Four years ago, I wrote a somewhat controversial article on hourly billing. Since then, I’ve had countless debates, championing the merits of abandoning hourly billing. I’ve educated the naïve, and changed the minds of the entrenched. This article expands on these concepts, and clarifies many of the salient attributes of Value-Based Fees.
Up on my Soapbox
Most consultants have historically charged a time-based fee, usually hourly. This is a vestige of the legal and accounting professions, where huge firms like the Big Four served as the model. As the adage goes, “if you can’t be part of the solution, there’s money to be made in prolonging the problem.” Thusly, many attorneys, accountants and most consultants follow this model because they:
- are not thinking on behalf of their clients but on behalf of their expertise (IT, strategic, HR, procurement, etc.), so they always come up with some solution already performed by hundreds of others as if client problems are always the same everywhere
- are not innovative enough
- are thus performing contract labor, becoming commodities performing the same activities any in-house lawyer, financial or other skilled laborer.
You can’t become wealthy working for someone else or charging by time units – period.
Price ain’t Value
Unfortunately, there are people in my clients’ firms who think they are somehow going to be cheated if they do not pay by the hour. This is typically driven by the internal finance departments or compliance officers who overrule the business development managers who are eager to engage me and are thrilled with a fixed price.
The issue with hourly billing is that you are charging the client for your input and not the value of your output. Your client doesn’t care how many hours you put in, only that you have removed their problem so that they feel the difference, within the elapsed time you agreed.
Hourly billing is inherently unethical. I have been unable to figure out how the consultant’s accepted concepts of conflict of interest can possibly accommodate a system in which the consultant’s economic interests and the client’s are so diametrically opposed. If I bill by the hour, and a task takes me longer to complete, that’s good for me (more money) and bad for the client (more time before relief or satisfaction).
When clients are content to look at hours worked, it is clearly because there is a lack of trust. I’ve had attorneys actually bill me for discussing their bill with me…in six minute increments, of course.
Hourly billing therefore acts as an incentive to do the wrong things for your client in order to avoid cheating yourself out of the money the client would gladly pay you for the value you provide.
Ultimately, the main disadvantage of charging for your time is that it’s adversarial; it promotes conflict. The client wants a quick fix and the consultant wants a slow fix.
Consulting Economics for Idiots
You’ll find countless advice on formulaic approaches to determining your “ideal hourly rate.” These methods usually involve envisioning some annual income you desire to earn, dividing by 2,000 (the typical number of work hours in a year), and voila! For example, you wish to earn $120,000/year. Following this formula yields $60/hour. For the consultant, this is not at all realistic, since as a sole proprietor, the consultant usually has to bear the costs of insurance, work space, equipment, and all the time that goes into marketing. This generally leaves the consultant with only about 1,000 hours in which to bill clients per year. Following the above formula again, that $60/hour rate becomes $120/hour. Well, $120/hour may sound great to many consultants.
However, what happens when the client attempts to negotiate your rate? They all do. So, you prepare for this by inflating your rate to, say, $140/hour and take the tactic of tricking your client into accepting the lower rate of $120/hour. Again, we wade into the pool of the unethical. Ultimately, you discover that other consultants in the same market are now competing with you on price, advertising rates below yours. You’re now forced to work and bill more hours to meet your desired income goal. Perhaps you get desperate and pad the bill with a few more hours, just because you think you can get away with it. Again, unethical. The only way to survive a price war is to refuse to join in!
So now, you have been reduced to a commodity, competing on price. Perhaps you can convince your client that you can deliver more value for $140/hour than someone else can for $120/hour, but why even have that conversation in the first place?
As Alan Weiss says,
I’m not claiming that every professional services firm charging hourly rates is this unethical, but some are. It’s a shame that this kind of creativity couldn’t be invested in better service for the client or quicker results, but then, there wouldn’t be as many hours to bill. This is the lunacy of hourly billing.
The price to charge should be relative to the value the client tells you they will derive from you doing whatever you do.
There are no guarantees, of course. No doubt you will make a cursory check of the expected cost of delivering the client’s results in order to ensure it will be highly profitable for you too!
Training & Skill
Your training and skill level has every bearing on your ability to do the work. However, this has no bearing on the amount you should charge except that if you can’t do the work within the desired timeframe you won’t be able to charge anything! The price to charge should be relative to the value the client tells you they will derive from you doing whatever you do. I said that before, right?
How long you actually spend doing the work doesn’t matter to the client as long as it’s within their elapsed time requirement. The client wants the result – End of story.
If the client gets the result sooner, they have the benefit of its value for longer, so it could be argued that you should be paid more if you finish sooner. Reducing your overheads is for you to take advantage of, not the client.
Clueless Clients & Scope Creep
Virtually all objections to value-based fees, specifically in IT consulting, center around clients not having a firm grasp of what it is they want. Practitioners of agile software development espouse “embracing change” through a time-boxed, iterative methodology. This works incredibly effectively for internal software development teams. For external consultants, it becomes more challenging because the scope of a project becomes less clearly defined from the outset. From another perspective, one might consider this phenomenon to be perpetual scope creep.
Scope creep only happens if you let it. If you and the client agree upon a fixed scope – in writing – before work starts, it is easy to see whether or not any “Can you just …” work is within the scope and therefore within the fee.
If the scope cannot be fully described, documented and agreed upon at the outset, then a preliminary project to gather the necessary information to allow this needs to happen (and get paid for) first.
By telling the customer they can have more if they pay more in the way some suggest is making a rod for your own back! The clients will ask for more and then try to argue that they shouldn’t have to pay for it.
Having helped them before the outset to see the full value of no longer suffering the pains their problem was is causing, you can set your fixed-price, fixed-scope fee at a level that gives them a huge return on investment and gives you a huge profit.
One solution I’ve found for reconciling agile/iterative development with value-based fees is to have the client ascribe a value to a particular release, spanning multiple iterations. The release, after all, is the vehicle by which the ultimate value is delivered!
Clients inevitably hit the consultant with a “surprise”. If the surprise falls within the agreed upon scope of the project, it should be dealt with within the agreed upon price of the project. If it’s beyond the scope of the current project, then it forms the basis of a separate discussion about a separate, separately chargeable project.
I’ve found the biggest problem a consultant will encounter is a client who is unable to articulate value. You have to help the client understand the difference it will make to them and their business if their problem is solved/removed. Only then can they explain it to you so you can understand it.
Hourly billing isn’t transparent, it’s unethical. The longer the client waits, the richer the consultant gets (if you consider a couple of hundred bucks “riches”). If you want to be a commodity, bill by the hour and suffer price competition. If you want to be a consultant, bill according to the value of the results you help generate. Helping a client in five minutes is far more valuable than five weeks, so why not believe in yourself and charge for your talent not your time? I’m outta here!
In preparation for publishing this article, I’ve circulated it through my personal network of experts. Several thought-provoking questions arose, so I’d like to summarize them here.
Value-Based Fees is Just a Commission
This is not a form of sales commission; it is an agreed upon and considerable proportion paid before you ever start work on the client’s project. This puts the client totally in control of their costs, but it’s not a cost; it’s an investment in their business’s future!
And if you fix their problem very fast, they benefit from the value your fix brings for longer. Billing by the hour, you’d earn less if you were that good! Basing prices on value to be received by the client creates win-win. Both parties best interests are one and the same in this case; both want a great job done within a reasonable elapsed time.
Sometimes projects go off the rails. Avoid allowing the client to cancel the project at all costs. Postpone, delay, reschedule, or negotiate on payment terms if you must. Do not negotiate your fee as a concession.
Ensure that your work is guaranteed. If you do not meet your clients’ objectives, and cannot meet them after sufficient notification and an attempt to correct the shortcoming(s), you are ethically bound to refund your clients’ full fee. This has been my personal commitment to my clients for over a decade.
Ongoing Service & Retainer Fees
Frequently in IT consulting, a lot of work is “maintenance” in nature, or even incidental Q&A via email or phone, etc.
In the case of an ongoing service you could create a retainer arrangement; a quarterly fee, say, for access to you, not for any maximum amount of work or hours. If the issue can be solved in the space of a short phone call, it’s included! If it involves more than this – annual accounts for example – this needs to be a separately chargeable project with a finite scope.
If the ongoing service is regular work – bookkeeping and salaries for example – you could establish an annual value and create an annual arrangement payable monthly.
Sometimes clients need considerable time to articulate value, and consultants need time to discover just how much work will really be involved to ensure a profitable and successful engagement. Avoid the temptation to bill hourly for this work. Agree upon a reasonable amount of time, for a fixed fee, to work with the client to determine the scope of value, and the scope of work. Be careful to focus only on the what and not the how of solving the client’s problem. Being intimately involved in the discovery will almost certainly ensure a proposal that’s accepted every time.
Q: Isn’t working for multiple clients simultaneously “double dipping?”
A: No! Since you are not selling time, there is no conflict. Feel free to deliver as much value for as many simultaneous clients as you can comfortably handle without sacrificing quality for them…or quality of life for yourself!
Q: My client has two project opportunities. Can I work on both at the same time?
A: As you cannot work on two projects at once for the same client, you then have to agree upon the relative priority of the two. Do you stop one to start the other then resume the first later, or do you start the second when the first is finished?