For large projects, I don’t have an hourly rate.
In fact, I don’t even worry about measuring increments of time until we get down to smaller things like maintenance agreements, or smaller projects less than a few hours in scope.
A rate implies that you’re measuring effort in increments of time, not return on investment.
Now for smaller edits, like adding text to a page every so often, it doesn’t make sense to value price. So at that point, I don’t bother with value pricing, because this is when hourly makes sense — when the large projects are finished, and things are back to a normal flow.
The Agency Model and Measuring Value
Most companies that work in an agency model bill clients by the hour. This works, if the client is large enough, and budget is large enough to not be a concern.
But I feel hours worked is the wrong metric to measure when it comes to most projects.
I understand why agencies bill hourly, especially larger ones. Projects that have lots of moving parts and are massive in scope are too easy to estimate wrong. And when you’re dealing with enterprise level clients, estimating wrong on the agency side can mean not covering payroll for many months.
But for the sake of our discussion, let’s say we’re not looking at enterprise projects, and we’re not looking at agencies with 100+ people on the payroll. What if we’re strictly talking about projects that range between small and regional businesses? What makes the most sense for both the client and the agency — hourly pricing or value based pricing?
Effort Doesn’t Equal ROI
Here’s what I dislike about hourly billing for large projects. It measures the effort that someone puts into a project, and not the return on investment that project will bring to the client.
The types of things that I may be thinking of when projecting a measurable return on investment:
- Increased revenue
- Saving the client time behind the scenes
- Increased long-term efficiency / better workflow
- Increased customer satisfaction / ease of use
- Solve a marketing problem
- Add a new feature that will lead to more customers or revenue
All of these translate into either making the client more money or saving them money.
Since the start of 2015, I’ve been shifting more and more towards value based pricing. What this means is for projects of any substantial size, my goal is to measure the long-term value the client will receive from the project. What I’m not measuring is the amount of hours it took to get that return.
Why We Use Hourly Billing In Design and Development
In the world that we’ve grown up in, we’re used to measuring things in increments of time. Most people in the world get paid by an hourly wage. This makes hourly rate a concept that everyone can understand, without ever thinking too much about why they think in those particular terms.
Naturally, when you’re hiring a web design consultant, you ask how much their hourly rate is. When you look at agencies, you want to know how much their hourly agency rate is.
What’s really happening in your unconscious mind is you’re trying to figure out how many hours a project is going to take. You then multiply that number by the hourly rate of the web company. The majority of web developers and web agencies also measure the cost of a project by the hours of effort that project will take.
The Economics of Running A Web Design Company
For most web professionals, there’s only two major differences between a solo designer/developer and an agency.
For the solo designer, the hourly rate is 100% of what they get from the client, but then they have to pay their own taxes out of that. For the agency, they pay the designer one rate, but bill them out at another, higher rate. If the agency hires contractors, this is usually more profitable for the agency. Contractors are responsible for their own taxes, and oftentimes set their rate too low to adequately cover this. If the agency uses traditional employees, they have to pay taxes and benefits for that employee on top of paying their normal salary.
In both of these scenarios, there needs to be enough profit margin for the design agency or solo consultant to stay in business and grow.
Value Based Pricing (How I Do It)
The way that I practice value based pricing is to try and figure out how much long-term value a client will get from a given web project. My goal is to give them a 10x return on their investment, so most project investment levels will be about 10% of this projection.
My goal is to calculate, over a set amount of time, how much will your revenue increase, or how much time and money will you save as a result of doing this project with me?
Occasionally, a project investment will be determined by the complex of the problem you’re trying to solve, and how much that’s worth to you to make that problem go away. The goal is still to 10x your investment, even when the value is more difficult to quantify. (Some projects have an indirect impact on the overall success of the client business.)
Why I Don’t Quote Hourly Rate For Large Projects
So, if you call up a web design firm, and ask what their hourly rate is, knowing that their projects are hourly based, you’re already doing the math in your head. You’re not thinking about the long-term return on investment of the project, you’re thinking about how you can keep the cost down.
But if you find out that a web consultancy does value pricing based on the project, and not the effort, it frames the relationship quite differently.
When a design firm charges hourly, it is against their better interests to do things in a more efficient manner. This is why many web agencies are more heavily populated with junior developers instead of higher priced employees. The hourly agency rate is the same, no matter who is doing the work. Junior and Senior developers are titles that indicate what a person’s salary is, and their scope of responsibility within an agency, not how many years they’ve worked.
This leads to a realization that hourly billing in the agency model has some fundamental flaws.
Senior developers generally cost the agency more in salary, and because they are more experienced, they code faster and with a higher quality. Junior developers take longer, may make more mistakes, but cost the agency less. This makes junior developers more profitable.
So, in many agencies, the formula is to hire junior developers for as little as possible per hour, bill them out at as much as possible per hour, and bill the client as many hours as possible.
Even if the agency is morally solid, and determined to provide as much value as possible to the client, the system that both parties are working inside of puts them inherently at odds.
This leads to a moral dilemma.
Why Hourly Billing Doesn’t Work On Many Projects
I’m not trying to say all agencies are bad for billing hourly. Far from it. But clients and agencies have two distinct and separate goals in an hourly billing system.
The agency’s goal is to bill for the hours they’ve worked on a project. The client’s goal is to get the project done in as few hours as possible.
But here are other two other things to consider:
How is long-term success being measured for this project? How does the price of the project correlate to the benefit to the client’s business?
Hourly rate is a metric that is completely irrelevant to the success of the client’s company.
If you pay $10,000 dollars for a web project and see $15,000 total return, you’ve only netted $5,000 in total value.
But if you spend $25,000 on a project and see $100,000 in total return, now you’ve netted $75,000 in total return.
There’s a big difference in how everything is framed.
Cases like this illustrate why cost is an unimportant thing to worry about. Investing in your company’s overall outcome is something quite different altogether.
Another thing that sucks about hourly billing on large projects has to do with the psychology of price anchoring.
Price anchoring occurs when you hear a number. Perhaps your web company gives you an estimate based on the hours and rate they expect the project to take. But midway through the project, they may discover that their estimate was off.
The client is anchored to the original number they heard. It’s human nature. Even if the original number is presented as an estimate, our inclination is to take it as a quote.
The agency now faces the choice of telling the client their estimate was wrong (disappointing the client), or eating the extra hours themselves (hurting their profitability and morale).
Value based or fixed bid pricing is beneficial to both parties in a couple of ways.
It’s About Managing Expectations
One, it takes the risk off the client, and puts it onto the web agency. When the price for a project is set, no matter how many hours it takes, the investment total is known to both parties in advance. This allows the agency and client to plan accordingly.
Two, it takes the focus of the conversation away from tracking hours, and towards delivering a solution and solving the problem for the client.
Three, it eliminates disappointment that is tied to price expectations. There’s a big difference between a project originally quoted at $20,000, and a project that was quoted at $15,000 but ran over due to hours and ended up costing $20,000.
Though these projects cost the same, the expectation of the client is very different in each case.
When Pricing Is Difficult
The larger and more complex the project, the harder it is to accurately predict the man hours it will take to complete. The more moving parts a project has, and the more people are working on it, the harder it is to predict the hours it will end up taking to complete.
Even if your hourly estimate is padded to compensate for the unknown, extremely large projects (enterprise) are very difficult to assess.
This is why you are more likely to see an hourly agency rate in very large agencies — because it reduces risk to their profitability. These mega-agencies are also more likely to only serve enterprise clients with very large budgets.
For smaller, mid-sized, and regional businesses, it may be good to consider what metrics are important to the consultancy they are hiring — total value or hours spent?
For the smaller agency or solo consultant, it may be good to consider how you are estimating the value you are giving to each client.