Traditionally, most firms price their services using an hourly rate. Yet this causes some rather serious problems for both the firm and its clients alike. We’ve written about why timesheets hurt more than they help, however, that article didn’t touch on everything. There are two additional concerns that we’d like to focus on here:
Income Ceiling - when pricing by the hour, each employee of the firm can only produce revenue in proportion to the number of hours they can bill - limiting their contributions.
Risk Imbalance - when pricing by the hour, clients are paying for efforts even when results are not achieved. In other words, clients bear almost all the risk while the firm gets paid even if they produce nothing of value.
The income ceiling issue is one that has frustrated an untold number of effective and experienced professionals. Yet, so few have taken the next step to discover better compensation models or to discuss the issue with their clients to find more alignment.
The famous, Peter Drucker, put it quite succinctly that “all profit is derived from risk”. In other words, profit and risk are related. Ron Baker, Founder of the Verasage Institute, a think tank dedicated to the eradication of timesheets and hourly billing, says to “take calculated risks and choose them wisely”.
The insurance world can teach us something
There is an old axiom in actuarial circles that fits here: “there is no such thing as bad risk, only bad premiums”. We could adapt that by substituting “price” for “premiums” and arrive at a compelling realization. We are in the risk mitigation business. How’s that for a paradigm shift?
If we are in the risk mitigation business, does pricing by the hour help? I highly doubt any of us has ever seen an insurance company quote us an hourly rate. It’s much more sophisticated than that. So are airlines and they deal with blatant risk each time they put a giant, heavy metal tube in the air… hundreds, if not thousands, of times each day.
Billing by the hour is the opposite of innovation
One of the most simple ways to enter our profession is to look at competitors and copy them. We offer such things as an hourly rate (that is very close to what we’ve seen others charge), the fallacy of “full-service”, and often chase the very same clients. This is how we’ve evolved over thousands of years, by copying our neighbors after seeing what appears to work. However, in business, that’s precisely the wrong way to build a business if you want to be sustainable and highly respected nationally or internationally.
Unfortunately, to add insult to injury, how many times have you been absolutely frustrated that clients want to compare you to a competitor solely based on your hourly rate? Try as you may, they focus on that one variable instead of evaluating your firm on the expertise and outcomes you have achieved for other clients. This is a behavior we have taught them by choosing to employ an hourly rate. Effectively, we encourage the behavior by not giving them an alternative model and standing up for the value we a capable of delivering.
To poorly paraphrase Ron Baker, “the value of a service to be perform is always worth more than the service after it has been performed”. This, inherently, explains why so many clients push back on invoices given they are no longer troubled by circumstances needing your specific form of intervention and expertise. By offering more compelling pricing options at the outset, you can innovate towards a model that clients love while also capturing more value.
A better alternative with transparency
The concept of a fixed price is not new, however, it requires more from professional firms to deliver correctly and profitably. Fixed prices make clients happy. Think about it. In fact, they also make you happy as well - when you are making purchases and need to determine if the value will outweigh the price you pay. The predictability allows for straightforward budgeting before the engagement starts. This is price transparency. Upfront pricing also implies clients see the value in what is to be delivered as opposed to the anxiety of reviewing an invoice after the fact and fighting to understand what they are being charged for and what was delivered.
In fixed pricing, the initial conversations between your firm and the client are extremely important and require everyone to slow down. Scope is critical in this paradigm. First, asking questions to understand the value of the future state in the eye of the client (scope of value) so your firm can determine whether the engagement can be completed profitably. Secondly, defining the work to be performed to achieve the desired outcome and who needs to do what (scope of work).
Another crucial element here is project management. It’s absolutely critical to manage the engagement to adhere to the timeline and deliverables agreed upon at the outset. This is where your firm will either shine or stumble so hiring exceptional project managers is a must. It’s also where you have the ability to recognize scope creep and address it proactively with the client in the form of change requests so everyone always remains on the same page. When clients know how much a request will cost upfront, they can more easily weigh the pros and cons, which helps keep them happy and allows you to capture more value.
Put some skin in the game
When a client is unhappy with your results, you will likely do whatever it takes to make them happy. Sometimes this means reworking deliverables until the client is happy, agreeing to a lower payment, or even maybe adding scope at no cost to address something your firm should have caught earlier. In any event, you are effectively guaranteeing your service so why not be proactive about it? Why not formalize a service guarantee so clients know you have their back even before an engagement starts?
Along those same lines, why not reassure your client that they will never have to pay for anything that was not agreed to before the work was performed? Effectively, offer a price guarantee. If you miscalculated costs on your part, own it. As a side effect, this causes a virtuous cycle, in that, your firm will continuously improve at scope definition and project management. In the end, everyone wins and the reputation of your firm soars.