Understanding Fixed Fee, Value Billing, and Value Pricing
I want to be completely up front here. For those that bill by the hour, improving operational efficiency can be devastating to your bookkeeping business. Why, you ask? Simple – we can eliminate at least 70% of the time traditionally spent sorting, organizing paper and doing data entry. If we are tied to hourly billing, theoretically, we would earn 70% less per client. Under hourly billing, we are penalized for embracing innovation and technology.
I recently conducted an experiment. We had our best and fastest bookkeeper manually enter transactions for a client. It took her 40 hours at an hourly rate of $50 per hour to sort and input a year’s worth of transactions. We gave her a slight advantage, as we had already opened all envelopes and “uncrumpled” the paper in our scanning process (approximately two hours). We used Optical Character Recognition software to create searchable PDF files. We were then able to extract the data and import it into the accounting software. We had to review the transactions and make minor adjustments.
This stage took about an hour. We then took two hours to compare and reconcile the imported results to the manual input created by our bookkeeper. There were minor coding variances, but overall, the end result was very close. In total, our side-by-side test took approximately five hours to reproduce the results created by our bookkeeper. We shared our results with the client and asked him if he cared whether we paid a bookkeeper $2,000 to do the work or if we charged him that same $2,000to deliver the same result, knowing that our “cost” was based on five hours of work, not 40. He actually laughed and said he would pay $2,000 either way because he knew it was done right. He placed a significant value on our service. Ask yourself, has anyone ever asked to buy an hour of your time? I am confident that the answer is no. People buy the end result of your efforts (peace of mind), not time.
I generally see four common approaches to billing for services:
- Hourly Billing – A simple formula (hours worked multiplied by hourly rate) is used to create an invoice. There is an inherent conflict because clients are often surprised at the end, if hours worked are higher than anticipated. Slow paying customers are often silently protesting what they perceive to be an unfair bill.
- Value Billing – Value billing is usually based on hours worked and an artificial limit of what we believe a client will pay. We usually make internal decisions to “eat” time rather than risk conflict with a fee sensitive client.
- Fixed-Price Agreements – Fee discussions are held with clients before work begins. We clearly lay out the framework for the engagement, including payment terms, deliverables and overall scope of work to be performed. Clients love the certainty and are generally happy with fixed-price agreements. Opponents to fixed-price agreements worry about losses and cost overruns. You can mitigate this risk by knowing your costs up front and by avoiding scope creep. Scope creep, or doing additional work for free, can be avoided by clear client communication. You must train your team to identify out-of-scope work immediately and communicate with clients to negotiate change orders before the additional work is started. Fixed-price agreements usually include terms for an advance retainer or monthly fees. I recommend a simple menu of services to assist you with pricing.
- Value Pricing – This is the ideal model in theory. However, it is also harder to implement in practice. Similar to fixed-price agreements, value pricing requires up front discussions with your client. Value pricing is unique in that we attempt to determine exactly how much value a client places on our services. We strive to build value by identifying business pain and tailoring our solution accordingly. We maximize our revenue by determining the maximum amount that each client is willing and able to pay for our services. Value pricing can be very rewarding and build loyal client relationships if you can clearly demonstrate your value. Value pricing has two common objections:
- We are gouging clients: identifying needs and offering high quality solutions at a fair (and agreed) price is not gouging.
- Clients talk, and they will know that I charge different fees: Good. Then, they will also know that each client pays based on their specific needs and solutions. No two businesses are identical and have identical needs, so how can we expect that fees be the same?
The second secret to earning more and working less is to implement fixed-fee pricing to get paid for the value that you deliver.