Time’s up: The benefits and challenges of moving away from the billable hour

BY CHRIS BAYSDEN
August 1, 2014

Debbi Warden, CPA, CGMA, still remembers exactly why her bookkeeping firm decided to—as she colorfully puts it—jump off a cliff.

“It felt as if every other week we were putting dollar signs in front of our clients,” she said of her firm’s previous billing practices. “We are a relationship business. And we didn’t want dollar signs interfering with the relationship.”

Warden, an accountant who runs a firm called The Business Manager near Denver, wondered if changing her billing model might help. It’s a question many CPAs have considered in recent years, especially as more and more consultants have called for the elimination of the billable hour. Warden’s experience provides an instructive case study for firms that want to understand the challenges and potential benefits of such a change.

She jettisoned the firm’s old model, in which practitioners charged most clients $75 an hour and invoiced after the work was completed. Instead, a majority of clients began prepaying a flat rate through an automatic monthly bank draft. The rate varied by client.

Today, about 55% of The Business Manager’s clients pay a flat monthly fee. ( Editor’s note: The “internal rate” Warden uses to calculate that flat fee has since risen from $75 per hour to $85.) Another 40% are on a prepaid retainer (especially those with fluctuating workloads, such as companies that have a lot of seasonal business or those engaged in mergers or acquisitions). Warden has been thrilled with the change, which reduced costs and improved relationships with her firm’s 40-odd clients. “The focus is now on the work, where it should be,” she said.

A CHANGING PRICING MODEL

Warden is just one of many CPAs to experiment with new pricing methods in the past few years. Those methods come in different shapes and sizes. Some firms still use billable hours internally to help calculate a fixed monthly rate for a portion of clients. On the other end of the spectrum are firms that completely discard the notion of an hourly metric and instead use “value pricing,” in which prices for all—or almost all—clients are based on the value of the service provided to the client.

Three-quarters of U.S. accounting firms use some sort of fixed-fee pricing, according to the 2012 National MAP (Management of an Accounting Practice) Survey, which was sponsored by the AICPA Private Companies Practice Section in association with the Texas Society of CPAs. The percentage of firms using value pricing jumped to 56% from 41% in the 2010 survey.

Despite the changes, the venerable billable hour is anything but dead. Hourly billing remains the most popular method, with 86% of firms doing at least some client billing on an hourly basis. Ron Baker, a well-known value-pricing consultant, adds that many firms that say they use value pricing have really just implemented an altered version of hourly billing.

Warden made the change to fixed pricing in large part because she feared that the billable-hour model antagonized clients. Recruiting and retaining clients require building strong relationships with them. Unexpectedly high bills that result from a firm taking longer than expected to complete a project can damage those relationships. Even if the extra time was the client’s doing—through scope creep, for instance—this kind of billing practice is almost guaranteed to create friction with clients.

“We’re being bad business people by not thinking our projects through in advance,” said Michelle Golden, a value-pricing proponent at Kennedy and Coe LLC. She joined the firm, which has 250 professionals across 11 offices, as a partner in the fall of 2013 specifically to lead growth and increase the firm work that’s priced in advance (which is now at 65%).

In addition to potential customer complaints, the billable-hour model catches flak from consultants for other reasons as well.

MEASURING THE WRONG THING

“The billable hour measures the wrong thing,” said Baker, the founder of VeraSage Institute, a think tank for professional-knowledge firms. Baker, long one of the billable hour’s most passionate critics, said that the practice focuses on the practitioner’s inputs, namely time, rather than on the output (i.e., results).

The value of the results should determine the cost of the service, not the time it takes to achieve them, he said. Otherwise, practitioners can find their revenue stream severely limited. There are, after all, only so many hours in a day.

Baker also laments the model’s cost to firms. He estimates that most firms spend 10% to 25% of their gross revenue filling in and tracking time sheets. “My question is, ‘What is their ROI on it,’ ” he said. “Let’s face it: The only place that time spent should matter is in prison.”

Despite those perceived drawbacks, moving away from the billable hour is full of challenges. Some firm leaders assert that they still need to track time to determine their costs and gauge which services produce the biggest margins. (Baker disagrees, arguing that other methods—such as price-led costing, project management, key predictive indicators, and after-action reviews—are better suited to determining and managing costs than time sheets.) While the exact terminology may vary, firms that eschew the billable hour typically replace it with some form of upfront pricing. Many CPAs fear—with good reason—that they will have trouble accurately pricing jobs before they perform the work.

“CPAs by nature are overanalytical, and it is easier to budget/staff/forecast and set goals using total and chargeable hours as the measure,” said Blake Christian, CPA, a practice management expert who works at the Long Beach, Calif., office of public accounting firm HCVT LLP. “CPAs are conservative and nonconfrontational and have a hard time with defending billings that are not backed up with detailed hours.”

Golden puts it more succinctly: “It just seems really scary,” she said.

THE PRICE YOU PAY

In part, because of the relatively straightforward and stable nature of most of her firm’s work—outsourced bookkeeping—Warden was able to base her pricing on a simple calculation. She examined the accounting services firm’s work on an annualized basis—everything from reviews, to year end, to quarterly payroll taxes—and simply divided the annual fees by 12. She then contacted clients and told them that the firm wanted to move to a system where it charged clients a fixed rate by automatic withdrawal at the beginning of every month before performing the services. (The firm’s engagement agreement allows for an annual reassessment to the rate depending on the amount of work that clients need completed.)

Interestingly, clients that The Business Manager had really good long-term relationships with were often skeptical of the proposal. They suspected the change was actually designed to hide a rate increase. Clients tried to calculate everything themselves in an effort to double-check Warden’s math.

“And, of course, they were using incorrect calculations,” she said. “We had really stirred the pot.”

She responded by scheduling one-on-one conversations with clients to explain the details of the change. Those talks helped allay client concerns, and the firm was able to move forward with the plan. New clients, who started with fixed pricing from the beginning, did not push back and were accepting of the model.

Warden’s experience with client pushback is the top concern of many practitioners who fear that moving away from the billable hour will cost them customers. Whatever its drawbacks may be, the billable hour is a quantifiable metric that clients have accepted for decades. Flat fees, even if disclosed upfront, can seem more opaque. What if customers are so suspicious that they bolt for a competitor?

“My response is, you will probably lose some of your clients,” said David W. Cottle, CPA, CGMA, a consultant who has been counseling CPA firms for three decades. “But you will lose far fewer than you think you will.

“Most of the ones you do lose—they’re not your better clients,” he added.

PLANNING IS KEY

What of CPA firms that provide services different from those that Warden specializes in? Or firms much larger than The Business Manager?

Consultants say that upfront, fixed fees can work across almost all sizes and specialties (one notable exception would be bankruptcy and estate and conservatorship work, where time sheets have to be submitted to the court). The key: Pricing in advance requires CPAs to plan the project in advance. CPAs need to determine who will work on the project and how long it will take. Policies must be in place to deal with additional client requests during the process—such as the use of change orders—since scope creep increases CPAs’ allocated costs.

Even with careful preparation, firms are almost certain to see hiccups in the transition. In Warden’s case, employees at her firm initially spent more time than expected on projects. She refined the firm’s internal processes to solve the problem.

“But we had to be careful, because at one point, we had an accountant so accountable with her time that she didn’t want to go over the budgeted hours for the flat rate, so she started shortcutting some of the tasks,” Warden said. “For instance, in an interim bank reconciliation, she was just going to wait until the end of the month. And I told her, ‘No, we do all the work we normally do. We just keep it within the hours if we can, and if we can’t, that’s the risk that we take.’ ” Warden said that if the firm goes over on time—without a change brought on by the client—the firm eats the additional allocated cost rather than charging the client for it.

WHAT'S IN A NAME?

While Warden’s firm uses fixed pricing, some firms prefer to switch to what consultants call “value pricing.” Nomenclature can work against firms looking to make such a change. While “billable hour” is pretty self-explanatory, the term “value pricing” can be confusing to both CPAs and their clients. Is “value pricing” just another way to say “fixed pricing”? Does “value” mean that something is cheaper in price? Or does it mean that the service provided won’t be of high quality?

Baker defines “value pricing” as the maximum amount a customer will pay for a CPA’s services before the work starts. The concept frees CPAs to charge more for a project than they would under the billable-hour model. For instance, the tax return for a client with $150,000 in annual income might take roughly the same amount of time to prepare as the return for a client with $1 million in annual income. But with more money at stake, the value provided to the higher earner is greater—hence, the practitioner charges the higher earner more to prepare his or her return.

With the billable hour, “you’re subsidizing a rich client, in effect,” Cottle said.
Value pricing also rewards efficiency on the accountant’s part. Such an approach helps CPAs boost revenue without working additional hours. Consultants know that CPAs already fret about pricing perceptions and don’t want to do anything that makes it look as if they are taking advantage of clients. Noble as that philosophy is, consultants say it can cause CPAs to undervalue their services.

And while value pricing can increase CPAs’ revenue, there are benefits for clients as well. First, they get price certainty upfront. Second, value pricing can also provide clients with some price flexibility. That’s because value pricing is more nuanced than a fixed price. Golden explains that a “fixed price” is one in which a firm unilaterally decides what it will charge for a project.

A value-based price, on the other hand, is jointly determined in consultation with the client. Practitioners using value pricing offer clients a suite of service options such as:

  • The original scope of the work being performed;
  • Timing and payment terms; and
  • Upgrades and add-ons (these would be what contractors call change orders). 

The price tag for a project depends on which options clients select. The price for a project that a client needs completed in a month, for instance, could be less than a project the client needs finished in a week. With options like that, clients have a seat at the table in determining how much they pay—and in some cases, they may select options that give them a lower price than under the traditional billable-hour model.

A FINAL NOTE OF CAUTION

Warden’s experience offers a final note of caution: The transition to a new model, which took her three to four months, can easily create billing confusion. That’s because clients will receive an invoice for work completed under the old billable-hour model at the same time they get their first upfront invoice in the new fixed-pricing model. In the same vein, Baker points out that larger public accounting firms should make the change one client at a time instead of by practice area. Otherwise, they can encounter similar headaches. In either scenario, clear communication with the client is critical.

Warden is candid about the challenges that a firm such as hers faces in moving from the billable hour. The transition requires additional work. It can cause pushback from concerned clients. And firms will make some mistakes when pricing jobs early on. Despite all those obstacles, she’s adamant that her firm made the right move.

“I think it just takes the dollar signs out of the relationship,” she said. “I love it.”

EXECUTIVE SUMMARY

Some practitioners have moved away from the billable hour in an effort to improve client relations. Others see an opportunity to implement new pricing alternatives that can increase margins.

Three-quarters of U.S. accounting firms use some sort of fixed-fee pricing, according to a 2012 survey. The percentage of firms using value pricing jumped to 56% in a 2012 survey from 41% in a 2010 survey.

Firms that move from the billable hour often replace it with some form of fixed, upfront pricing. Upfront pricing requires CPAs to plan and organize more on the front end.

Fixed, upfront pricing can cost CPA firms revenue if it is not properly executed. Accountants have to stick to the price unless the scope changes—even if it takes them more hours to complete than projected.

Some clients are suspicious of pricing format changes, and transitioning to a new model also can create confusion. Communication is crucial to preventing the loss of key clients. 

Chris Baysden is the AICPA Magazines & Newsletters team's senior manager, newsletters. To comment on this article or to suggest an idea for another article, contact him at cbaysden@aicpa.org or 919-402-4077.

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