Friday, May 30, 2008

The Folly of Hourly Billing

Imagine you needed to get to San Francisco and called the airline of your choice to purchase a ticket. “Baton Rouge to San Francisco” you tell the friendly voice on the other end of the line, “What is the price please?”

Such a simple question that usually begets a simple answer after a few short, qualifying questions such as dates of departure and return. But let’s assume it is your typical business professional (read: attorney or accountant) that fields your call. The conversation then may go something like this.

“What is the price you say? Well it depends,” says the rather hurried voice.

“Depends on what?” you ask, surprised.

“Well, who is flying the plane for one thing, and the number of other crew members it will take to get you to Frisco. It also depends on if we have a head wind or a tail wind, how many times we have to check the radar and with the various ground controllers, and the age of the plane.”

“That sounds rather complicated,” you say.

“Obviously, you are not familiar with airline work. There is no way we can know every thing we need to know in advance and we must make a profit to stay in business. And, by the way, we will not bill you until we double check the going rate for all of the variables. That may not be for 30 to 45 days. But don’t worry, we are honest…we will write everything down for you in the greatest detail and send it along with the bill. If there is a question, just call. But remember, if you don’t pay the bill very soon after receipt, we will send you some threatening letters and you may not be allowed to fly with us again.”

Sound silly, right. But this is the way most business professionals treat their clients. Why is it that these professionals refuse (in most cases) to quote a price for their services? The answer is usually the one seasoned business persons hate. “That is the way we’ve always done it.” It simply happens without thought.

Clients, by and large, accept this treatment, but the trend toward fixed pricing is creeping into the marketplace. Who cares how long it takes the business professional to get a result? As a matter of fact, most clients want a quick result, and are willing to pay for it. By bowing to the almighty billable hour, the business professional is discouraged from attaining a quick answer. “I can’t bill enough if I get the answer too fast.” Is this upside down thinking or what? From the first meeting, business professionals and their clients are friendly adversaries. They play the game of hourly billing, selling time, expense reports, and labor rates.

Another silly analogy to drive home the point goes something like this.

You know there is gold buried on a 100 acre tract of land. Which relationship would have more value to you…the one with the guy holding the shovel, or the one with the guy holding the map? The map right…anyone can dig…gotta know where! Just because the guy with the shovel may take longer to do his job, is that job more valuable than the knowledge held by the fellow with the map?

It is not the labor (read: amount of time spent tracking down answers or options) that clients crave, it is the intellectual capital, professional perspective, and a favorable result that garner true value. The fact is... time does not equal value. If this were true, why do business professionals invest in technology that allows them to be more efficient at research, form production, copying, and communication? Would it not be more profitable for them to slow down the process and reach a result at a much slower pace? If time and labor were truly the only factors in computing value, would not an ordinary rock found next to a diamond, deep in the mine, be just as valuable as the diamond itself?

It is time for the business professional to wake up and run his/her practice like a business. If insurance companies can set fixed prices for their products in an environment of super risk…so can attorneys and accountants. The client doesn’t owe you a profit; you have to generate that yourself by delivering quality results through a reasonable process.

If the business professional cannot give you, the customer, a fixed price for a particular service because of the variables involved, is this the professional you want working for you? We all know that unforeseen circumstances may arise, and if they do, the price may change. But pricing a service by the hour (usually a service that has been performed multiple times in the past by the same practitioner) places all the risk squarely on the shoulders of the client and also provides no incentive for the business professional to gain an efficient result.

But hark! There is a better way and it is called value pricing.

Value, like beauty, is in the eye of the beholder. If this were not true, how can we explain airline seat pricing? The guy or gal sitting next to you may have paid 2 to 3 times more or less than you depending on the circumstance. And, believe it or not, no one is up in arms claiming how unfair this is.

Yet, conventional wisdom tells us that any hour of a professional’s time is as valuable as any other hour….BS (Barbara Streisand)! And who has perpetrated this farce? Why the professional of course. Why? How about risk aversion? (And this is the guy giving you business advice!).

It is much less risky for the business professional to use rate times hour billing (a cost plus profit method) than pricing his product based on value received (or perceived). Again, why? Because the professional doesn’t know the value the customer places on his work product. How can he? Value is subjective and the product delivered is intangible in most cases. In other words, you cannot kick the tire on an idea, an experienced perspective, or a creative business theory.

But are not ideas, perspectives, and business theory even more valuable than most tangible property? Microsoft’s market capitalization is in excess of GM, Ford, 3M, Weyerhaeuser, Daimler/Chrysler, Monsanto, and about 60 other Fortune 500 companies…..combined. Microsoft remember, has no factories, no machinery to speak of, and very little real estate. Its value is between the ears of its employees. This is called intellectual capital!

So….do the customers (clients) of professional service firms buy hours? I think not. They buy intellectual capital. I’ve never heard someone brag about how long it took their attorney or accountant to come up with that good idea or business strategy. And certainly they do not brag about how long it took Porsche to build their automobile. People buy solutions to problems and/or good feelings…but what do most professionals sell….hours.

Is there a solution to this madness? Yes, and it is called fixed or value pricing. Just like buying a shirt or tie at your local haberdashery, professionals should provide the price for the service to the customer prior to rendering the service. Now professionals….place a cool cloth to your forehead…you probably feel faint, but it is not that bad. Your customer (client) should know what he is willing to pay you for you to provide the requested service…and you should know your costs in rendering the service (if not, get a grip and come into the real world). Actuaries do it, airlines do it, just about everyone else in the business world tells their customers the price of their product or service in order that the customer make a well informed buying decision. You know the one, it goes like this…do I give this cat my hard earned $ for that product or service, or do I do without it?

“But I don’t know how long it will take me to provide that service and who knows what I may run into when I get started”….these are the laments from most professionals when the fixed pricing subject is broached. Phase pricing in litigation circumstances, fixed pricing for tax return preparation and telephone inquiries are possible solutions. The utilization of “change orders” when circumstances change has been accepted in the construction industry for years…why not in professional “construction” projects…are we not “building” solutions?

But back to setting the price…how is it done and how do I know what value the customer (client) places on my work. Now again…get the cool cloth ready professionals…ASK THEM!!!. If the dollar amount they tell you is much lower than you are willing to accept, consider it one less billing argument you will have at the end of next month’s billing cycle, if the price is much more than you expected to hear…accept the job and consider him a “last minute flyer”… in airline terms.

As a customer in the market for professional services, you do have a choice when it comes to which firm(s) will represent you. Why should you take all the risk and not know what services will cost when you enter into a business arrangement with your professional? Talk about the price up front and give the professional a reason to resolve your issue as expediently and effectively as possible. Remember, hourly billers need hours to bill! Hourly billers have no incentive to resolve your issue quickly…if they do, guess what?.... they make less money! For hourly billers…its all about them.

Caveat Emptor. Let the buyer beware!

3 comments:

Shama Hyder said...

I was just speaking about this with a client today! Hourly billing is very antiquated. The best way to charge is to take a portion of the value your provide. Value = charge.

jodi said...

Shama, If you liked this post you will love the various information found at www.verasage.com. Hope to hear from you again soon.

Tim

Brenda Richter, CPA said...

WOW - Ron Baker's entire life's work condensed into one blog.