Don't Charge By The Hour
If you charge by the hour, you're not able to deliver the value you want to deliver.
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$45,000 For One Hour’s Work
I remember Seth sharing this story many years ago:
I had a college professor who did engineering consulting. A brand new office tower in Boston had a serious problem–there was a brown stain coming through the drywall, (all of the drywall) no matter how much stain killer they used. In a forty story building, if you have to rip out all the drywall, this is a multi-million dollar disaster. They had exhausted all possibilities and were a day away from tearing out everything and taking a loss. They hired Henry in a last-ditch effort to solve the problem. He looked at the walls and said, "I think I can work out a solution, but it will cost you $45,000 if I succeed." They instantly signed on, because if he succeeded, the project would be saved.
Henry asked for a pencil and paper and wrote the name of a common hardware store chemical and handed it to them. "Here, this will work." And then he billed them $45,000. That's quite an hourly wage. It's also quite a bargain.
Seth’s short treatise on hourly work is worth a read.
With a handful of exceptions, I don’t charge daily or hourly rates.
If a client requests it, I push back against it. I’ve walked away from several projects over the years because the client insisted on an hourly rate.
The reason is hourly rates can never really capture some of the value I can bring to the table.
Saving Clients Hundreds of Thousands of Dollars
Several years ago I engaged with a client who was in the process of selecting a vendor for a project.
They had received a few quotes from a vendor and were about to sign one at an annual cost of $240k per year based on a projected number of users.
The projections felt way off to me. So I spent two hours running the numbers using a formula we had developed to predict the number of active users in these kinds of projects. I combined this with research looking at communities of organisations of a similar size.
By my estimate, they wouldn’t get anywhere near the number of users the vendor had projected. I contacted the vendor on the client’s behalf and told them to put the client on two tiers below - at $125k per year.
The contract was for three years.
The three hours of work I invested in this saved the client approximately $345k. But the ability to do that took over a decade.
I wouldn’t have been able to do that in my first few years of consulting because I didn’t have the instinctive sense to know when the numbers were wrong, to have developed our own formula, and to have the ability (or relationships) to negotiate a vendor down.
This highlights the problem with hourly rates. If a new consultant without this experience, expertise, and relationships, charges $150 per hour and I charge $1.5k per hour (for example) which reflects the difference in value we provide (as per the above example), I doubt any client would find my quote reasonable.
There simply isn’t an hourly rate which would reflect the value I brought to the project and be accepted by the client.
(Aside - renegotiating the proposed vendor contract wasn’t even in the scope of the project. On an hourly rate, I could have been accused of wasting time by attempting it).
(Another aside - a nearly identical situation arose two years later. Only this time I asked for 50% of any cost savings as a result of my work. The client agreed and I reduced the vendor fee over three years by $204k. The client’s account team refused to pay my invoice of $102k. Turns out anything over $50k needed to go to an RFP and my contact didn’t have budget approval to sign above that. This put our contact’s job at risk so we decided not to pursue it. Two months later, our contact took a job at a new firm 🤷🏻♂️).
The Difference Between Consultant’s Quality is Huge
Silicon Valley likes to talk about 10x engineers.
Maybe we should talk about 10x consultants too?
The difference in value between a new and experienced consultant is vast and can never be captured by an hourly rate.
Many years ago, I was hired to save a dying community of teachers. The community had been running for almost five years, but activity had been declining for the past two.
I was the third consultant brought into the project. The previous two had undertaken research, discovered that teachers were too busy, and recommended the community should require less time to use. None of these recommendations had any impact on the level of participation.
They had listened to what teachers were saying but hadn’t heard what they needed.
Like Seth’s professor above, I probably could have written the solution down on a piece of paper and walked away.
Making the community easier to use didn’t make the community more relevant to teachers right now. It didn’t increase their desire to visit. It simply made the community slightly easier to use.
The solution is so obvious it’s easy to miss it.
If lack of time was the most pressing problem for teachers the community should be about that very problem. Instead of making the community require less time to use, we made the community a place for teachers to share their time-saving tips!
Within six months, the community had surpassed its peak from years earlier activity.
The rub in this story is this is a rare project where I was forced to charge an hourly rate. As a result, I ended up being paid less than the two consultants who came before me. They worked more hours and failed. I worked fewer hours and succeeded - but was paid less!
Common Problems With Hourly Rates
Let’s go through a few of the more common problems with hourly rates.
1) Hourly Focus On Time vs. Value
Hourly rates create a misalignment in incentives which becomes a fertile breeding ground for mistrust. The key problem is obvious.
If a consultant is charging an hourly rate, it creates an incentive to work as many hours as possible. This can manifest itself in two ways.
The consultant might find tasks to do which aren’t essential to boost their billable hours. This slows down the project at an additional cost to the client. Believe me, there is no shortage of tasks you can take on in a project which are beneficial, but non-essential.
The consultant might inflate the number of hours worked. Unless the client insists on the consultant using a tracking tool, a consultant can easily claim activities took longer than claimed. This is fraudulent - but is known to happen.
And even if neither of these things happens, there’s always the chance a client thinks it happens.
It’s painful for everyone involved when you send in your billing report and the client responds with ‘some questions’.
2) Hourly Rates May Limit Contact
Let’s imagine you’re working with a client and the client has some questions or concerns about the project. Any time the client wants clarification or to ask for your help, they now have to make a budgetary decision. That adds unnecessary tension.
They could simply try to figure it out on their own and save money or they can decide to pay a fee and get you involved.
As a consultant, I want to be involved in the process as much as possible. I don’t want the client to have to make a budgetary decision any time they have questions, I want their default stance to be to contact me.
Likewise, there might be times when I want to engage the client deeper on an issue and set up additional calls. But now the client has to balance these requests against the additional cost (and maybe even the perception I’m trying to add additional hours to the bill).
Hourly rates directly work against successful collaborative outcomes.
3) Hourly Rates Devalue Your Speed
If you’ve been consulting for a while, you have templates in place for the vast majority of situations which may arise and deliverables you can create. The information will change from one client to the next, but the templates will remain the same.
Better yet, the templates will save you a lot of time on the project. However, if you’re charging by the hour, those same templates which save you and the client time will cost you money. You can’t charge for their creation again.
Likewise, the more experience you have, the quicker you will be able to do things. Experienced people are able to do things faster than newcomers. This again limits your earnings.
Theoretically, this should be factored into the fee you charge. A newbie consultant might charge $120 per hour and a more senior consultant $200 to $300 per hour. In practice though, if a client is comparing hourly quotes they typically fail to consider why one fee might be significantly higher than another and simply assume a senior consultant is overcharging.
4) Hourly Rates Create Uncertainty On The Final Fee
If you’re charging by the hour, you better be very good at estimating how many hours a project might take. No client will engage a consultant without having an estimate on the number of hours a project might take to give them an approximate cost.
Clients will happily pay less if the number of hours is less than anticipated, but they will rarely pay more if the number of hours is more than expected. It’s very much a case of heads they win, tails you lose.
The problem is circumstances can change quickly. A project can be stalled due to unforeseen events. It might take a huge amount of time and energy to gather the data you need, for example. Senior stakeholders might have some questions or require additional materials which weren’t considered at the beginning of the project.
Now you have to have a difficult discussion with the client explaining the budget will actually be higher than anticipated. It might not be your fault, but that won’t make the client feel any better.
Hourly rates also create uncertainty about what you might be paid. Projects can be halted at any time for any reason. If you’ve turned down other projects to ensure you have the capacity for a client and the project is suddenly stalled - you’re the one that loses. Simply by refusing to give you more work, the client can cancel the project by stealth without having to go through a termination process.
The Upsides of Hourly Rates
Given hourly rates are still widespread, we should talk about some of the upsides too. There is a reason they are widespread.
Perhaps the biggest is flexibility. You should get paid for any additional time a project requires that was unforeseen in advance. Hourly rates can allow for that flexibility. If a client wants to change the scope, add more elements to the project, or want more from you, you simply increase the number of hours to match what they want. So long as you don’t surpass the agreed cap, you should be fine.
Another upside (to the client at least), is transparency. Clients can get a sense of how much time is spent on the project and judge a fair payment for the amount of work. Fixed fees are often something of a black box. You never really know if you’re paying a rate which reflects effort (though to be honest, you shouldn’t care if it takes 5 hours or 500 hours as long as you get the outcome you desire).
Finally, hourly rates are good if you don’t have a clearly defined project to work with. Freelancers often work on hourly rates because they are well suited to short-term projects. Sometimes you don’t want to have a separate negotiation for every project you take on.
What To Do If You’re Asked For An Hourly Rate
If you’re asked to charge an hourly rate, I’d first suggest highlighting why an hourly rate isn’t a good deal for the client. You should have a standard response along the lines of:
We charged a fixed amount rather than an hourly rate. This is because we don’t want our clients to have any uncertainty about the final amount they will pay nor have to make a budgetary decision every time you want our help. If the project takes more hours than we anticipate, there won’t be any additional charge to you.
Even in responding to RFPs, it might be possible to push back against hourly rates. I recently found this example from McKinsey in which they use the term ‘best value pricing’. The entire section is worth a read.
Often organisations are flexible and will accept a fixed fee to overcome those objections. Yet, organisations in some sectors (notably, professionals like legal firms and government organisations) will demand it. They simply can’t pay you without an hourly rate.
Allow For Flexibility If You Charge An Hourly Rate
If you are forced to charge an hourly rate, I suggest using a template like the one below which uses a blended hourly rate with an estimated number of hours, costs, and a range of fees.
This is from an accepted proposal a few years back
This lets you create a range of hours a project might take and provide some flexibility - while also having a fairly clear idea about what the total amount might be.
Aside - if you charge an hourly rate you will typically bill by the month or by the deliverable rather than the typical 50% upfront and 50% on completion.