 1 of 4

expensive rectification work, but others sued for consequential damages based on the firms
negligence.
Firm Bs poor reputation spread rapidly and they found it increasingly hard to secure work at any
price. Design quality was further eroded by the defection of staff, whose motivation to apply their
skills in the atmosphere of cutting corners and whose job satisfaction in designing cheap projects
was reduced to zero.
The loss of experienced staff was the final blow. The partners dissolved the practice before lack of
work and crippling professional indemnity insurance premiums sent them broke.
Cause: poor quality design as a deliberate component of cost cutting to sustain low fees.
Effect: loss of reputation; loss of staff; litigation.
In most cases involving litigation, the firm ends up worse off than if it has missed out on the job in
the first place.
2.3 Case Study 3 Token fees for friends
Firm C was recommended by a friend (A) to carry out a pre-purchase house inspection. They did
so and produced a brief report which satisfied the friend and prospective buyer (B) who
subsequently purchased the house.
Because the inspection and report was for a friend of a friend, Firm C charged only a token fee for
this work.
A year later, the new owner (B) decided to extend the house and called in another architect for
advice. This architects preliminary report listed several structural defects which required costly and
extensive modifications to be completed before the extensions could be added.
The owner (B) sued Firm C who, in its defence, stated that it had already done more than could
have been reasonably expected for the token fee and that, in any case, the inspection and report
had not anticipated possible extensions to the house.
The court ruled against Firm C for failing to observe and report defects which on any reasonable
inspection, should have been apparent to a qualified person. The judgement went to appeal, but
was upheld.
Cause: token fee
Effect: cursory inspection, incomplete report; expensive litigation.
2.4 Why you must make a profit on every job.
Contrary to popular belief, profits are not funnelled straight into the pockets of the firms principals.
The profits of a typical consulting firm are essential to support the ongoing businesses in a number
of ways:
(a) Profits in the form of retained earnings provide a cushion that enables a firm to operate in lean
times without either going out of business or laying off key staff. The cyclical nature of the
construction industry demands that considerable retained earnings be available to ensure
stability.
(b) Profits are the source of investment in new equipment, furniture and other capital goods which
are essential for the continued growth of the firm.
(c) A record of consistent profitability is a key measure which all banks use to determine the
amount of credit which should be made available to a firm to finance its day-to-day operations.
If the firms borrowing capacity is too low, its ability to grow will be severely impaired.

The information contained herein is intended as an advisory service only. No warranty or guarantee whatsoever is given as to the accuracy of any
information contained in this Practice Note, nor is any liability accepted for any actions taken based on this information. You should seek professional
advice on any specific matters pertaining to topics discussed herein.

New Zealand Institute of Architects Incorporated

PN 3.209 Page 2 of 4

(d) Continued profits provide the money to compensate the firms best performers with pay
increases, improved benefits, bonuses and profit sharing.
(e) The profits earned must provide the shareholders with a rate of return greater than could be
obtained from more secure investments such as Treasury bills, money market funds and high
quality bonds. If the return falls below these more secure investments, the sources of capital
will soon disappear.
3.0 APPROPRIATE FEES
You can justify your fee on any number of alternative bases. The real issue is what your services
for this specific project are worth to this client. Consider these issues:
3.1 Value
What characteristic will enable you to achieve a fee at the high end of the range for the type of
project? What is truly unique in your organisation that would justify an even higher fee? How much
real competition is there?
3.2 Fixed or time-based fees
Ensure that the hours presented or allowed are high enough to give an adequate margin of safety,
especially in large projects that tend to become more complex than may be assumed initially. Use
a salary multiplier that includes a proper margin for overhead costs and profit.
If the client feels that your multiplier is too high, it may be possible to lower it by extracting some
items as direct project costs.
3.3 Negotiating scope rather than price
If you show up at the checkout counter of your local supermarket with $50 worth of groceries, but
you only have $40 in your pocket, the cashier will give you two options:

Come up with a further $10, or

Put back the $10 worth of groceries.

As an employer you must look long and hard at a checkout cashier who will allow you to take home
$50 worth of groceries for $40. Yet, as design professionals, that is precisely how we negotiate
many of our contracts. The price goes down immediately there is the mere hint that the client
thinks it is too high or more than they can afford.
The cardinal rule of negotiation is never reduce your price without receiving some concession in
return.
One effective way to gain concessions is to negotiate on scope rather than price. Prepare a list of
items that can be deleted from the agreement in order to reduce the cost, while still maintaining the
integrity of the project:
These items could include the following:

Limiting the number of design alternatives to be evaluated.

Using standard systems instead of custom-designed components.
Requiring the client to contract directly for site investigations or other sub consultant work.
Specifying that some design activities are done by the contractor, based on performance
specifications, with shop drawings submitted for approval.

A careful analysis of each project will usually reveal a number of methods to reduce costs. At the
negotiation session you should be prepared to discuss the cost impact of any possible combination
The information contained herein is intended as an advisory service only. No warranty or guarantee whatsoever is given as to the accuracy of any
information contained in this Practice Note, nor is any liability accepted for any actions taken based on this information. You should seek professional
advice on any specific matters pertaining to topics discussed herein.

New Zealand Institute of Architects Incorporated

PN 3.209 Page 3 of 4

of these measures. To present these properly, you must do your homework before negotiations
begin.
4.0 NEGOTIATING FEES
No matter how well the scope is defined, there will be some situations in which the client simply
cannot, or will not, authorise enough money to cover all your costs, let alone allow for a reasonable
profit. In such cases, considerable ingenuity is required to avoid the dilemma of either taking the
project at a loss or declining to accept the project.
4.1 Saving interest costs by improving cash flow
One way to accept a project at an apparent loss is to specify invoicing procedures in the contract to
improve cash flow by including payment of a substantial retainer by the client upon project
initiation. The entire retainer should be held until the final payment.
Another way to improve cash flow is to establish a weekly billing cycle based upon a preestablished billing schedule. For example, if a $130,000 project is scheduled to last 13 weeks, the
contract can specify a billing amount of $10,000 each week. It is also useful to include a clause in
the contract guaranteeing that interest applies to late payment.
These approaches can cut the overhead rate substantially by reducing or eliminating the cost of
interest to finance project expenditure. It may even be possible to create a positive cash flow, thus
actually generating revenue from the interest earned.
4.2 Reducing normal overhead costs
Another way to accept a project at an apparent loss is to reduce or eliminate costs that are
normally built into your overhead rate. For example, if your firm allocates accounting costs to a
general overhead account as do most design firms these costs can be reduced for a specific
project by obtaining agreement from the client for a simple billing format with no backup
documentation of expenses such as copies of time sheets, telephone logs or receipts. Under this
arrangement, the client is still protected by being allowed to audit the invoices on a random basis.
4.3 Working overtime
Another approach is to take the project at a compressed schedule and work overtime. If the client
agrees to pay for overtime hours at the same rate as regular hours, this can be an effective way of
reducing the overhead rate, because overtime hours generally do not carry the same burden as
straight time hours. For example, once the office rent is paid it costs little more to occupy the space
sixteen hours a day than it does for eight hours a day, although award overtime rates may reduce
the benefit of this approach.
4.4 Use Internet Banking
This makes it easier for your client to pay your account on the due date. Even a few days in
arrears can make a significant difference in the actual amount of money you receive, especially if
you are operating an overdraft facility.

This note is based on a Practice Note issued by the Association of Consulting Engineers Australia
(ACEA). It is highly relevant to architects as well as to engineers and it is published with the kind
permission of the ACEA and the RAIA.

The information contained herein is intended as an advisory service only. No warranty or guarantee whatsoever is given as to the accuracy of any
information contained in this Practice Note, nor is any liability accepted for any actions taken based on this information. You should seek professional
advice on any specific matters pertaining to topics discussed herein.

New Zealand Institute of Architects Incorporated

PN 3.209 Page 4 of 4