Understanding contract costs

17 February 2012

Paul Smith sheds light on management fee and catering overhead costs included in catering contracts

Earlier last year while undertaking a catering tender exercise on behalf of a very well known international corporation for their London offices there was an interesting moment when we were explaining the future contract structure to those catering organisations tendering to provide the catering services. Half way through the discussion, the Managing Director from one of the catering organisations piped up, ‘Management fee, what’s that? We won’t be needing a management fee’.

It’s worth explaining why he had arrived at this conclusion. As an intentional strategy and at the client’s request we had invited a number of catering operators that worked predominantly in the commercial sector, including those working in museums, visitor attractions, as well as event caterers. The client had decided that they wanted to understand any differences, both culturally and in terms of approach, that such operators could bring to their catering services in comparison to those caterers operating only in the corporate sector.

The statement made during the briefing may at first appear naive; however, when you consider that the person commenting had only ever managed concessions and fully commercial catering operations, it is more understandable. As such, they had been used to paying a fee to their client organisations for the privilege of operating in their premises. However, what they hadn’t been aware of was that for those operations that do not make a surplus, i.e. part subsidised in this case, the only means for the caterer to achieve any remuneration for operating the service was through a management fee, paid by the client to the caterer.

The above example is extreme in terms of total lack of knowledge that management fee based contracts even exist. However, from our experience what is clear is that there are a number of senior management decision makers and contract managers that do not entirely understand what an appropriate level of management fee is and what should be included or excluded within the fee. Prior to shedding light on this subject along with a brief overview on overhead costs, it is useful to consider the types of catering contracts that typically include a management fee element.

Contract Types Including Management Fee

The three more typical styles of catering contract within the workplace, universities and a number of public sector and governmental organisations are Cost-Plus; Fixed Price and Performance Guarantee. Under a cost-plus model the caterer provides its expertise and invoices the client for all operational costs, plus a management fee. Typically, these contracts do not have a ceiling and therefore if the caterer fails to either optimise the revenue or effectively manage the costs, it is the client organisation that picks up the bill. Fixed price contracts provide a greater degree of certainty and work very much as the name suggests. The client receives a specified service level for a defined sum, which also includes a management fee. As may be anticipated there are pros and cons with this particular style of contract and while it can be appropriate for some organisations, it can prove costly and inflexible for others. The third contract type comes in many guises and is often referred to as a performance guarantee contract. These types of contracts are often interpreted in different ways and frequently have nuances that mean that when compared against peer organisations they include varying levels of ‘risk and reward’ for the caterer, often with elements of the management fee at risk against performance. In addition to the above there are other contract types that are much more commercial, with an element of the profit from the operation replacing the management fee. With the exception of the latter, they all include a management fee. So what should be included within the fee?

Management Fee

While management fee includes the caterer’s fee or profit for providing knowledge, expertise and managing the service, it can also include other elements, with some caterers bundling in central support costs and head office management costs. When requesting details of the management fee, it is therefore essential to specifically request that it be broken down as follows:

Head office management costs
Central administration costs
Profit/caterer’s remuneration

We have seen a number of ‘management fees’ also including what may be more typically considered as operating overheads or sundries. Ensuring that the management fee only includes the above elements allows meaningful comparisons to be made. This could be against other bids and industry benchmarks in a tender exercise or for an existing operation, benchmarking against industry ratios.

It is also worth stating that there should be a clear breakdown in terms of the elements that are included both in ‘head office’ and ‘central administration costs’, ensuring fair comparisons to be made as well as providing vital information as to the level of central support that will be provided to the onsite catering operation. With this information it is subsequently possible to determine if the proposed level of support is appropriate to the needs of the organisation, while understanding if the potential caterer’s profit element is fair and reasonable. Furthermore, don’t forget to check if the fee is fixed, based on a percentage or a combination of both and how much, if any of it, is at risk against which criteria.

Operating Overheads

In terms of operating overheads or sundries, this cost, included within the catering account, relates to sundry costs associated with the day-to-day catering operations. While this is likely to be common knowledge to many, the items which make up the overhead or sundry costs can often include significant differences when compared across different catering contracts. The following are some of the more typical sundry/overhead costs that may be included:

Disposables (cups, napkins etc), cleaning & consumables, uniform & laundry, postage, stationery, computer costs, equipment maintenance, kitchen deep clean, cash collections, equipment hire, quality assurance audits, light equipment replacements, travel costs, recruitment and advertising, marketing and promotion. These are the more common items, although, it is not uncommon to see a number of other appropriate, as well as less appropriate costs, included within the overhead cost. However, what is key to ascertain is if the items costed are relevant to the needs of the catering service and if the levels quoted are likely to be appropriate. In many cases it may be that the caterers when bidding for a tender do not have enough information to fully understand the operation and have therefore included them to prevent any nasty surprise at a later date. Nevertheless, once they are included it does not necessary mean that they will be excluded in the future, depending upon the type of contract.

With some of these costs it may prove difficult to determine if the level is commensurate with the needs of the operation, for example, disposable costs. It is here where benchmarking against environments with similar dynamics is of considerable benefit. Other costs such as computer costs and light equipment replacements are potentially more straightforward to determine, especially if it is the client organisation that is responsible for these costs.

In Conclusion

While management fee and overhead costs have not always received a great deal of attention from all client organisations they are now being recognised for both the savings that can be achieved, along with ensuring that the contract is supported appropriately, providing greater value to both customers and the client organisation.

For anyone wondering what happened with the company that were unaware of management fee based contracts, they ended up being awarded the contract! While they had not heard of a ‘management fee’, they took the time to understand the operation in greater detail, realising that with a finite number of employees on-site and limited opportunity to grow the potential customer base further, the ability to achieve a commercial surplus would be unviable. Adapting to this new environment while applying the commercial principles from their other operations, combined with an alternative catering contract structure, has resulted in both parties sharing the success of a more commercial approach. This has included the removal of a previously required subsidy, with the client organisation now only paying a minimum management fee.

Paul Smith is MD of Montfort Catering Consultants.