There is no ‘right’ way to bill for every business, but there is an optimal approach for your specific business. To ensure that you have an appropriate billing structure, try to match the approach with the nature of the work you do and the value you deliver.
Hourly fees, fixed fees, project-based fees - when you delve into it, there seem to be endless ways to bill clients! Which is the right one? Or - better question - which one is right for you?
In this article, we’ll be covering more or less all the options, when to use them, and what risks to watch out for with each. By the end, you should be able to confidently choose a billing approach that works for both you and your clients.
Why this is important?
At the end of the day, a client is sending you money for a job. Surely it’s better to just pick a billing approach, move on and focus on doing good work? Why over-engineer the thought process?
Two reasons.
One, it’s dangerous to be blase about anything to do with pricing. Pricing is ultimately how you get money in the door. Money enables you to keep the lights on, not to mention invest in your business's future. It is serious and it deserves time.
Second, your billing approach determines what your services sell for and hence what they are worth. You shouldn’t just copy your competitors. Your service could be different (efficiency, quality, friendliness) in ways that materially affect your costs, and the value to the consumer.
Your billing approach ultimately determines whether your business survives and - hopefully - thrives, in an increasingly cutthroat world of empowered, information-rich consumers.
Fundamentals
The golden rule that you should follow, when selecting an approach to billing, is that the billing approach should mirror the work you are doing.
The most basic application of this is to do with cadence. If you are doing an intensive two-week project, you would not charge a 12-month subscription. On the other hand, if you are selling a monthly podcast and newsletter subscription with light email support, a 12-month subscription might make more sense.
Most articles on billing approaches deliver a laundry list of options, give a few pros and cons, and ask you to pick one. What they don’t cover is the important fundamental differences between the various approaches - regarding how they link price and value.
There are three ways to calculate value:
Time-based: number of hours worked
Utility-based: perceived willingness to pay
Results-based: linked to a quantifiable outcome
Time-based billing is appropriate for jobs that require individual expert attention. Counseling, for example, is a one-to-one activity, and requires a trained professional to devote a portion of their limited time to a specific client. More time = more value. More expertise = more value.
Utility-based billing is appropriate for products that can be produced at scale. Software is a great example. Microsoft charges $149.99 for Office, because it knows that most people are both able and willing to spend that amount. It has no direct link to ‘time-to-deliver’.
Results-based billing, also known as contingency billing (and often mislabeled ‘value-based’), is based on the tangible results of an engagement. No-win, no-fee models in law work because lawsuits can have clear verdicts and financial outcomes (e.g. damages).
There is no universally correct approach to billing, and all three of the above have their place. But there are approaches that are better suited to certain types of businesses.
3 approaches to linking value to price:
The remainder of this article assumes that you deliver a service that is time-based. That means that you:
Are selling expertise or skill, rather than selling goods
Are delivering a service that requires one-to-one attention
Are not in the habit of/in a position to offer contingency-based fees
For time-based businesses, time (and time-tracking) is the North Star when it comes to billing clients and communicating value, not to mention running the firm itself.
Approaches to billing
With the basic foundations laid, we can now get down to brass tacks.
When the value of your service is based on time and expertise, the final bill will, one way or another, reflect a total number of hours worked, multiplied by an hourly rate. The hourly rate may be:
Person-based: Higher expertise → Higher rate
Task-based: More difficulty/complexity → Higher rate
For a project involving multiple individuals or a variety of tasks, the overall hourly rate will be a blend of the respective rates.
It is also possible to apply a single rate to a project (project-based), either based on the difficulty of the project itself, or as a blanket rate applied to all work (standard rate). Remember that both of these are implicitly assuming a mix of expertise that is reflective of the firm and the type of work it does.
For a time-based business, you have essentially two choices in terms of how you determine the bill:
Estimate & Commit (Fixed): Guess up-front how much time will be required and what mix of expertise and skills will be needed, and commit to a fixed fee.
Track & Report (Variable): Agree on an hourly rate (or rates) with the client and bill at intervals throughout the engagement based on the actual time spent and work done.
Estimate & Commit
In this approach, you calculate (explicitly or implicitly) the fee based on a prediction of the amount and type of work required for a given engagement. When estimating in this way, it is common to take shortcuts, such as applying a day rate per resource (i.e. assuming a certain number of hours worked per day).
If you are performing an actual calculation, it is important to take into account any specific factors that may inflate the hours or skew the team towards one time of resource, in comparison with a ‘typical’ engagement.
Committing to a fixed fee in advance can take many different forms, but ultimately falls into one of the two buckets below. Which one you choose depends largely on cadence (i.e. the ‘shape’ of the work over time).
One-off
When to use it
The “project-based” fee is a standard approach for many engagements such as painting a house, or conducting a review of a company prior to acquisition, where the endpoint is clear.
Engagements with a clear beginning and end are easier to predict. This is particularly true if the project is carried out in a relatively short period, and the person setting the fee has overseen many similar engagements before. It is even possible to ‘productize’ a commonly-performed project, and advertise it as such on a service page.
Risks with this approach
The main risk is “scope-creep”. This can happen when the client and the contractor enter an engagement with different views of what has been promised. It can be addressed by a clearly defined scope of work at the beginning of the project, stipulating the boundaries both in terms of breadth (reviewing one website, not two) and length (maximum of two rounds of feedback).
Pro tip
In billing for larger projects, it can be helpful to employ milestones: breaking the project up into a series of goals, with payments spread across the project lifecycle. It can also make sense to bill a portion of the total project fee up-front (10-50%, depending on the project size). This is not only helpful from a working capital perspective, but also reminds the client of the link between value and fees.
Recurring
When to use it
The recurring or subscription-based approach works best when the amount of effort required is not only predictable but regular, and with a low capacity for variance. There are actually very few services that are this predictable or regular, but provided the total value delivered in a given year is in line with the total subscriptions paid, the equation still balances.
One example might be a law firm offering support to small, early-stage businesses, who are short on staff and experience, and may need help with routine tasks such as trademark applications.
Risks with this approach
As with the one-off example, the risk of offering an all-you-can-eat service for a fixed fee is that people will take advantage of the system. It only needs to be a small number of clients to drain your resources and impact your profitability, your availability for other clients and your time to develop new business and run your firm. The answer is to limit your exposure to unlimited requests by placing reasonable limits where appropriate, similar to defining the scope of a project in the example above.
An added issue with recurring fixed fees is the illusion of stability. Like getting paid a salary as an employee - a ‘stable’ income can suddenly go to zero if the employer decides to end the relationship. The more you are dependent on recurring fee relationships, the more fragile your business, particularly at an early stage.
Case study: Dangers of all-you-can-eat
Restaurants can offer an all-you-can-eat buffet for a fixed fee and still make a profit. Why? There is a natural limit to what a human being can eat at one sitting. In other words, the variance is low.
This is not the case with all types of value, as Deutsche Telekom discovered in the early days of mobile internet. Against the advice of their consultants, they offered unlimited data for a fixed monthly fee. Because it is possible to consume considerably large amounts of data as an individual, they not only incurred significant costs in building the infrastructure to meet the demand, but later had difficulty monetizing the demand having already introduced the concept of unlimited data.
Hourly
When to use it
The Track & Report approach is ideal for engagements that:
require well-paid resources to deliver
are difficult to estimate up-front in terms of effort
Risks with this approach
The difficulties with this approach can come at the point of sale or at the point of payment. Prior to the sale, a client may be apprehensive about committing to an engagement of uncertain length and potentially unlimited budget. At the point of billing, a client may challenge whether the work carried out was justified and worth the fee.
Neither of these problems is insurmountable. Clients can and do commit to ‘open-ended’ projects with variable fees, and the industries that use these fee models consistently make money!
When it is hard to commit to a fixed fee, you can give a client an expected range (which is easier to predict based on experience). As for negotiating the bill: the key with all customer disputes over pricing is being able to link fees paid to value delivered. Luckily, being able to point to an itemized timesheet is an excellent way to do that.
At many professional services firms - such as consulting or law - casework is often indeterminate in length as it consists of solving problems. It is therefore hard to commit to a fixed fee. Furthermore, since the resources involved are highly-trained and expensive to keep on the payroll, going over budget can make a project very unprofitable, very quickly.
Pro tip
Just because you follow a Track and Report approach doesn’t necessarily mean you must bill in arrears. It is possible, and even advisable, to request an up-front deposit, known in the legal profession as a retainer, representing a block of hours paid for in advance. This also helps to establish that the client is serious. If retainers are not the norm, you could consider offering a discount for paying up-front.
Decision tree for time-based billing
Conclusion
It is not difficult to settle on the correct billing model if you consider the dynamics of your core business carefully, and choose an approach that mirrors it closely. Implementing a billing model is harder than choosing one, because life is complicated and clients (and employees) will always be full of surprises!
With the right tools, however, you can meet these challenges head-on. Learn more about how My Hours can help you implement your chosen billing approach, whichever you decide is right for your business.
