We are in the midst of a multi-part discussion about how service firms bill for their services. Between hourly, retainer and project fees, there are a lot of ways that service firms bill for their work. We are looking at each method, its strengths and weaknesses, and also some alternatives.

Each method of billing for services has  advantages and disadvantages: Charging for time (e.g. the “billable hour”), charging for production (project fees or monthly retainers) and pay for performance. Today we’ll look in detail at charging for time.

Many firms start out by charging for their time because it’s easy to track, it ensures that you make at least some money for the work you do, and few clients will argue with time-based billing (as long as the rate isn’t too high). Hourly billing is ideal in a situation where neither you, nor the client, have a good way to predict what needs to be done to accomplish what they need. And lets face it, when we were getting started that’s exactly the situation we were in!

After working this way for a few months (or years) you may discover a few problems with time-based billing.

1. If things take too long, you can’t usually charge all the time (some of it gets “written off,” effectively lowering your hourly rate). But if things go really well, and you brilliantly get something done in half the time, you can’t charge more. This is the “heads they win, tails you lose” element to hourly billing. Some clients go further by mandating that you bill hourly against a cap or maximum project fee. This is the ultimate set-up for they win (if you are fast and efficient), you lose (if you run into a roadblock or things don’t go as planned).
2. Sometimes you work extremely hard all day on a project, and for whatever reason the client doesn’t see the value in it. Other times you are daydreaming while waiting for a stoplight and you have a breakthrough idea that is worth a mint to your client. How do you bill for either of those events? Hourly billing does a poor job of aligning payment with value.
3. When you bill for time, clients avoid spending time with you. This is not a good thing. If you want to be a trusted advisor for your client, you want them to call you with challenges and opportunities as they come up. That way, you can have more influence and discover additional projects and ways that we can help them.
4. The better you get at things the less you earn, so you have to raise your rate. This is okay if you are able to hire cheaper resources to do the more mundane work. But it often results in pushback from the clients about your rate. “Why am I paying $350 an hour for you to do that?” Again, more time gets written off.

So, the upside to hourly billing is that you make “something” for all the work you do, but as you can see, write-offs erode that value and in trade you have clients who don’t want to talk to you. Further you lose the potential upside of those brilliant ideas you have that don’t take any time. In order to make money you have to give time.

My main objection to hourly billing is that it shifts the cost risk from the service provider to the client, and in most situations the service provider is the expert! You should have a good idea of how long it will take you to complete the work and what value the client will get from the project. You are in the best position to decide what you need to earn and what they should be willing to pay. If your not, you need to be (maybe an assessment phase could help?). If you are the expert and you know (approximately) what it is going to cost and (about) the value the client will realize for your work, then hourly billing really does a poor job of aligning the client’s needs with the provider’s needs.  In fact, it puts you at odds with your client. Your client wants work done quickly, and expertly. You want to take more time, and explore every option.

How has hourly billing worked for you? How has it worked against you?

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Brad Farris is a small business advisor with Anchor Advisors, Ltd. in Chicago, Il. Since 2001 Anchor Advisors has been helping creative professional firms to grow, by helping them clarify their purpose, get the most from their people, keep their eye on key performance measures, and implement consistent processes. Brad is also the author of The Business Owner’s Champion: 6 Practices to Build your Nerve and your Business.