Value Pricing vs Hourly Billing

Value Pricing vs. Hourly Billing. Which is Better for Partnerships?

The billable hour is lazy. Most service companies bill at an hourly rate, for a few reasons. It’s easier to bill hours as they accrue than to create a thorough, accurate estimate in advance. It limits risk for the agency on projects with many variables which may drastically affect the amount of work needed. It allows businesses to easily track the effort which has gone into creating a product. All of this is great for the agency, but these benefits to the agency come at the detriment of the client.

In my experience, clients care about the following aspects of a project:

  1. Price
  2. Delivery Date
  3. Quality
  4. Completion

(This is the “good, fast, cheap” triangle, by the way.)

Meeting these client expectations can be challenging, particularly in an environment where every decision is weighed against billable hours. Ultimately, the problem with the billable hour is that the time invested into a project says nothing about the final output. Time measures efforts, not results. One agency may spend 100 hours delivering a sub par product, while another could deliver something truly exceptional in half the time.

For many years, Gauge worked under the billable hour model. It was (and still is) the industry standard, and it was the only way we knew how to bill. Over time, we came to realize that hourly billing had more drawbacks than benefits. Today, we face those challenges head on with a revolutionary pricing model that provides benefits to the agency and the client through fixed, value based pricing.

 

Hourly Billing Leads to Conflict

At Gauge our goal is to build long-term partnerships with every client. This relationship is based on mutual trust and strong communication. Our experience with hourly billing taught us that hourly billing often puts the client and the agency in opposition, creating unnecessary conflict and working against developing trust and partnership, putting client and agency in opposition.

Work Stoppage

Under hourly billing (also referred to as Time and Materials, T&M billing), budgets for projects and service are frequently allocated in advance but billed after work is completed. Because billing hourly provides no incentive to the agency to provide thorough estimates, problems frequently arise when the budget is exceeded. In some instances, work is halted or put on hold until an additional budget is approved. This extends the project timeline, delays completion, and leads to frustration for both the client and the agency.

Overage

On the other hand, if work isn’t stopped when the budget is exceeded, hours and dollars continue to accumulate, bloating the cost of the project, often without the client’s awareness or consent. If costs are not carefully monitored and managed, this can even occur without the agency’s full awareness. This also leads to frustration on both sides, frequently resulting in both client and agency incurring unexpected costs.

Rack Rate Sheets

To make matters worse, preallocated time may be offered at “a discount,” meaning overage time is billed at a more expensive “standard” rate (sometimes referred to as a “rack rate”). Receiving an overage invoice at this higher rack rate can be alarming for a client, leaving the client feeling deceived, and forcing the agency to spend more effort to justifying costs after the work has been completed. Nobody wants to haggle over an invoice; that doesn’t build trust or goodwill.

Management & Strategy

You can’t build a strong relationship without communication; in an agency/client partnership, it needs to flow freely. Yet under hourly billing, the client is billed every time they pick up the phone or send an email. This naturally discourages communication, but it places particular stress on the types of communication that build relationships and generate new ideas. Developing a deep understanding of a client’s team, industry, and business allows an agency to offer services that help a company grow—the ultimate goal for both the agency and the client. While everyone recognizes that communication and management are important to accomplishing successful outcomes, hourly billing makes these necessary services painful.

Hidden Costs

Creating a high-quality product requires many necessary services and an investment in creating sound processes by the agency. The problem we have experience with the hourly billing model, particularly when time is preallocated, is that the “hours advertised” do not translate directly to the “task-based hours” which are delivered. Frequently the services that present the most value to the client are hidden costs.  Account management, status meetings, code review, deployments, testing, monitoring, emergencies, and other administrative tasks are hidden costs which erode the expected budget.

As an example, let’s explore the typical process for implementing a new feature:

  1. Task requirements are gathered by the Account Manager.
  2. Functional specifications are detailed to the developer.
  3. Code is written The developer writes the code (these are the “task-based hours”)
  4. The Account Manager provides status updates to the client.
  5. A second developer reviews the code.
  6. The code is deployed to a staging environment.
  7. The code is tested by a Quality Assurance (QA) specialist, or by an automated system which must be programmed separately.
  8. The code must be reviewed and approved by the Account Manager, and then sent to the client for approval.
  9. The approved code is packaged into a tagged release, documented, and deployed.
  10. The code is tested again in production.
  11. The Account Manager notifies the client that the code has been deployed.

Following this careful process often costs less for the client, because work meets expectations, performs better and requires less rework when compared to executing the task based work alone.

When an agency looks at an hour, they know a percentage of that hour will be devoted to code review, quality assurance, project management, communication and other overhead necessary in ensuring a great outcome. The client, on the other hand, often unaware of the thoughtful process and effort invested into every task, expects the full hour to be devoted to the task at hand. This misunderstanding often leads to confusion as budgets are spent more quickly than expected, and then again as overage piles up when budgets are exceeded.

Fatal Flaws

This goes to show that hourly billing is a suboptimal approach to forging strong relationships, building trust, providing transparency, and ensuring a high-quality outcome because it works against the aspects of a project that are most important to clients.

  1. Time approximates cost to the agency, not the valueprovided to the client.
  2. Delivery dates reflect the skill of the people assigned to a project.
  3. High-quality outcome is ensured by following a well-defined processes.
  4. Project completion is achieved when work is successfully delivered, not when the budget has been spent.

 

Practical Examples

Hourly billing incentivizes agencies to deliver projects over budget and offer a mediocre level of service. For example, under hourly billing, every time a client’s website goes offline, work is done, hours are billed, and the agency makes money. The more issues a website has, the more money the agency makes.

However, if an agency offers emergency support at a fixed price, the agency makes more money when the site is stable and has fewer issues. The agency has a vested interest in ensuring stability through automation and other innovative solutions.

By the same logic, hourly billing discourages agencies from investing in internal systems, as that investment does not lead directly to revenue. Building institutional capital through documenting and sharing knowledge, creating process, developing and automating systems, training staff, and building relationships are deprioritized, to the detriment of the agency and the client. For example, imagine the issues that arise under the hourly model when a junior developer is assigned to a project. If they take longer to complete a task, the agency makes more money; if the work isn’t completed correctly, the agency makes more money! Under the billable hour, in almost all instances, less experienced team members are the most profitable.

Some agencies work around this obvious oversight by charging a higher rate for access to their more experienced staff. This is an excellent solution—until a senior developer is assigned to a project which could have been executed just as quickly and effectively by a junior team member. A common technique to avoid this is to “escalate” to senior team members only as required. In practice, this becomes a costly solution as time spent transferring knowledge is effectively doubled.

In contrast, under a fixed price project, the agency has an incentive to train and mentor the junior staff, so the whole team can work more effectively and efficiently. The most talented staff provides the most value, and is, therefore, the most profitable for the agency. This benefits the client too because the work is more likely to be delivered at a high quality, on time.

Efficiency Vs. Effectiveness

Efficiency focuses on doing things right.
Effectiveness concentrates on doing the right things.
Productivity is about doing them both at the same time.

–Reinvent Your Enterprise, Jack Bergstrand

In an organization using the hourly billing model, everything is built for efficiency. The problem we have seen is that focusing on efficiency alone seldom produces desirable results. To be truly productive, you must first spend time thinking about the most effective solution. Becoming effective involves more than just careful planning, research, and experience—it also requires an investment in building relationships and training. The more social capital and shared knowledge a team has, the more likely it is to devise a great solution.

Failing to plan is planning to fail.

Most clients we have worked with appreciate the cost certainty of a price agreed upon before work begins. To make this model work, we must do thorough discovery, plan carefully, and be thoughtful about the work we recommend. We believe that eCommerce retailers need a partner, a strategic advocate who can help them make the decisions that shape their business and guide them as they grow. This is our mission, and this message is instilled in every member of our team.

The opposite of the word professional is not unprofessional, but rather technician. Professionalism is predominantly an attitude, not a set of competencies. A real professional is a technician who cares.

— True Professionalism, David Maister

The first rule of any company is “Make a great product.” At Gauge, we take that a step further; our goal is to “Make the Story Great.” Every brand, site, and business has a story, and the heart of the story is never a product—it’s people. Hourly billing may be a useful way to manage dollars, but it’s a terrible way to build a partnership. At Gauge, we’re more than simple vendors or technicians, we are professional partners.

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