Too often, I encounter clients that charge their clients an hourly rate for their services. Most of these services represent knowledge work billed by the input (time), not the output (deliverable or results). I see it all the time. The lawyer that charges $325 per hour to write you an operating agreement, or the web developer in India that charges you $9 per hour to develop your website. What the buyers of these services want is an operating agreement or a website, so why do we continue to focus on contracting with consultants and service providers based on the cost of their inputs and not their outputs?
Let me be clear, outputs can take many forms. Outputs can be a deliverable such as a report or project, they can be a desired result such as a successful implementation, or outputs can be business advice that increases market share or profits, achieves expense reductions, etc. The real question for consumers, consultants, and service providers alike is: Does hourly billing still make any sense in your industry?
I have often said I do not care about the hourly shop rate at my local garage. I only care about what it will cost me to get my truck serviced.
Recently, one of my sons needed to replace the engine in his Chevy truck. He bought a comparable low-mileage used engine from a local salvage yard and investigated several options for swapping engines. The quotes he received for the work varied widely. The shops ran the full gambit too, from a certified Chevy dealership to a shadetree mechanic working out of a garage in his home. The latter said it would take him several days to complete the swap. Another said the swap could be done in one day. While time was not the ultimate determinator, my son was free to just focus on the overall cost of the job.
Turned out the shadetree mechanic operating out of his converted garage had the lowest overhead; however, his quote was not the cheapest alternative. While his hourly rate was much lower than everyone else’s, the time he estimated it took to complete the job more than made up for his lower hourly rate. Ultimately, my son neither went with the shadetree mechanic nor the authorized Chevy dealership and found a local shop that specialized in rebuilding engines. Since the rebuilds they performed required the removal and installation of engines, the simple removal of an old worn-out engine and its replacement with a newer one was something they were specialized to perform.
Why Reconsider Hourly Billing
I believe that hourly billing for knowledge work is simply a legacy practice shackled to the status quo. However, several developments have caused people to reevaluate the status quo regarding hourly billing and to seek alternatives. Below are three reasons that buyers are beginning to rethink purchasing services by the hour:
Many consumers are becoming dissatisfied with the current system of being billed by the hour because it is no longer meeting their needs. They have come to realize that getting billed by inputs and not outputs is inefficient and unfair.
Changes in technology, demographics, and social norms have given rise to the gig economy and remote work, causing many people to question traditional employment models and seek more flexible alternatives.
External pressures such as economic downturns, political upheavals, or public health crises have led consumers to reevaluate the status quo and seek new solutions. For example, the COVID-19 pandemic has forced many businesses and individuals to reconsider traditional ways of working and living.
How Hourly Billing Became the Norm
How did we get here? Since the dawn of time, goods and services have been priced according to the value they bring to the consumer. A blanket made by one person might have been traded for a cooking pot made by another, or a bushel of corn grown by a farmer traded for a deer shot by a hunter. The exchange rates were based on the value of the goods and services for each party. That all changed with the advent of the industrial revolution.
As industrialization took hold, many workers moved from being paid for the value of the goods or services they produced to being paid by the hour. This shift was driven in part by the need for standardized work hours in factories, where workers needed to be on the job for a set number of hours each day to ensure the plant operated at maximum productivity.
Later, unions and labor laws helped to establish minimum wage laws and other protections for workers, which further entrenched the hourly wage system.
Today, most of the workforce is no longer working on the assembly line floor where they are just a cog in the industrial gearing. Now, we operate in a knowledge economy where a computer and a network connection are just about all that you need to produce your output yet, the hourly wage system is still the norm in many industries.
There is a growing interest in alternative models such as value-based pricing, where workers are paid based on the value they deliver to the client or employer, rather than the amount of time they spend on the job.
The Shackles Preventing Change
So, what gravitational forces keep us shackled to getting paid and buying services by the hour? There are four forces binding us to the hourly billing status quo:
Charging by the hour or getting paid by the hour is straightforward. It’s easy to track the time spent on a project and to calculate the total billable hours.
Charging by the hour remains a common billing practice, and many clients have come to accept it as a default option. It’s also easy for clients to compare different service providers and understand a project’s cost.
Charging by the hour reduces the risk for service providers, as they are guaranteed payment for the time they spend on a project and not on the outcome they deliver to the customer. This can be particularly important for new or small businesses that do not have a lot of financial stability or experience in understanding the level of effort required to produce deliverables.
Charging by the hour allows service providers to adjust their fees based on the specific needs of each client and project. This makes it easier to work with clients who have varying budgets and changing requirements.
However, as discussed earlier, charging by the hour has some limitations and may not always be the best option for service providers or their clients. Many consultants and service providers are exploring alternative billing models, such as value-based pricing or project-based pricing, which focus on the value they bring to the client rather than the time spent on a project.
One great example can be found in personal injury law. Lawyers have always been known for their high hourly fees. There is a limit to how much consumers consider justifiable, which puts downward pressure on the hourly rate lawyers can charge their clients. So today, most personal injury lawyers have abandoned their hourly fee structure in exchange for participating in the outcome of the case by offering contingency fees, whereby they are paid based on the outcome of the case.
Why Charge by Value and Not by Hours
Alan Weiss, in his book “Million Dollar Consulting,” argues that consultants and service providers should not charge by the hour but by the value they create for the client. Here are five key points Alan makes about why you should charge based on the value you provide and not on an hourly rate:
When consultants and service providers charge by the hour, they are incentivized to work slower and take longer to complete the deliverable. It also leads them to accept additional low-value peripheral assignments, encourages scope creep, and promotes non-essential tasks, all of which are not in the client’s best interest. The client knows that the longer you take to develop the deliverable, the more you will charge them. The client then wants to exercise more oversight to ensure that they are not being overcharged. This oversight not only creates extra work for both parties, which adds no value but also leads to a feeling of distrust.
Charging by the hour can limit a consultant or service provider’s earning potential because there are only so many hours in a day. When you charge by the hour, eventually, you will reach a ceiling on your earnings that is limited by the number of billable hours they can work in a day.
When it comes to consulting services, hourly billing does not consider the value you can bring to a specific deliverable or outcome. For example, while many clients may be willing to pay a premium for a consultant’s specialized skills and knowledge, even if the direct value that they receive from the specific project is difficult to quantify, charging by the hour alone means that a consultant who provides significant value to the client may be underpaid. In contrast, a consultant who provides little value but spends more time on the project may be overpaid.
Clients perceive hourly billing as unfair if they feel that they are being charged for time that was not necessary to complete the project, creating tension in the consultant-client relationship. A few years ago, I recommended a highly regarded turnaround consultant to one of my clients. The client objected to the bill when they saw that the consultant charged them for attending team meetings they felt were not part of what they hired the consultant for. The fallout resulted in the consultant eventually being fired, my client taking every opportunity to disparage the consultant’s reputation whenever his name came up in a discussion, and this incident continues to create tensions in our relationship to this day since I was the one who made the referral.
Clients often underestimate how much effort and hours it takes to achieve a deliverable and are surprised when they see the final bill. This leads to frustration and a lack of trust in the consultant, as the client feels that the consultant is not being transparent about their billing practices.
Overall, Weiss argues that consultants should focus on charging for the value they provide to their clients rather than the time they spend on a project. This can help to build a stronger relationship with clients based on trust, transparency, and results. By focusing on value, consultants can also increase their earning potential and avoid some of the limitations of hourly billing.
Is it time to reconsider whether you should be billing by the hour?
