I’ll go out and say it. The billable hour is 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 help with 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.
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 thinking has four major flaws.
Flaw #1: Bias
The major flaw with the billable hour is the bias on the part of the service provider to spend an unnecessary amount of time on the task. Rather than providing laser focus on the client’s needs, those charging by the hour have a bias to do whatever pads their timesheets.
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.
I caught up with Mike McDerment, CEO of Freshbooks, about this very subject, as he’s a staunch supporter of value pricing (he has written an e-book on the subject called Breaking the Time Barrier). 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, 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 inefficiency and lack of innovation, and it punishes efficiency. 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?
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
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.
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, it is exceptionally difficult for the client to estimate costs and can lead to frustration. 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 costs. The marketer kept quoting hours but 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,” John says.
Value Pricing Isn’t Perfect
The most difficult part of value pricing determining the external worth of your services.
So how do you price your services if you don’t use time as a measure? Well that is the hard part. Setting prices is a skill that only comes with experience as well as trial and error.
I do not profess to be an expert in value pricing, 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 it requires a lot of creativity and an open mind. 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 seems like something better left for the Dark Ages.
There are a lot of resources online about how to employ value pricing. I urge you to check them out.
A Customer-First Approach
The goal for all service providers is to provide exceptional customer service to your clients in every aspect of your services. That starts right from the very pricing of your services to their ultimate delivery. Every part of that funnel needs to take a customer-first approach.
I believe that the service sector is trending towards value pricing, although the adoption is slow. 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 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.