Four Major Flaws of the Billable Hour and Why You Should Employ Value Pricing Instead
I’ll go out and say it. Charging by the hour for your services is a cop out.
The billable hour is, in all actuality, a terrible measure for pricing your services. No one says to themselves, “You know what? I feel like buying 4.75 hours of my accountant’s time today.”
Rather, they’re more inclined to say something like, “You know what? I really need some of my accountant’s help with some of my year-end tax planning.” Charging an hourly rate for that help is a cop out. Instead, one needs to determine the value of what that help is worth. Because essentially, this is what any client is buying, the value of what you bring to them in relation to their needs.
No one wants to buy time. People want to buy value and how that value will ultimately benefit them. Many in the service sector have it so entrenched in their minds that the value they bring to their clients is tied to the number of hours they spend on them. But this is flawed in many respects.
FLAW 1: BIAS
The major flaw with the billable hour is that there is a bias on the part of the service provider to spend an unnecessary amount of time on something that the client truly doesn’t want or need. I’m not saying that people do this on purpose. Most are honest. But the issue is that the bias exists and it goes contrary to the goals of the client.
Rather than providing laser focus on the client’s needs, those charging by the hour have a bias to do whatever pads their timesheets. Again, I’m not saying people intentionally do this, but the bias does exist, and from this, we can lose focus on what really matters: the client and their needs.
I caught up with Mike McDerment, CEO of Freshbooks, about this very subject, as he’s a staunch supporter of value pricing (if you haven’t read his e-book on the subject, you can check it out here). Mike believes that the billable hour “misaligns clients and their trusted service providers” because “clients are economically incented to have an engagement take fewer hours, and while the service provider is economically incented to work more hours. In the space between, mistrust can emerge.”
True alignment can only come from a pricing method other than the billable hour.
FLAW 2: REWARDING INEFFICIENCY
The billable hour rewards those for inefficiency and for lack of innovation. It’s no wonder that so many professional service firms have stagnated. Why would anyone want to continuously innovate their business model into something more efficient if that innovation would actually lead to reduced revenues?
The billable hour rewards those who are inefficient and punishes those who are. This ends up translating to terrible value for the client and lack of innovation in the business itself. By putting a value pricing approach in place, the business is literally forced to find innovative ways to increase efficiency and effectiveness.
FLAW 3: LOOKS INWARD, NOT OUTWARD
Another major argument against the billable hour is that it is based on internal costs. As a result, the client doesn’t relate to it and has no frame of reference for anything you are doing. Newsflash: the customer doesn’t care about the amount of time that you spend on them nor do they care about how much your time costs. They don’t care if it takes you two hours to complete a given task, nor do they care if it takes you 200 hours. They simply don’t care.
Valuing your services based on time is a major disconnect from what the client actually cares about: the end result. That end result is worth something to the client which should translate to the value, or price, of your services.
When you employ the billable hour, you are basically taking an inward looking approach to pricing your services. You are looking at your internal costs and then pricing an hourly rate based on that. This is completely out of touch with what the client cares about. The client doesn’t care about your internal costs, they care about how they will benefit from your service and what that benefit is worth to them. At the end of the day, businesses in the service sector need to put a customer-first approach to pricing their services and in order to do so, the first step is to ditch the billable hour.
FLAW 4: LEADS TO CONFUSION
When quoting costs using the billable hour, estimating these costs on the part of the client is exceptionally difficult and can actually lead to frustration. In fact, I went through this very frustration as of late when looking to engage some online marketing assistance.
I was speaking to someone exceptionally knowledgeable and liked what he had to say but we kept getting tangled up with regards to costs. I kept getting quoted in hours, but the problem is I had no idea how many hours this would take. The subject matter was far from my area of expertise and since I had no frame of reference, I literally had no clue what the costs would be. Although I think this person could have helped us out, I ultimately lost interest trying to figure out whether these costs were in our budget, which probably resulted in a lost sale.
John Wires, founder of Toronto virtual legal practice Wires Law, understands this frustration all too well and implements a fixed fee approach to their firm’s services. “I moved to fixed pricing out of necessity for my clients. It gives them certainty in their legal spend, allowing them to make a business decision about whether it makes sense to retain me,” says John.
VALUE PRICING ISN’T PERFECT
Probably the most difficult part of value pricing is actually pricing your services and determining what their external worth is.
So how do you price your services if you don’t use time as a measure? Well that, actually, is the hard part. Determining the external value your services are worth is something that only comes with experience as well as trial and error. I do not profess to be an expert in value pricing, actually far from it. But what I do know is that it is something that needs to be continuously monitored and re-evaluated. There is no right or wrong answer. The pricing needs to make sense for all parties involved.
What I can say about value pricing is that a lot of creativity and an open mind is involved. Escaping the clutch of the billable hour mindset is not an easy thing to do, but once you understand the principles of value pricing, the billable hour just seems like something that’s better left for the dark ages.
There are a lot of resources online about how to employ value pricing. I urge you to check it out.
DROP THE BILLABLE HOUR
At the end of the day, the goal for all service providers is to provide exceptional customer service to your clients in every aspect of the service you are delivering. That starts right from the very pricing of your services to the ultimate deliverance of your services. Every part of that funnel needs to take a customer-first approach.
I personally believe that the service sector is trending towards value pricing, although I believe the adoption is slow. Mike McDerment also believes that things are trending this way.
“Adoption of value pricing has begun, and it won’t stop – it’s simply a better way of working. That said, change is hard. There are deeply ingrained cultural norms that revolve around the billable hour. But for those accountants [and other service providers] who are open to change and finding better ways to work, there are strategies to overcome every obstacle on the road to value pricing,” says Mike.
Change is indeed hard. But having an open mind is one of the key cornerstones for success in business. And if you’re going to change your mindset from the billable hour to value pricing, you better believe an open mind is needed.