Table of Contents:
I. Why do we engage in hourly billing?
II. Why don’t big names engage in hourly billing?
III. What’s the risk of hourly billing?
IV. Price Anchoring
V. How to Sell Using Price Anchoring (Quick 3 Steps)
VI. Conclusion & Resources
Why do we engage in hourly billing?
Tell me: What do all the “gurus” say you should focus on when you go about pricing your services? They talk about pricing per hour.
It’s not your fault. You believe it because when you started working, you were paid per hour.
A “job” = exchange of hours for money.
So then when we go out and start software consulting companies, marketing consulting companies, freelance businesses, etc.,…. we think about hours. Even when many bill “projects”, they still compute the price based on the # of hours it’d take and charge that.
Example: 3 x $100 an hour = $300 for a logo
Why don’t the big names engage in hourly billing?
Look… there are consultants charging $50-100 an hour and there are consultants charging tens of thousands per day. Don’t believe me? According to my copy of Dan Kennedy’s Magnetic Marketing*, Dan charges something like $19,000+ per day to fix their marketing and build a direct mail funnel.
Why don’t they engage in hourly billing? They don’t because they would never get as affluent as they are charging hourly rates. I mean, some of these guys charge tens of thousands just to speak at an event. How do you think it would sound if they actually talked to people about what they made per hour?
What’s the Risk of Hourly Billing?
There are three risks associated with hourly billing: Commoditization, Profit Loss, and Inefficiency
The thing is, when you charge by the hour, you’ve essentially made yourself a commodity. A commodity is something that’s just like everything else. So when you say, “I’m a consultant who does X and charges Y!” Well, your client is only thinking about the rate. They’re not thinking about why you’re different or the results you’re going to bring compared to what anyone else can bring them. They’re only thinking about the rate. So they’re going to compare you to the next person who does X but charges Z, and they’re going to pick the cheapest one. Or, they’ll go with you until they decide they don’t want to pay your fee anymore.
And then there’s the profitability ceiling…
Here’s an example where hourly billing goes wrong as applied to profitability:
Let’s say that you are one of the tens of thousands of IT consulting firms who charges between $100-$150 an hour to do IT stuff. (Software development, network infrastructure, whatever.) Now, when it was just you there was a lot of money to be made. You were bringing in 200K a year and had negligible business overhead (let’s say $12K a year for office space and training and such.) Great.
But you wanted to make more money. How did you do that? Well, you got more contracts at $100-$150 an hour, but you outsourced some of the work for $50 an hour. So now you have people underneath you making $100K a year and you pocketed the remainder.
The problem? As you hire people, you expenses go up and your profits go down. Now you have to hire people to do all of the business stuff, like accounting and sales and HR.
And the only way to make more money? Take on more contracts and hire more people. You can’t charge more, because that $100-$150K is the market rate for what you do. Your clients know that what you do is a commodity and can and will go elsewhere if your rate is too unjustifiable. So you just keep taking on more clients, hoping that eventually your costs will stabilize. Or maybe you pay people less, taking on more junior employees. Or maybe you make your employees work more while pocketing the rest.
Either way, it’s a quick train to burnout land.
In short: your profitability has reached its ceiling. Congratulations.
Instead, what this company (and I swear there are tens of thousands out there like that fictional one I described) should do is focus on the end result they’re creating and point pricing to that. Instead of making only $200K for a year’s worth of work, they could anchor at $250K… $350K… $450K… and actually make a profit that doesn’t revolve around billing employees at 4x what they’re actually getting paid.
When you know that you have 10 hours to do a job and you’ll only get paid if you sit there for 10 hours to do it, do you think there’s any incentive to work faster or get better at what you do? No. It puts you at a moral dilemma. If you weren’t paid by the hour, you could buy tools or do things in such a way that you get your client’s work done faster and better. Instead, you are tied to hours because otherwise you can’t pay the bills. So will you buy a tool that will do the job better, or get the job done quickly so the client can reap the rewards quickly?
The answer is no, you don’t. Instead use up the hours you’re allotted because that’s the only way you make money.
There are only three ways to make money at that point:
- Charge only what time you spent, but over time be forced to take on more and more clients once you’ve reached the per-hour ceiling. (You become more efficient so your per-hour becomes less profitable.)
- Charge what was quoted, whether you actually used all that time or not. (Cheating and lying to your client – that’s bad mojo.)
- Take all the time allotted to do the job, and never break away from the working-all-the-time wheelhouse you wanted to get away from in the first place. (At this point, you might as well go back to your j-o-b.)
Instead of all of that drama, you could just price according to the project’s value, do the job in the time it takes, and deliver value quickly so your client can reap the rewards. No killing yourself, cheating yourself or your client, or being inefficient. Just work you want to do at a rate that pays your bills.
Sounds good, right? Then let’s look at price anchoring and how it affects your billing.
FREE course -> “Charge What You’re Worth” by Brennan Dunn
Price anchoring is the idea that the first piece of information you receive about something will create a bias that colors the rest of your experience. This is why it’s so hard to change your prices with existing clients, and why you have to anchor it to something else (e.g., your posted rates are now significantly higher than they’re paying, and you don’t want them to feel like they’re getting second-rate work from you because they’re paying less. Etc).
How to Sell Using Price Anchoring:
Look at my previous post on pricing for more details, but here’s the shortcut version:
- Find out what their most painful problem is
- Discover and discuss what that most painful problem costs them or is worth
- Talk about your pricing in relation to solving that problem
The best way to achieve this is to price per project. What value are you giving in exchange for your fees?
- Hourly billing reduces your total income and makes you a commodity
- Price according to value, not to yourself or market rates
- Use Price Anchoring to your advantage
I want to add something here: Something magical happens in your head when you stop thinking about hours. The first is that you become more efficient. The second is that you stop working so darn much and you stop sweating it. If you’re bringing the value and end result you promised your consultants, then you’re doing your job. Who cares if it only takes you 20 hours? That’s your business. And if it takes you a ridiculous amount of time to do a job? Well, that’s your business (/problem) also.
The results are what you’re promising and what your clients pay for. Anything else is just a golden handcuff and a focus on the wrong thing (e.g., labor instead of the end result).
You want both you and the client to be on the same page and focused on getting a very specific end result.
Now go thee forth and make more money!
If you found this post helpful, you should get on my mailing list. And please… share this with someone who needs kick in their pricing booty.
- Double Your Freelancing Rate (course)* – I highly recommend this one. I attribute this to my rate increase success.
- Kevin Rogers’ Truth About Marketing Podcast
- Magnetic Marketing* by Dan Kennedy/GKIC (link is to discounted version)
- The Art of Value podcast
- FREE course – “Charge What You’re Worth” by Brennan Dunn
* this is an affiliate link. Just do some Google searching for the title if you’d rather those pennies stay in Amazon’s/whoever’s pockets instead.