This article was originally published by Donny Shimamoto for The Sleeter Group blog.
Many value pricing evangelists tell you that you need to trash timesheets. I disagree. My firm does value pricing and we still keep timesheets. The taboo on keeping timesheets is appropriate if you use timesheets to judge “staff productivity” and “hours billed” as the way to value a project. So part of adopting value pricing is going through the management mindset shift of not judging performance based purely on billable hours.
Defining and Applying Value Pricing
I define value pricing simply: “Pricing a service at a rate that reflects the value of the service delivered.” My firm applies this definition to both hourly and fixed-fee engagements. Our standardized hourly services are billed based on the perceived value of the service. For example, we would charge a set hourly rate of $100 per hour for bookkeeping regardless of whether a partner, manager, or staff does the work. This is because we’ve determined that this is the acceptable rate for that service based on our staffing costs and our market.
Originally, we billed by the person performing the service: partners billed at $250 per hour regardless of the type of work done, managers at $200 per hour, seniors at $150 per hour, and staff at $100 per hour. But as we had turnover in the lower-level staff, we found that seniors and managers had to step in to help with the lower-level work. This would cause an increase in the billings to the client, which the client would then complain about. Or we’d have to “write off” fees to adjust the bill down to the originally agreed-upon amount. Both are bad results. If we were going to write off the fees anyway, why not just charge the client the lower amount? So that’s what we did—we switched to pricing based on the value of the service provided, not on the staff who provided it.
This switch also allowed us to gain leverage on lower-level staff who demonstrated early competence in higher-level skills. For example, if we charge $200 per hour for risk management services, then you would expect that a manager normally performs this work, since that is their bill rate. Well, if we have a senior who is already able to do this work, does that mean that we only charge $150 per hour? Definitely not, we charge $200 per hour—the value of the work done.
Moving to Fixed-Fee Value Pricing
The next evolution in our billing was the shift to value-priced fixed-fee engagements. One of the keys to doing fixed-fee pricing is knowing what it takes to provide a particular service. There are three elements to this:
- Knowing the steps in the process to perform the service,
- Knowing what will cause those steps to take less or more time—“business drivers,” and
- Knowing how long it takes to perform the steps based on the business drivers.
For example, preparing an individual tax return requires different steps than preparing a corporate tax return. With an individual tax return, some of the business drivers may be the number of W-2s, K-1s, and 1099s; number of investments sold; and number of rental properties. Then you should be able to associate the amount of time, on average, it take you to process a particular form given the quantity of the business drivers.
This doesn’t mean that you have to get exact counts of each of the business drivers from the client. You can use predefined ranges (e.g., up to five W-2s/K-1s/1099s, and five investment sales, etc.) and then price the service based on those ranges. Whether you price it based on the low, middle, or high count of business drivers is totally up to you and should be based on your judgment regarding the service’s profitability and the prevailing rates in your market.
There are definitely services where you can’t determine a fixed fee at the beginning of an engagement, so you have to bill by the hour—for example, litigation support and other projects where a precise scope can’t be determined due to lack of information or complexities. So be sure that you are only doing fixed-fee pricing for the appropriate type of engagements.
Learning From Timesheets
Even with the fixed-price engagements, we still do timesheets. Why? Because we want to see if our understanding of the business drivers and time associated with those business drivers is correct. As part of our engagement wrap-up, we analyze how the team performed against the “budget.” If we were “over budget” or “under budget” we revalidate whether our understanding of the business drivers is correct and whether time associated with those drivers is reasonable. Sometimes the variance occurs because a staffer may be able to work faster or slower, or ran into a problem. This allows us to identify high-performing staff or identify staff weaknesses that may need to be addressed through additional training or coaching. Or maybe it was just a random issue that we had no control over related to the client.
The main point is to use the information from the timesheets either to adjust your estimation methodology, adjust your estimation formulas, or identify opportunities for staff development. Note that none of this is punitive—an important point to convey in order to ensure that staff don’t “eat time” to avoid reprimand.
Measuring Engagement Profitability
Lastly, with the time data, you can apply staff cost rates (we use salary and an overhead multiplier) and compare that to the revenues generated to determine if the engagement provided the expected profit. We also incorporate engagement profitability into our staff bonus compensation, so that team members benefit if the engagement is profitable.
You may also price engagements based on whether you think it will lead to more work. For example, our risk assessment engagements are priced more to break even rather than yield high profit. Why? Because 95% of the time, the risk assessment leads to follow-on work. And risk management work (as I mentioned above) is one of our premium services, so billed at a higher rate. So even though the assessment engagement does provide value, we price it lower so that clients are more likely to agree to allow us to do the full assessment—which then leads to follow-on work for which we have a higher margin.
So the takeaway is that you don’t have to give up timesheets to do value pricing. And make sure you do your homework before you jump to fixed-fee value pricing—understand your process, business drivers, and time requirements. When used together, value pricing and timesheets can also help to increase firm profitability and guide staff performance development. Why are you waiting? Start adopting value pricing now.