You have a potential customer. The customer is happy with your proposal, but asking for a discount. What should you do?

In order to explain how discounts can be beneficial both for you and for the customer I first have to explain the typical commercial model for professional services. Fortunately the model is fairly simple: Daily rate * Utilisation - Salaries - Overheads = ProfitabilityDaily rateYour daily rate is pushed up by your ability to generate value and down by the competition. In an industry with very low barriers of entry, like the IT industry, the competition keeps rates somewhat stable. Too high and you'll have difficulties with sales, too low and the company doesn’t survive.UtilisationUtilisation means the percentage of billable days out of the total potentially billable days in a company. A realistic utilisation rate in strategic consulting and IT services is between 60% and 80%. Maintaining 100% utilisation rate is impossible without people working plenty of overtime. Some time is always required for supporting tasks like sales and there are gaps in between projects. On the other hand anything less than 50% is likely to cause financial difficulties quickly. Utilisation level can vary greatly and naturally has a very big impact on the profitability.SalariesSalaries and other costs related to them are typically not very flexible. Each region has typical market level compensation that most companies pay. The salaries and other perks naturally vary from company to company, but on the longer run a company has to pay broadly market level salaries. Too low cost level on salaries and perks means it's difficult to attract and retain talent, too high and the company ends up in financial difficulties.OverheadsOverheads are the most flexible part of professional services business. This is your office, tools, admin, non-billable sales and anything else that doesn’t directly generate revenue. Things like how much time you have to spend on sales or how much work is required for contracts and billing can have a big impact on your overheads.ProfitProfit is required to keep the business sustainable. Professional services based on relatively large projects is not very stable, there is a limited number of projects running at any given time. There will always be some rough patches and for that a company needs to have some cash reserves. Healthy profitability level is the best way to ensure this. My experience is that roughly 20% annual profitability level before taxes is required to keep the business stable and relatively stress free. This will generate enough cash to keep the business safe. If you don't have sufficient cash reserves you may have to cut your costs during bad times. Having practically all of your costs in people this means letting people go. This can give a strong signal that you either don't take good care of your people or that you don't know how to run the business. Either way it may lead into you losing some of your best people and making a difficult situation even worse.How about the discountsThe discounts can actually help you to maintain healthy profitability level. This is possible only if you make your commercial model fully transparent to the customer. Explain to the customer how they can help you to become more profitable. There are many potential solutions where both parties win, the customer gets a discount and you become more profitable. Practical examples:

1. I lower my daily rates by 5%. The customer agrees to give me at least 8 weeks notice for all new projects. This makes my resourcing easier and leads to higher utilisation.
2. I lower my daily rates by 10%. The customer agrees to purchase at least 2 million euros worth of services during the year. Each project only requires a purchase order that can be set up in minutes and the reporting requirements are very simple. This lowers my overheads by reducing time required for sales and administration.

In both examples the customer saves money and I will be more profitable. In a transparent customer relationship it can make sense to do discounts based on volume, flexibility and increased efficiency. The customer can really help your business a lot if you simply explain how.How to implement a discountDon't discount your daily rates! The customer doesn’t usually pay for you making promises, they pay for you delivering value. In a similar way you should not do up front discounts for promises, you should do them when the promises are delivered. For example if the discount is based on volume it’s better to give a voucher for free work to the customer than discount the daily rates from day one.   Photo Credit: World of Good via Compfight cc