Key points
- Fixed pricing can erode margins when services expand.
- Extra services are common and need to be priced fairly to protect profitability.
- Clear unit rates, robust cost modelling, and proactive renegotiation help protect profitability while maintaining trust.
- Proactive negotiation rooted in transparency can prevent last-minute cost disputes.
Long-term service contracts are a win that increase business value. But they come with a trade-off with locked in pricing. As contracts evolve, which they often do, the pressure to deliver more for less quickly emerges. This can cut into earnings, create last-minute cost disputes, and put client relationships at risk.
Managing these shifts requires clear structures, accurate cost assessment, and proactive negotiation. With the right approach, growth can strengthen client relationships without eroding profitability.
The reality of contract evolution
It’s common for services to expand during a contract term. Additional site visits, expanded deliverables, or extended timelines emerge as client requirements evolve. This growth represents opportunity and strengthens business relationships. However, it introduces significant risk for margins and overall profitability when pricing structures haven’t anticipated these changes.
The biggest risk is committing to fixed prices when actual costs exceed estimates. Service expansion can mean delivering more for less, reducing margins for all suppliers involved.
Several tools and strategies exist to manage these risks and protect profits.
Change rates
One effective tool is to include service growth or change rates in the contract. These rates are agreed in advance for extra work and are often priced separately from the base contract. However, they can get overlooked during tight bidding deadlines, with inadequate time spend appropriately costing rates, only to become critical when service volumes increase significantly.
Defining service units clearly
When setting unit rates, clarity is essential. Define exactly what counts as a unit of work. A clearly defined rate per unit avoids disputes and confusion. A service unit might be one inspection, one hour of labour, one delivery, or one day of equipment use.
In pricing service unit rates, contractors need a clear understanding of incremental costs (the additional expenses) associated with higher volumes. Robust financial modelling achieves this. Contractors should consider costs such as wages, maintenance, insurance, and plant and equipment. They must also understand when these costs will be paid over the life of the contract . This should then be compared to how the contract compensates for those costs plus a return.
Understanding these cashflow inflows and outflows requires detailed financial analysis. This analysis makes it easier to identify risks and quantify the true impact of service expansion for each specific cost component.
Recognising the true cost of growth
Accurate cost assessment requires mapping out how each cost component behaves as volumes increase. This includes both direct and indirect impacts of service expansion.
Direct costs include additional labour, materials and equipment usage. Indirect costs can be significant and are frequently overlooked. These may include higher insurance premiums from expanded coverage requirements, or growing administrative overheads due to additional reporting, coordination and management.
Financial modelling effectively identifies these cost relationships and their timing. It also highlights mismatches between costs and revenue. For example, wage increases may occur mid-year, while revenue adjustments might only happen annually. Material costs such as concrete or steel may fluctuate with market conditions. This can create cashflow gaps that need to be quantified and planned for.
Strategic approaches to mid-contract renegotiation
When contracts lack adequate provision for growth, strategic renegotiation becomes essential. Success requires preparation, timing and careful management of client relationships.
A detailed and well-planned contract ensures that growth remains positive for both contractor and client. This maintains the business relationship while ensuring commercial sustainability.
Detailed cost breakdowns supported by financial analysis demonstrate how pricing adjustments reflect real incremental expenses rather than profit maximisation.
Financial modelling also helps anticipate pressures in advance. Pricing concerns can then be raised early, before cost absorption creates financial strain. Proactive discussions are more constructive than reactive negotiations triggered by cashflow issues.
Protecting future profitability
Although renegotiation may be necessary at times, the best safeguard is to plan for change and growth upfront. This protects value for all parties in the contract.
Here’s a checklist for pricing contracts that’s inclusive of growth
- Include growth or change rates for additional volumes or services in your pricing structure
- Appropriate indexation provisions with consideration of specific cost categories and timing mismatches
- Contracted thresholds that adjust pricing based on predetermined volume thresholds (e.g. 10% increase in volumes triggers price review)
- Regular pricing review periods that allow for market-based adjustments
Service expansion reflects client trust and ongoing demand. These are positive indicators for any business relationship. However, without the right pricing mechanisms, growth can undermine margins and threaten commercial sustainability.
By understanding the true costs of service expansion and documenting impacts thoroughly, contractors can ensure their contracts grow in value as well as volume. Strategic renegotiation preserves valuable client relationships through transparency and partnership. The key is viewing scope expansion as a natural evolution that requires commercial adjustment.
