The Billable Hour Versus Value Pricing
For decades, the standard billing practice for accounting firms has been timesheets and hourly rates. The hourly model is built upon the foundation of time and money, that is, exchanging one’s time and services for compensation. This methodology is still the most common pricing model in the professional services field, but little by little, value pricing is gaining in popularity.
The value pricing model widely differs from the hourly model. Value pricing requires that the seller, generally a professional services firm, determine what a customer is willing to pay for one’s expertise before the work is complete. In the hourly model, billings take place after the work is complete.
How does one value price their customer? It centers around a conversation and a thorough understanding of your customer’s needs. Each customer is unique and therefore you offer them a unique value proposition and, as a result, you should offer them a unique price. For example, if you were to implement an automated inventory system or online accounting system with tons of automation for a customer that could earn them millions of dollars in revenue or save them hundreds of thousands in expenses, they would see significant amount value in your services. That customer would be willing to pay an amount far larger than any professional would have billed them using the hourly model. Value is in the eye of the beholder.
The lure of the hourly business model is that, in theory, you cannot lose money on any engagements. The professional has a record of the time required to complete a task and will bill out the hourly rate established for the individual completing that task. The hourly model ensures that you recover the cost of the inputs (wages) and receive a markup for the work performed.
PROS AND CONS
One of the downsides of the hourly model is the administrative work that comes with it. The requirement to create and track timesheets is not inconsequential and the stress of reaching or maintaining billable hour goals is a constant drain on employee morale. Billing using timesheets can also cause tension between a professional and their customers if the customer feels that the amount they owe is too high (since they have no way to verify how many hours were spent to complete an engagement).
Value pricing eliminates some of the downsides associated with the hourly model. From an internal perspective, by eliminating the timesheet, it shows trust in your team and empowers them to take responsibility for creating value instead of being so concerned with staying within budget.
From a customer perspective, since the price is established ahead of time, the sticker shock that accompanies the hourly model is eliminated. The value pricing model also allows for easier budgeting both for the professional, the firm and the customer because everyone knows what it will be ahead of time.
But, the biggest advantage that the value pricing model offers is the incremental price that one can charge when delivering value on an engagement. Going back to the automated inventory or online accounting example, if a professional is an inventory expert and can implement a system in 10 hours – they can charge 10 hours of their time using the hourly model. In this situation, the professional has a price ceiling – they cannot charge more than the time they spent to implement the new system. On the other hand, whether the engagement is one hour, 10 hours or 100 hours, the professional using value pricing is pricing based on the value provided to the customer. In a situation where a customer sees significant value in a professional’s work, one would be significantly short-changing themselves by using the hourly model. Rather than paying for time, value-pricing ensures that your expertise is rewarded.
Learning how to properly determine scope is the key to successfully implementing value pricing in your practice. Initial client meetings become imminently more important because the need to accurately determine what services the client is going to require prior to starting an engagement is critical, yet not always easy to do. The hourly model allows for the customer underestimating how much work it will take to complete an engagement, because the professional can bill them for extra time. With value pricing, it can be more difficult to renegotiate the scope of your engagement since you are pricing in advance. During initial conversations with a prospective customer, it’s imperative to ask the right questions to determine what the customer’s expectations are and where they derive value.
As the accounting industry shifts more towards cloud accounting solutions, it will become even more important for firms to integrate value pricing into their practices. Cloud accounting systems are bringing increased automation to everyone’s workflow and this makes the hourly billing model less practical given that the number of hours required to complete the same tasks is greatly reduced. Fortunately, limiting data entry requirements increases the time one can spend reviewing client data and providing real-time insights more frequently. This leads to greater customer satisfaction since customers are provided with visibility over their performance, leading to faster and better decisions.
With cloud accounting tools, customers have continual access to their financial statements. Meetings and discussions are moving away from a presentation of financial information and more towards a discussion about inefficiencies or patterns that can be observed and suggestions for improvement. By embracing the cloud environment, accountants can increase how quickly they can react to trends in their customer’s finances. By providing these insights in a more timely manner, professionals are providing significant value while reducing the time they spend on mundane data entry tasks.
Going forward, profit drivers are no longer going to be in the completion of a bank reconciliation or a tax return, but in the added value that one can provide in an advisory capacity, which will necessitate a move away from hourly billing. Firms must accept this truth and be proactive in migrating their practice to value pricing if they want to deliver an amazing customer experience.