Why hourly billing rates are a bad idea in small business accounting

This excerpt below comes from a 10/23/2019 article in Accounting Today by Loren Fogelman titled “Your Hourly Rate is Unfair to You and Your Clients”. It echos and reaffirms many of the concepts I’ve used to develop my Pricing Policy.

An Hourly Rate Creates Tension

Clients closely watch the clock when you charge for your time. Consider this:

• Speed: Clients who pay for time want you to get the job done as quickly as possible. Your firm earns more when you slow down the work flow. Although it’s not intentional, an hourly rate rewards inefficiency.

• Tracking: Consider how much time you spend calculating costs, tracking your time, sending your bill and waiting to get paid. Your clients hire you for a result, not your time. What if you based your fees on results rather than time? Then you no longer track your hours. Plus, you receive payment before the work begins.

• Scope: Your client expects the work to be done within a specific time frame and budget. Many projects take longer than expected. You either notify the client that the estimated time and expense has changed, or you absorb the extra cost.

• Skills: Your skills improve with time. You’re much more efficient than when you first started out. This means you now earn less for the same work. Charging for your time caps your earning potential.

• Write-offs: You may not know how to charge for some services, so you do them for free.

I’ve found hourly rate to be completely unworkable in my practice with two exceptions:

1. A way to provide estimates of the cost of a project

2. Re-billing of third party charges that were billed to me as hourly rates*

Other than these situations, I avoid hourly billing rates whenever possible. It makes much more sense to me to focus on results, relationships and quality of work. This pricing method is referred to as “value based”.

While value based pricing holds many advantages over hourly billing, it also has four disadvantages:

1. A value pricing proposal requires an accurate estimation of my total fully burn ones internal costs in advance. This is often difficult and time-consuming. At this stage of the work relationship, there is no assurance that this work will be compensated.

2. It requires a sales conversation to agree on the value of the project. This conversation is often held early in the work relationship before a strong trusted adviser relationship has fully developed.

3. Since we don’t use paid estimates, the cost of producing the value pricing proposal and holding sales conversation must be incorporated into the project price proposed. This intangible cost can be difficult for a client to accept since this is our cost, not their cost. By definition, this cost violates the fundamental principle of the value-based pricing method.

4. It reduces the probability that we will accept small marginal work projects. While we might see this as a good thing for our firm, we recognize that many issues that small business clients have infilled needs that they consider vital that fall into this category.

Still, overall, there is no doubt that value pricing is the better way to provide accounting services to small business clients.

* I’ve recently decided to “unbundle” client charges for 2020. This results in more transparency and reduced risk of conflict of interest.