The traditional ‘practice model’ of old is …
Hours taken x hourly rate +/- write off = Price.
Typically a time based billing process. It’s a labour for hire business model. More labour = more hours = more revenue.
The hourly rate was set based on a multiple of hard salary costs – say $80,000 / 2000 hours worked X 4 = $160 per hour.
Then the price was set either based on last year plus a bit OR it was set based on ‘it should take X hours’ multiplied by your rate and voila – the price is set.
All of this assumes that last year’s price was about right, the salary of the person was correct, the salary multiple was right and the estimated time taken was right. That’s a lot of assumptions.
Then a dollar budget was given to the team member(s) based on all of this. You’ve got a budget of $5,000 to get this done. And voila again – somehow the work came in at $5,000.
How did they do that?
Did they stop the clock, start the clock, go faster, go slower, write some off, not charge for extras. YES, YES and more YES. You did it when you were in their roles and now your team are doing it as well.
This model is so inefficient. In fact, it promotes inefficiencies (stop the clock, start the clock, go faster, go slower, write some off, not charge for extras).
This model creates a ⅓, ⅓, ⅓, model. Remember that one? One third for salaries, one third for overhead and one third for the Partners. Problem is salaries run more like 40-50%, overheads more like 20-25% and profits more like 20-30%.
And, as the salaries go up, the charge rates go up and the profit margin rarely does. All sound familiar?
If you want to change the model and the behaviour then something radical needs to happen. Here is a simple (well not so simple as it involves change) 3 step process to force the change. In order.
- Get rid of hourly rates (keep the timesheets) and go to $1 per hour. This will break the nexus / mindset / process of pricing and it will encourage team members to put ALL time on the clock. You can better manage scope creep / seep and you’ll get a more accurate average hourly rate.
- Price the job based on the value contribution to the client. This is both art and science and the rule of thumb is if they keep saying yes too easily the price is wrong – price it higher for the next one. You’re selling intellectual property – not time – and your IP has been honed over many many years and it is worth a lot. Of course, you must get the client to agree in writing on the price and the scope of works before starting. You can’t value price after the fact.
- Put a time budget on all jobs. You might start the budget based on your AHR target (say $500) and work backwards. Job sold for $5,000, AHR target is $500 therefore 10 hours is the maximum budget. They will still hit the 10 hours so you need to continually increase the AHR target. It’s just human nature for the team to hit the hours / $ budget. When you get the hang of step 3 then you workshop every project for maximum efficiency and the AHR target becomes less meaningful.
An AHR of $500 for a firm that does 10,000 delivery hours is a radically different business model to one that is $125. Same labour costs, more profit, more capacity and more fun.
If you are happy / content / comfortable with the traditional model then don’t change a thing. You’ll continue to get what you’ve always gotten.
If there is a healthy discontent for the present then make the changes.
Lesson for the week over.
What do you like / don’t like?
What changes will you make?
What questions do you have?