I just received a bill from my lawyer today in which he itemized his time spent on my file last month. He spent four-tenths of an hour on an e-mail to a colleague and one-tenth of an hour leaving me a voice mail.
I have found billing by the hour to be a liability in trying to build a sellable business. Years ago I owned a small design studio that charged by the hour. We had $750,000 in revenue, of which more than 20 percent was flowing to the bottom line, yet the business was worthless because we were simply four people hawking hours.
Billing by the hour reinforces that your firm is just a collection of people and, therefore, that future profits (what acquirers pay for) are contingent on your sticking around. That’s one of the reasons firms that bill by the hour rarely get acquired, and if they do, their owners are bound to sign on for a torturous three- to five-year earn-out, the equivalent of selling their ownership status in return for a glorified job.
Not only does billing by the hour undermine your ability to be acquired; it has a number of nasty side effects while you’re building your business. Billing by the hour:
- Makes customers hesitate before calling you for advice (Wouldn’t you rather be the go-to person for your clients?);
- Creates a negative cash flow cycle because you have to know how many hours were worked before sending a bill;
- Forces employees to fill out time sheets, making them feel as though they work in a sausage factory (No offense to the sausage workers of the world);
- Leaves your customers feeling “nickel and dimed”;
- Provides a disincentive for your employees to work quickly and efficiently, ultimately peopling your company with a bloated and slow-moving set of clock watchers.
The alternative to billing by the hour is to pick a few things you’re really good at-and that your customers ask for-and to come up with a standard formula and a standard price for delivering them. Don’t think it would work in your business? The practice of law is arguably the most addicted to billing by the hour, yet a Toronto-based lawyer named Jane Harvey has a standard set of services for which she charges a flat rate.
Are you still tied to charging by the hour?
With a law and business background, I see both sides to this argument. It’s very hard to justify the hourly rate to business people, but it’s even harder to talk a lawyer out of the billable hour structure (despite various examples like the Toronto lawyer).
Don’t forget that billing by the hour caps your earning potential because there are only 24 hours in a day (and I agree that the disincentive to efficient work is a huge problem).
I agree with Robert Brady (and the author of course), billing by the hour limits your earning potential. No matter how much you bill for an hour of your time, you only have so many in day. I admit I’m guilty of this more than I would like.
You hit the nail right on the head when you said “your clients will feel nickel and dimed”
This is the worst thing you could want your customers feeling. You want them to feel like they’re deriving great value from your company, not being squeezed for every second of profit. Smart article.
@StartupSidekick (Follow me on Twitter for fresh entrepreneurial advice)
I have to take an opposing opinion to your blog post. Not knowing how much time is spent on an individual client or account is the surest way to bankruptcy in a professional services firm. We have seen it time and time again in the Public Relations field of companies servicing clients under retainer and losing thousands of dollars each month by over-servicing them. Retainers are fine and can be a profitable way of servicing clients when they have specific limitations to the extent of the work. You have to control your costs, and best practices dictate that you know your operating costs for each client that you serve. Without proper time tracking you cannot get an accurate picture of your profitability.
Any would be acquirer of a professional services firm is going to do their due diligence as to the profitability of the company they are buying. If you are the seller, you are going to hurt the companies value when the acquirer finds out you are losing money on clients.
Best way to avoid the over-servicing issue is to run the timesheets but value bill. We have fixed fee arrangements, collect the cash by direct debit, and use the timesheets to manage the team members. Measuring the hours spent allows us to keep the service level agreement under review, while avoiding the temptation top add hours so that the fees are higher.
You have to combine it with a decent employee reward program to get the very best results – something I’m still working on!
In my field of Web/WordPress development, it is often extremely difficult to accurately predict how long the tasks I’m being hired to carry out will take.
When I have worked hourly, the client still expects an estimate, but that estimate really turns out to be a pretty fixed price, since estimating one price and then hitting them with a much higher billtends to cause a lot of bad blood that’s just not worth it.
Many hourly jobs have turned out to take much longer than I expected due to unforeseen difficulties (bugs in the software I was installing, additional complications in the client’s web site that were not apparent until I got in there and started working, etc). The result was that I ended up making way less by the hour than I had intended.
For this reason, I am thinking of moving away from hourly work entirely and focusing only on work where my hours can be accurately predicted.
For projects I’m not so sure of, it’s probably best to err on the high side of how long I think it’s going to take, not worrying about losing the job since those types of one-off gigs are not going to be my bread-and-butter.
Thanks for the great article!
There are numerous arguments as to why hourly billing is difficult for those who perform tasks which are not predictable. As a virtual assistant, I give my best estimate of time but I too, can run into issues that are beyond my control.
If I am working on a newsletter for a client, there have been times when the template is fussy or the changes that need to be made require more time to ‘fit’ than originally anticipated.
So hourly has been the only solution to compensate for my time. But I’d really like to be fee-based…it would just make life so much easier!
Anyway, I reviewed, “The Wealthy Freelancer” for a website and one of the solutions to this dilemma was to bill hourly for the unknown portions of any given project and then flat fee base for the rest of the project.
But I agree…flat fee is the way to go…for all the reasons you listed.
Please give us more information on Jane Harvey’s fixed prices; concrete examples will help implement fixed prices. Thank you.
I agree with you John, there are very few businesses around that cannot switch to a flat fee based structure. In my opinion, the hard work that it takes to set up business systems is what deters people from doing it and coming up with excuses why they can’t.
In a fee based system, there is nothing wrong with providing a contract stating what someone gets for the fee and providing an additional clause that says anything beyond what is outlined can incur additional costs.
As long as you are up front about those costs before the client signs and before the hours are spent doing it, clients will be happy. Particularly when anything above and beyond the norm is their choice, not simply a bill at the end which charges for one tenth of an hour…
Stephen Eugene Adams
John, I couldn’t agree more. One of the best things that happened when I left public accounting to start my own business is that I got to stop keeping track of my time. As most of us know, a lot of the billed time is padded or understated because no one keeps perfect track of their time. One of the interesting things that is happening in the printing environment is that a lot of us are becoming marketing and communications consultants. We are exploring implementing a retainer charge rather than a per-project charge. However, having come from the billable hour scene, I refuse to charge by the hour and therefore the closest I will come is billing by the month.
I’m sure there is a joke somewhere that involves a prostitute, a lawyer and charging by the minute…
I have wrestled with this for years. I’ve gone back and forth on charging based on value and based on an itemized statement and have seen pros and cons of both. I can say, however, that I am not a big fan of feeling like I am my clients’ outsourced hourly employee. My general question is, overall, how does the way you bill impact the perception your clients and prospects have about your brand, the value of your services and the expectations the have of you.
I agree with the article that “It’s difficult to sell a business that is based on charging by the hour.”
That does not mean you can’t run a successful business that charges by the hour. There are thousands of companies that make good money charging by the hour. However, if you ever want to sell that business it is more difficult or you won’t get as much. You are basically selling a client list, instead of selling on the potential profits.
In providing technology support exclusively geared to small/medium businesses, hourly billing is certainly a smart way to protect the value of my time. However, much like deciding whether it’s worth buying new tires for an old car, the corollary is that any tech-job is worth only so-much to the client. Because of that, I rarely charge by time, and instead gear my billing relative to ‘what the job was worth’. Sure, sometimes I spend more time than I’d like, but my client base is strong, refers me often, and pays on time and without complaint. It’s a good trade-off.
I’ve often felt awkward/stuck trying to reach an hourly rate. I don’t like feeling like I’m up against the clock when I do that. I prefer a flat fee so I can do things at my own pace/rhythm (which naturally varies).