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Why we are getting rid of our hourly rate

Like everyone in advertising and digital marketing we are taught that our business is based on an accounting principle known as cost plus. Take all your costs (salaries + overhead) and add your profit. Pretty simple.

To figure out what to charge your clients, you estimate the hours to do a job and apply your billable rate. If you’ve estimated hours correctly and your billable rate properly encompasses your costs and profit you achieve your business model.

Under this model companies have a billing capacity, which is a formula to determine the revenue your company can make in a year. Cost plus billing assumes labour is the primary unit of value in the system. You can only bill as many hours as you have. This means professional services firms can only ever add people or increase their rate to grow.

Very early on Geoff and I struggled with some of these ideas. For starters, we never tracked time at Teehan+Lax. We learned a long ago that time sheets were a fiction. People just made them up. I know because for years I made mine up. What’s the point of a time sheet if the data is false? It’s not telling you anything. Don’t do them.

Secondly, we created a simplified rate card. We only had two rates: one for Partners and one for Associates. We did this because we were sick of agencies having these long rate cards that confused clients and created unnecessary complexity.

But since we started there was one idea that we could never reconcile. There was very little relationship between the time we spent on our projects and the value we delivered. We could see things that took very little time having big impacts in client’s business. Our business model wants projects to have more hours since we are financially motivated to do so. But, we are a company that values being nimble and very efficient. There is very little incentive to be the latter when your business model is the former.

At the very first Toronto BarCamp, Jay Goldman, Michael Glen and I discussed these issues on how to get clients to pay not for the time but for the value. We couldn’t figure out how to do it and the discussion died.

Without a better solution we relied on cost plus billing and estimating hours to determine pricing.

Late last year I stumbled across the writings of Ron Baker. Ron is a former CPA who is one of the most vocal and main proponents of a movement in professional services known as value pricing.

I read his blog and then bought his book Pricing on Purpose. The book was a revelation to me.

Ron lays out a compelling argument as to why cost plus billing is not only wrong but economically flawed. While there are many reasons it is a flawed system, the biggest reason is that it misaligns the incentives for clients and agencies. In any system where hours are used to determine the price of work, its your incentive to convince your client it will take many hours and their incentive to convince you it won’t take that much.

If you are cost plus billing you are selling time. We didn’t get into this business to sell time. No one at teehan+lax became a creative professional to sell time.

Last Wednesday we sat with Tim Williams of Ignition Consulting to begin the process of moving away from the hourly rate in our business. It was an amazing day and we learned a lot.

The next day we removed our hourly rate from our site, our marketing materials and our vocabulary. We do not sell hours here and clients will no longer be able to buy them from us.

Jon Lax More posts by Jon Lax