Retainers: the key to financial security or a progress trap?

April 02, 2020

Retainers are an extremely tempting prospect. So much so, that I most often hear discussions of how they should be approached, not if they should be leveraged. Like most everything, there are pros and cons to retainers. When I consider retainers, I think about how they impact: Cash Flow, Cash on Hand, and Pricing Policy

Cash Flow

Cash flow is a relatively easy concept to grasp but is a really important thing to understand. Call it money in and money out, revenue and expenses, paychecks and bills, etc. We all understand the basics of cash flow. Similarly, we know that revenue needs to be larger than expenses in order to stick around for a considerable amount of time. This viewpoint is where retainers are most attractive.

It is fairly easy to project expenses. Most know, at least roughly, I spend this much money every month. Setting a budget and sticking to it is primarily something inside one’s control. Projecting revenue can be much harder and attempting to control it is almost a moot point. The market is fickle, and income can be hit or miss. Retainers offer a steady and predictable income stream. If we have $x in retainers and $y in expenses, we know if we will survive or thrive over the coming months. Or so it seems.

One danger with retainers is that they are likely, but not guaranteed. I often say, count your chickens after they hatch and grow into chickens. Even if you have a contract and a credit card on file, that can all go out the window. Cards can be canceled, and the courts are full of cases where one party failed to meet their contractual obligations. Indeed, when the economy turns sour, monthly expenses are examined; and squeezed or cut. Retainers often fall into the category of “we can live without this”. The apparent guarantee of income is not as bedrock solid as it appears.

Also consider that a pretense of guaranteed income can lull one into a state of laziness. Hunters stay sharp because they have to. Farmers get fat because they are surrounded by food. When a drought comes, farmers’ crops fall flat, but hunters follow the herd.

If you are going to rely on retainers as your income source, you must not become complacent. Secondly, you better fill your silo with grain. Which brings me to …

Cash on Hand

Cash on hand is just as easy to understand as cash flow but is regularly overlooked. Cash on hand determines the time you could survive, even if zero money was coming in the door. Best practices recommend having at least 90-180 days cash on hand which is well beyond what many businesses or individuals have.

I recommend that you put less weight on cash flow and instead focus on growing your cash on hand. Somewhat this is splitting hairs. Theoretically, if cash flow is positive, cash on hand will increase. However, people spend what is in their pocket. By changing your focus away from cash flow to cash on hand, you change your behaviors. You might find ways to make more, which is great. Alternatively, not spending what you have is even easier. Cutting cost is a natural way to increase cash on hand and results in very lean, efficient businesses. It may be six of one and a half dozen of the other, but I focus on cash on hand.

So, let us presume you are considering retainers from a cash on hand perspective.

We can take $x in retainers minus $y in expenses and know that our cash on hand could grow by $z each month. That is certainly attractive. As we look into the future, we have to recognize that our bandwidth is limited and being accounted for. Retainers lock the provider in as much as they do the consumer. While you have reliable income you also have less bandwidth, production power, etc.

When busy with retainers, we might not have availability for a highly profitable project that we did not expect. I have seen it countless times, and trust me, it hurts to pass on whales. The pain is felt initially, in the form of “lost” income. Long-term, passing on projects hurts our growth in many ways. That is one less client you have established a relationship with. One less amazing project in your portfolio. That retainer work, while reliable, is often not impressive and it does not grow your customer base effectively.

Run the math again on the equation: $x in retainers minus $y in expenses equals $z increase to cash on hand. You’ll probably notice a problem. While predictable, the growth to cash on hand is moderate. The problem is that our bandwidth is limited. The law of supply and demand says a decrease in supply increases price. Our bandwidth is limited, so, we need to consider our …

Pricing Policy

Understanding and leveraging pricing policy is the most important tool in the business owner’s toolbox. If you have not, I would first and foremost study the three most common pricing strategies: Cost-Plus, Market-Based, and Value-Based.

When considering pricing policy, you view retainers in a different light. Retainers are not a way to achieve predictable positive cash flow nor are they a slow and steady way to increase cash on hand. Retainers force you into a box and remove your ability to leverage pricing policy. The contract which guarantees you $a for a set volume of work almost certainly prevents you from capturing fair market value. That is a major problem.

Another problem with retainers is that happy clients often want to increase them. That’s right, it is a problem when clients want to increase their retainer. Clients think that they should get a discount for sending you more work. In reality, the more of your bandwidth a client takes up, the more they limit your ability to acquire new business in order to grow. So, while it is counter-intuitive at first, a client that wants to increase a retainer must pay a premium, not be given a discount. This paradox is tough to wrestle.

Solutions to these quandaries include flexible retainers, allocations for extenuating circumstances, short contract lengths, and any number of things. The problem with these solutions is that cure is almost as bad as the ailment. Negotiating a big, ugly, and complicated contract is more work and less effective than leveraging good pricing policy.

Let’s step back and reconsider cash on hand. If we have done the work to create and store substantial cash on hand, we no longer have concerns about cash flow. This gives us the ability to pass on poor projects and only take on the best of the best (“BoB”s – the opposite of “WoW”s, the worst of the worst). “BoB”s are the most profitable and leverage good pricing policy. This, in turn, makes the most of our bandwidth. When we extract the highest amount of profit from our bandwidth, our cash flow is excellent.

It kind of makes me wonder, were retainers invented by the supply side or the demand side of things? I for one, am not seeing a lot of upside for product-service providers.

Final thoughts

You caught me. I am biased. I don’t like retainers and I avoid them aggressively. Add this to the list of wrong things I do, like not charging deposits or having clients name their price. I embrace risk, manage it well, and even leverage risk for increased profitability. Not everyone is comfortable doing this and I recognize it.

However, before jumping at the opportunity to sign a retainer, strongly consider the downsides. Go in eyes open, forewarned, and forearmed. Furthermore, discuss with your clients the problems with retainers, and educate them as to how retainers hurt you. Good clients will understand that fair market value is fair for everyone.

Sure. Give retainers a consideration or even a shot. I know they can be leveraged well. Just make sure you don’t let retainers become a progress trap.