Should Clients Pay for your Research & Development?

I was recently asked this question by a good friend and colleague, @HiredGuns.:

Should clients cover R&D costs to develop something new? Or should a firm discount exploratory work b/c future projects will be easier?

This question is deceptively simple on the service, but, as I found, difficult to answer succinctly in a tweet and difficult to answer in the hypothetical in any case. Initially, I took the approach of assuming the topic was intellectual property. @HiredGuns clarified that the question was really asking about process. A word that is vague enough itself in the world of the 140 character tweet. Twitter wouldn’t be the same without it, but no avoiding it’s not easy to work within the limit sometimes.

There are two of angles from which I considered this question:

  • In a market economy with adequate competition, what is a fair offer in general?
  • What are the client’s assumptions? If client assumptions are wrong, what is the potential impact to the business relationship and vendor image?

What is a fair offer in general?

In our economic system the client is the one who determines the value of an offer. I can choose to pay little for products and services, or I can choose to pay a premium. How much I choose to pay — where on the range from least to most expensive alternatives I buy — affects my expectations. If I buy a cheap product, I don’t expect that I’ll receive a well-made, durable, high-quality product. If it’s a service I’m buying cheaply, I don’t expect to be given the same type of attention and support or receive the same level of service as those who pay more.

Client Assumptions & Implications

In the foregoing paragraph, I touched on client assumptions, but we really do need to think about it in greater depth. The vendor and the client both come to the relationship with assumptions about pricing and how it is fair to create an offered price. Both will also have assumptions about what it’s fair to pay for.

Clients who pay a premium do it for a number of reasons. They believe that paying more will entitle them to expect a higher level of service and a higher quality end-product. They will generally have this belief because of a vendor’s reputation or because of their existing relationship. It is arguable that if the client receives a product or service of value equal to what they felt they paid, how the price is determined or set is not very relevant. If it’s worth it, it’s worth it.

The only objective measure is to aggregate these subjective worth decisions across similar offerings — the concept of “fair market value” or FMV. FMV is useful, but tends to be inexact because it’s only as reliable as the exact similarity of the offers being compared. Usually those offers are not exactly similar, so the FMV is not exactly accurate as a tool.

For a vendor that markets itself as premium provider, it’s important to protect its reputation. Reputation is a brand quality, and brand is the value of any business. Unhappy clients, and there will always be some no matter how hard one works to minimize the occurrence, undermine brand value. Unhappiness occurs when the client’s assumptions are contradicted by their experience (or more typically, this is expressed as “expectations are not met”). If the client assumes that she shouldn’t pay for a vendor developing a process that will benefit the vendor’s future business but finds out this transpired, she may become unhappy. She may feel that she should have paid less because her contract generated extra value for the vendor.

My Grain of Salt

My opinion on the matter is that it’s essential to agree from the outset to reasonable expectations. These include the client’s expectations of me and mine of the client. In this way, we’re less likely to have an unhappy outcome because we both agreed on what we should expect from the other before we even began our relationship. The challenge in actually doing this is trying to cover every possible situation that could arise and avoiding a 20-page document on expectations alone.

Realistically, each transaction will be different, and never will you account for every possible expectation the client has. That’s where being flexible and fair (to yourself as well as the client) enters into dealing with extraordinary situations.

I think the hypothetical question comes down to ensuring reasonable client expectations. If you need the R&D to cross into a new area — a new market or offering a different product or service you haven’t in the past — it’s quite reasonable for the client to be made aware of this. If the contract is going to be more expensive because you want the client to bear the costs of your working outside your normal area of expertise or interest, she should be given that information and allowed to determine if the value is still there to proceed. The client then has the option of looking for a vendor who already works within the area they wish to explore and who may offer a comparable outcome for less.

If a side benefit of the client deciding to proceed is that you are now armed with new knowledge, technology, or processes that expand your profitability as a company, this was communicated and within the client’s expectations and acceptable to her.

If you are developing a new internal process, I would strongly suggest it’s never a good idea to add to the price of your contract with a client to do this. You’re billing the client directly for your business development, and I don’t think very many people would find that fair. If the client were ever to discover it, she’d likely be outraged, and if knowing this you were to hide it from the client, you’re dishonest. This isn’t necessarily contained within @HiredGuns question, but it’s something I know I’ve seen less reputable vendors do.

Of course, vendors pass all their business development costs to us. They need to profit, and profit comes from keeping revenue (what a company brings in) higher than its costs (what it cannot avoid paying). However, if the vendor improves its internal organization and becomes more efficient, it can use this to reduce its costs and increase its profitability without necessarily increasing revenue or raising fees. If it offers more value than before because of these improvements, overall rates and fees may increase; but that increase is typically spread over a customer base rather than being lumped into a single contract with a single client.

There’s an awful lot to this question. Did I overlook something? Did I answer it well at all? I’d love to get some comments from others because I’m sure there are multiple perspectives out there. How you answer the question also depends on what you read into it, so I can see another person going off in some direction I haven’t even considered in response. Either way, I think the most important thing is we think about these things, about fairness in billing, and about how we recoup for our internal development costs.

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About Fergus

Fergus likes to invent cool titles for himself, such as “Communications Specialist” or “Internet Architect”. What it really comes down to is that Fergus’s passion is internet communication. He believes that helping people communicate more effectively makes the world a better place. To this end, he seeks opportunities to help individuals, businesses, and non-profits to communicate their ideas, products, and services beautifully. Some examples of the types of work Fergus undertakes: web design, graphic design, programming, and search-engine optimization. Fergus also enjoys consulting with people about their existing web sites and strategies as well as their plans. Fergus doesn’t enjoy writing about himself in the third-person quite as much, but sometimes it seems a necessary evil.
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4 Responses to Should Clients Pay for your Research & Development?

  1. Reed Botwright says:

    I think you did a good job of illuminating some of the challenges faced when tryin to answer this question for your organization. And this is especially challenging in a service-based industry like web development. My contribution is to make the decision a little more specific: what do you do when you are asked to build something that you have never build before and may never again? Does the specificity of the application preclude eatin the costs associated with this development? You had no plans before the project to market the application of this solution, so should you be obliged to discount the final invoice because you MIGHT take advantage of this in the future? It might take me longer to build my first dam because I have never done so before, but should I charge less than the time it takes purely because I might make another using the knowledge I gained building the first one?

    • Fergus says:

      Thanks for your comment, Reed.

      I think in that specific case, because you have no guarantee of leveraging the experience, I think it’s reasonable to consider all the costs and pass them onto the client. If that includes learning how to build a dam and some extra time in building your first one, perhaps making some mistakes and fixing them along the way, it’s not something that is definitely of future value to the business. If by happy chance you end up building another dam in the future, that’s a happy coincidence. If you were considering opening a new profit channel by pursuing dam-building, that would be quite different.

      I would even go as far as to say, I think without contradicting myself, that this sort of one-off and the extra fees that may accompany it is a case of caveat emptor. The client should look at your business, see its portfolio, see if you have built any dams. She should look at firms that specialize in dam building. She should consider the offers from these various vendors and select the one she feels offers the greatest value. If the client has done any research at all and still selects a company that hasn’t built a dam before, it’s likely because she is putting more value on the relationship or reputation of the firm than on getting a lower price from another one that is specialized in dam construction. Those sorts of value decisions are ultimately up to the client to make.

      I think there is a good case for disclosure if the contract involves substantial benefits to the business that the client is going to pay for and may not be aware of. I think it’s certainly fair to say, “We’ve built a lot of structures, but never a dam. We’re confident we can build a great dam for you, but it will require some extra work on our part.” I also think it’d be an unnecessary and poor business decision to eat the extra development costs unless there was a strategy to diverse into other markets.

  2. I firmly believe that if a client doesn’t pay you for your research and development, that you don’t owe them full disclosure of what you’ve discovered.

    It’s difficult to not charge a fee for this with SEO, but sometimes in order to gain credibility, and to prove your knowledge you end up giving away this information..

    I would love more strategy on how to profit from this!! Any suggestions?

    http://www.searchenginemarketingfirmchicago.com

    • Fergus says:

      Thanks for your comment. Relating it to SEO made me think about the question another way. You’re right that when you’re selling a service that is as arcane and mysterious as SEO, the clients’ only touchstone is result. It’s also interesting to consider that SEO is research intensive, bu at least in that case it’s not so much R&D but an integral part of the service unless you’re very niche in your subject matter and can be expected to have developed a general keyword structure and strategy for a sector already.

      I gave thought to promoting my new business with a free 360 degree analysis of the potential clients’ sites, strategies, goals, and results. Naturally, SEO was a fundamental part of the analysis. The more I consider it, however, the more I realized that in providing an SEO analysis at no charge, I would essentially be giving away a full-spectrum strategy that the client could attempt to execute or share with a different professional. It seemed too valuable to just offer up as a promotional device unless the presentation was a very careful balance between useful information and working for free.

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