Hourly Rates—Confusing Effort with Results

On one of my very first consulting assignments, I neglected to regularly back up data on my computer and lost an elaborate analysis in a sudden power failure. I bemoaned my lost hours and valuable work to the project manager but, as you might expect, got little sympathy. I did get some good advice though: Never confuse effort with results.

I flashed on that advice recently as I was sitting across the table from a client who asked the inevitable question, “What’s the hourly rate for the people you are proposing for this project?” That led us to discuss if the proposed consultants were “worth” their hourly rate. Sound familiar?

Way too often, such conversations degenerate into how the client can monitor and limit hours—all in an effort to keep costs down—not on how to achieve results.

You can’t blame clients. The hourly rate is the gold standard for pricing in the industry. For decades, professional service providers have trained clients to expect it, and it’s now used extensively to compare consultants.

It’s time to dump the hourly rate once and for all.

To begin with, the hourly rate is a totally bogus number. It’s computed using very broad (and sometimes flawed) assumptions about a firm’s costs, volume and profit. And, many consultants toss those assumptions out the window and discount their hourly rates when they believe doing so will improve their chances of winning a project.

And then there’s the matter of results. You probably know the urban legend about the consultant who was asked to help a client restart a machine that had died and caused a halt in production for a manufacturing plant. The consultant eyed the machine from all angles, circled it twice, and whacked it three times with the client’s rubber hammer. The machine sprang back to life, and the consultant left after fifteen minutes of work.

But, the client was outraged with the consultant’s high-priced invoice. “We could have swatted that machine three times without you.” he yelled. The consultant’s predictable reply was, “Yes, but you didn’t know where to swat it, and that’s why you called me.”

By charging a client for time alone, you completely undermine the expertise you’ve spent years building, and you limit the profit you can justifiably earn. Dozens of pricing alternatives exist that don’t rely on the hourly rate. Look for alternatives that lead to discussions with clients about the outcomes they want to achieve.

When pricing your next project, think results, not effort.

Comments

[Computer Consultants]

Yes, I understand the problem and it would be nice if we could think in the fixed price for job done, but this relies on a paradigm shift on both sides.
I deal with Financial Directors and other members of the finance department who mostly speak in hourly, daily or weekly rates. This frustrates me as I am unable to give an accurate figure as with most things the scope will develop and many open up thus extending the time frame. If I am working to a fixed figure then I would either renegotiate my fee or if the original fee was low because I had anticipated the extra requirement then the changes would be encouraged.

I have seen businesses employ both models: fixed price & low initial bid.

The later relies on the fact that the requirements are very rarely captured and the internal teams will fight to have the project scope extended without any intervention of the contractors. Cynical but it happens all too often.

How do we change the world of consulting, we need to change the customer. Education ??

[ctd]

Other than success fees, the only type of fee that gets any widespread use is a fixed fee. But I don't know that it necessarily solves all the problems. The lawyers/consultants set the fee based on how many hours they think it will take - so its almost an hourly fee in disguise. And many clients dislike it because they think either the fee quoted is actually higher than an hourly rate fee would be, or (sometimes not incorrectly) that the fee will be based on senior people doing the work and, once accepted, the work is done by juniors or is done in a rush to come under the set figure.

Of course, there are situations in which fixed fees work well - where the work is clearly delineated, or where there is a volume of work such that some files are profitable (fees greater than work) and some unprofitable, but overall its worthwhile.

I agree with GS above - the hourly fee has so many problems and encourages inefficiency, bill padding etc. But how do you validly - from all perspectives - do it differently in all circumstances.

Plus, from a management perspective, timesheets are very useful tools. So they are going to exist anyway.

[gamma sync]

What is a good reference to alternatives to the hourly rate?

I know that lawyers are using 'success fees' now, where they only get paid if they win, but in my professional service business our clients are happiest when we prevent problems.

How do I price a non-event?