What do service businesses sell? If you looked at invoices from consultants, lawyers, gardeners, and others, you would assume these businesses sell hours. And maybe they do. But is that what customers buy?
I get this question a lot, both from consulting clients who want to figure out how to optimize their pricing, and from Mimiran application users who want to automate not just proposals but quoting, and suddenly realize they don’t know what to enter under “Products”, let alone pricing.
In this post, let’s look at how most services businesses answer this question, and why I don’t like that answer. In the follow-up, we’ll look at a more profitable, enjoyable, satisfying answer.
The default answer is “hours.” 500 hours of a senior software engineer. 120 hours of a solutions architect. 20 hours of earth removal. The advantage of this approach is that it’s simple for everyone to understand. I will work for you for a certain number of hours, and you’ll pay me a fee for each hour worked. Kind of like you’re a parking meter. (You can probably guess where I’m going with this–subtlety isn’t my strength.)
Now let’s look at the disadvantages:
- Your rates are tied to people. You can’t take a Senior Solution Architect who was $250/hour on the last project and sell her as a Junior Integration Consultant to the same customer for $125/hour, even if she’s not busy, and it would be the right solution for you and the customer. Even doctors have figured this out. They don’t bill an hourly rate for a checkup and the same rate for open heart surgery. The bill based on what they are doing (or rather, what the government and insurance companies think they are doing– but that’s a whole different discussion.)
- You invite commoditization. Whenever you quote a rate of $X/hour, you invite comparisons with a competitor who charges X – 20%, or X/2, or even X/10. Even if the buyer understands that you will take half the hours, and do better work, they only concrete thing they have to compare is the hourly rate. Especially in the age of outsourcing, this puts you at a big disadvantage. Back when I charged people like this, I had one prospect tell me that they knew I would be a great deal for them, but they couldn’t get approval to pay $175/hour. (I later learned how to bill them $300-500/hour, which provided tremendous value for them in a politically acceptable way, but we’ll discuss this more in part 2.) It didn’t matter what skills I brought, or how much faster I could complete the task, or how much value they would get out of the project. They simply weren’t authorized to pay that kind of hourly rate.
- You limit your compensation regardless of the value you deliver. There’s a story about a real estate developer trying to get a 9-figure project moving. His lawyer cleared away the obstacles with a few phone calls and presented a bill for a few thousand dollars. The developer said that the bill was absurd, tore up the invoice, and wrote a check for a million dollars. Most of our clients are happy to get good value, but unlikely to pay more than their invoices require. If you combine this issue with the previous one, you end up chained to your job, trying to hit utilization targets instead of value targets. You work yourself out of your own passion, the very thing that drove you to start the business in the first place.
- You have to watch the clock. Not only do you have to track your hours, you have to account for what you did with all of them. When I’ve done hourly billing, I found this could add an overhead of 10% to a project. Cost of time to me and money to the client that was not spent on solving their problem, but just on bookkeeping. If the client is paying by the hour, they have a right to know what happened in those hours, but this approach drives me crazy. I don’t have a mind that shuts off when I leave the meeting. I have had important insights and solved critical client problems while driving away from their offices, while jogging, in the shower, and yes, I’ll admit it, even on the toilet. Sometimes I’ll decide that it’s time for bed, especially if I’ve been stumped on something, close my computer, head for bed (very quietly if my wife is already asleep), settle under the covers, lay my head on my pillow, close my eyes, and then realize that I just solved the problem. I’ll suggest to myself just going to sleep, and that surely I’ll remember in the morning, but it’s too late, the wheels are turning, and get out of bed, back to my computer and take care of the issue. How do you bill for this in an hourly manner? Lawyers have the answer, of course, just bill for all the time, but I don’t want to think about billing, I want to think about the customer’s problem.
Most of you who read this are going to go back to billing hourly. That’s OK. Just set up your rate structure so you can make money, delight your customers, and retain your passion. Often, this just means raising your rates to the point that some of your customers say no, and you can say no to some of your customers.
I’ll discuss another approach in part 2…