Fixed-Fee Billing Is the Devil
Posted by James Archer on March 20, 2009
Once upon a time, Forty was totally into fixed-fee billing. Several months ago we repented of our evil ways—we now bill 100% hourly—and life’s been awesome ever since.
photo credit: kimberlyfaye
How did we come to this sudden change of heart, and what does it mean for our clients?
The Quick Overview
- Fixed-fee Billing: At the beginning of the project, the agency and the client agree upon scope, time line, and budget. Payments are scheduled at regular intervals throughout the project, with the final payment being paid upon completion.
- Hourly Billing: The agency and the client agree upon an hourly rate, and invoices are sent on a regular schedule (biweekly, monthly, etc.). There may be estimates, budget caps, etc., but generally no fixed scope or time line.
Clients Love Fixed-Fee Billing (In Theory)
On the surface, fixed-fee billing sounds great to clients. Everything is sorted out up front, you know how much you’re going to spend, you know how long it’s going to take, and you can withhold the final payment until you’re completely satisfied. What’s not to love?
Problem #1: The Flawed Assumption
Unfortunately, fixed-fee billing is based on a flawed assumption: that something as complicated, evolving, and variable as a marketing/design project can be completely predicted before it has even started.
photo credit: Zach Klein
Plans change; budgets are cut; new competitors arise; relationships evolve; discoveries are made; trends come and go; new technologies emerge; markets shift; obstacles are introduced; people change jobs; priorities are reevaluated – In a nutshell: life happens.
In the 15 years I’ve been working on design and interactive projects in a variety of contexts, I’m not sure I’ve ever seen one project that actually looked the same when it was done as when it was originally conceived.
If the project always, always changes in the middle, why would an agency bill based on the assumption that they can predict it from the very beginning? When these inevitable changes happen, they’re only ever seen as unwelcome intrusions.
Problem #2: The Adversarial Relationship
Fixed-fee projects turn the agency and the client into enemies; they’re competing against each other. The agency is trying to wrap up the project as quickly and efficiently as possible, and the client is trying to get as much value as possible out of the agency by constantly requesting changes, adding scope, etc.
photo credit: Dr. Hemmert
Because the agency and client are competing against each other, there’s very little real collaboration that takes place. Openness is replaced with secrecy. The agency talks to the client one way to their face, and another way behind their back.
Problem #3: The Ethical Dilemma
The third issue with fixed-fee billing is the way that agencies profit from it.
The “bad” clients (the ones who always squeeze the scope for everything they can get without paying more) get the best deal in terms of hours worked for dollars paid.
Meanwhile, the “good” clients (those who respect the agency and avoid pushing the scope too much) wind up getting a lousy deal, since they’re getting less work but paying the same.
The good clients are suffering so that the agency can afford the losses they take on the bad clients. Seems reversed, doesn’t it?
Can Hourly Billing Really Solve Those Problems?
photo credit: dotbenjamin
Hourly billing is based on the premise that projects naturally evolve, and that it’s okay for those changes to come up and be considered, even in the middle of a project.
This means that both the client and the agency have flexibility to respond to sudden obstacles or opportunities, rather than arbitrarily arguing about the project scope defined in a document drafted months earlier.
Hourly billing also puts the agency and the client on more equal terms with regard to the overall project budget. Instead of fighting each other, they have to work together to keep the budget in an appropriate place. The client has to keep an eye on the number of change requests being made, and the agency has to provide enough value per hour billed that the client keeps them on the project.
photo credit: sergis blog
Hourly is Flexible. Flexible is Good.
Since switching over from fixed-fee projects to hourly, we’ve noticed a significant change in our relationships with our clients. We’re collaborating instead of fighting. We’re genuinely communicating instead of just putting on a show. Our clients are paying for the work we actually do, rather than the work that was imagined at the beginning of a project.
We work with our clients to keep the budget within their range, and (because every hour counts) they help us with that by avoiding excessive change requests, revisions, etc.
The change to hourly billing has been huge for Forty, and we now insist on all projects being run that way, without exception. We understand the initial desire to know a project’s budget, and to have a guarantee that it’ll be locked to that budget, but that’s just not how projects actually work. We want to work on projects based on reality, not on scope documentation.
photo credit: Ernst Moeksis
Ultimately, our clients have been happier under this new system than under the old one, and that’s what matters most to us. Happy clients make for a happy agency.
Comments
Posted by joshua on March 20, 2009
Excellent, ezcellent point. Well written and I could not agree with you more. I have talked to so many people throughout the years about how hourly billing is always better because the projects always, always change and the very notion that the project will be the same at the end is not responsible thinking.
Posted by Joe on March 20, 2009
What an amazing and rational case for hourly billing. It makes perfect sense. If I were your client I’d be begging to pay hourly. Great article.
Posted by Russ Maloney on March 20, 2009
Wow James — I shuddered a bit while reading your post, because a few months ago, Keane underwent a very similar transformation.
In the early days, our manta was, “make it as easy as possible for clients.” This meant sucking out the uncertainty in project scope and cost so the client knew exactly what they were in for. What emerged, however, were a whole slew of problems. Most of it was political/financial game-playing, but I also were noticing that projects didn’t necessarily turn out as good as they could have been — a symptom of working against an immovable, looming hourly cap. I needn’t rehash the points you made. You damn well covered them all!
The absolute best situation — and the one we always try to explore with new clients — is the classic retainer agreement. Client pays for a block of time up front, we work against it and report our progress (or even share project spreadsheets, updated weekly) as we go along.
Posted by Marvin Forte on March 20, 2009
Great article. This is an age-old debate that I’ve particpiated in for many years. Sometimes it is hard to convince clients that hourly billing is a good thing but there’s really no question it’s the fair thing. I think most clients are worried that the agency will bill them for more hours than they actually spend, a valid concern. But doing business with someone requires a level a trust, without trust, you shouldn’t be working together to begin with.
p.s. Fix the typo at the beginning of Problem #2.
Posted by Ryan on March 20, 2009
Hi James. Good read. Only thing I would push back on is this: CERTAIN projects are very difficult to scope within a reasonable amount of accuracy (enormous web projects), others are not (designing a stationery suite).
Plus, I would say, the Adversarial Relationship bit is very much a reality in hourly as well (Why did this take THAT long, I won’t pay for this because you didn’t do what I asked, etc., etc.).
THEN, you have the whole “market value” thing. Paula Scher mentioned that she more or less designed the Citi trademark while sitting in the 1st client meeting. Does that mean it is only worth 1 or 2 hours of billable time? Her comment, and this is brilliant was more or less, “yes, this took just a few hours to come up with … plus a lifetime of experience in this field.” Point to consider. Market value can’t be ignored.
Unfortunately, there are billing pitfalls on both sides of the fence. My $.02 – Effectively scope, communicate, design and bill. More often than not, clients will get great work and you’ll be fairly compensated.
My opinion is that many design firms do a poor job scoping projects, reigning clients in when things go out of scope, and managing expectations. We’ve certainly been guilty of all three at times.
For more nebulous situations, retainers and hourly billing work great, but I am not convinced they are the “savior” you purport for all situations. :)
Posted by [Charlene] on March 20, 2009
Great post. You really spell out the traps and tendencies of fixed-price contracts. It sounds like you have found the best billing model for your work.
I do a combination of hourly and fixed price. I find that both models require consistent negotiation, just on different point. With fixed-price contracts, the negotiation is about scope, and with hourly contracts, the negotiation is about rates and time. It’s just a different negotiation.
The type of work I do is a big factor in how these play out for me. For every project, the client’s goal is a thorough, complete help system for the application. We both know what their end product looks like. The messy part is the application scope. No matter how confident the client is about the application features to be documented, in the end, the features are always different. The development process takes them down a different road that changes the scope of the work.
Unfortunately, most of my clients are working with limited development funds, and they require knowing up front how much the help system will cost. The cost is almost always not negotiable. As the scope creeps, the negotiation focuses on the thoroughness of the help system. What layer of information can we omit that impacts the overall quality of the help system in the least way possible. The discussion shifts back to scope.
Even with hourly projects, there comes a point where the client can see the end of the development dollar pile, and they start to talk scope.
About 80% of the work I do is fixed-price. To make me smarter at determining the cost, I do a thorough (some would say anal) cost analysis of every deliverable. Small details, hours spent on each type of task, contractor rates and time spent, completed size, etc. I always know the profitability of a completed project, and I use that information to set better fixed prices going forward.
Posted by Cristian Graziano on March 20, 2009
Your post considers some great points. I like your take on this – especially how “bad” clients and good clients fit into this model.
I wrote a few blog posts about this exact issue, and came to a similar conclusion. I looked at it from a risk-reward perspective though. Hourly billing = more risk for the client. Fixed-Fee Billing = more risk for the service provider. If as the service provider you take on more risk, you should expect more reward (I have a finance background – can you tell? :).
After writing those posts, I started thinking about value. I’m able to work projects substantially faster than others in my field. I may be able to accomplish something in 2 hours that others would take 7-10 hours because of my knowledge, experience, and resources that I’ve developed over the years. If I bill hourly, I’m only being paid for my time – not the value I’m providing. I’ve worked with clients to automate their data mining processes – and something that might take me a few hours to complete saves them 2+ hours/day and provides them the best data possible. This is worth thousands of dollars to the client – billing hourly understates the value I’m providing in that case.
I think this can be argued both ways. Hourly is definitely “safer” in that you are always making exactly what you expect for your time. In most cases I would say this is best. In the cases where you are delivering a high amount of value for your time, fixed-fee may be better.
It’s always important to consider the complexity of the project when bidding fixed-fee – and have a very detailed scope and needs analysis for larger projects. Anything to protect yourself. I’ve written up my process for when I do have to bill fixed amounts – and it has been incredibly accurate. I’d love to hear your thoughts: http://www.cristiangraziano.com/blog/improving-fixed-fee-quoting-by-using-the-complexity-factor
Posted by Russ Maloney on March 23, 2009
@Cristian: Gotta say, I dig your worksheet. It is reminiscent of this tool that I’ve been using for a few months:
http://konigi.com/tools/schedule-and-cost-summary-calculator
It accounts for low/high estimates and adds in a scheduling and management element…I’ve changed it up substantially to account for different types of projects, and added cost/profit formulas alongside the template for a soup-to-nuts look at how long each task will take, how much it will cost the company and what our profits will be after those costs. In the end, it’s an estimating tool, a project scheduling tool and a profit projection tool.
It’s kinda handy, but it fails to take into account the risk element you’ve brought to light. It’s good that there are finance-types in this biz! I may add a column to our workbooks to integrate risk and complexity, as you have shown.
Neither of our methods, however, fully reconcile the aspect of market value. In the end, it may just be an arbitrary number tacked on the end, post-number crunching. In this respect, I guess no true model can be built to take this into account. Indeed, the market value is subjective and relative — not only to clients and the market, but to each company and its time, talent and personal insight.
BAH. Estimating takes way too much time. When it comes down to it, there’s always going to be a game and a politic. Sucks.
Posted by Rusty on March 24, 2009
Good arguments James, however… In our 17 years we’ve flip flopped more than once in this game and have had bad experiences on both sides. There’s just no getting around it. The problem with quoting hours is that we have a highly skilled team and typically get projects done better and in half the time of most other web and advertising firms. If a client compared us based on hourly fee, we’d lose most jobs to the plethora of inept “hacks” out there. Of course you know they end up costing a client more in down-time and overall cost. (Actually much of our business is repairing the mess these “hacks” have caused in the first place.) However, when we quote by the project, we are low to average in price. So we have to quote on a project basis. We tell clients the quote is based on total estimated hours and we bill based on hours. We’re very good at staying within that estimate. However, if a project looks like it’s going over or a client requests additional changes, we let them know how much more time it will take. One thing our 17 years has taught us is to be flexible with clients. Pick your battles carefully and avoid them whenever possible, especially with good clients. It costs much less to keep a good client than it does to find a new one. A thousand dollar sacrifice to keep a client happy, usually returns itself many times over and keeps the spirits of the team up. And finally, life is too short for mean clients. Watch the danger signs and drop a hot-headed client immediately. Mean and penny pinching clients will cost you money and dampen the spirits of your team.
Posted by Preston Lee on March 30, 2009
Rusty: +1 to many of these comments. Each approach has its pros/cons and appropriate situations. At OpenRain, all larger projects currently operate on an hourly basis for many of the reasons laid out in the post, though we still must estimate the overall cost and timeline and raise flags early if issues develop with the plan. Smaller projects, however, are much easier to estimate and have lesser probability of radical vision transformation due to shorter time frames: so we’ll fixed bid small business projects.
Posted by Keith on May 9, 2009
Hey James, you’ve got a very well argued case going here and it all seems to make perfect sense in theory. In fact, these are most of the same reasons why Blue Flavor started out doing hourly billing only. After about two years (and many problems) we’ve switched to per-project billing.
When we were doing hourly we were running into the exact same problems you mention here. Our clients, for example, would take our estimates and treat them like they were fixed price and we’d have to constantly justify the hours we were using. As well, for some jobs some things would just take longer, for others it came easy. With design and development it can be pretty hard to predict exactly how long something is going to take. Saying “we need 10 more hours to finish that” isn’t all that different than scope negotiation on a fixed bid project.
Since we changed, we’ve seen the same kinds of benefits you mention here from making that switch. In fact, we’ve had very, very few problems with per-project (fixed fee) billing and it seems to be much easier to manager in many ways.
I’ll be curious to see how this works out for you in the long run. I personally think that it’s not really about how you bill, but how you communicate with your clients that matters. We’re very open, upfront and… well, blunt about how we estimate our scope of work and what we’re going to be delivering on. So far, when a client needs more work that’s clearly out of scope, we have a chat, adjust the scope, get a bit more money and move on. If the scope changes are small, well, we just deal with it with smiles on our faces.
I think what you’ve got here seems like a good solution and if it’s working for you, I see no reason why you should change it, don’t get me wrong. Just wanted to give the perspective that hourly billing has it’s problems too.
Posted by James Archer on May 9, 2009
Keith,
Thanks for the feedback! We’ve run into some of the issues you mention with hourly billing, even in the early stages of having made the switch, and I think you nailed the problem exactly when you said that “it’s not really about how you bill, but how you communicate with your clients that matters.”
That’s part of the reason what we’re in the process of adopting (and adapting) Agile processes to our business. Agile puts real communication at the top of the priority list, making it much easier for our clients to have a solid understanding of where the project is going and why. It also requires us to deliver value earlier in the project, so the client is receiving completed work, not just finding out that the budget is going up before they’ve even seen anything.
Stay tuned as Forty continues to evolve, and we’ll certainly post more about how it’s working for us over time.