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Why Hourly Billing Could Be Killing You with Jonathan Stark

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I am a big proponent of the idea that hourly billing is a really bad way to price your services and grow your business. Learn from Jonathan Stark as he discusses why you should leave hourly billing behind forever.

For more information on remote selling and a complete list of links mentioned in this podcast, visit this remote selling article on our website.


Why Hourly Billing Could Be Killing You with Jonathan Stark:

Full Transcript

Liston:
Welcome to Modern Sales, a podcast for entrepreneurs, business owners, and salespeople looking to have more and better conversations with your perfect clients. You’ll get a healthy scoop of psychology, behavioral economics, and sales studies to help you create win-win relationships. I’m your host Liston Witherill, and I’m pleased to welcome you to Modern Sales.

Liston:
Hey there. It’s Liston Witherill here with the Liston.io Show, and I am very excited to have a special guest today. That guest is Jonathan Stark. Jonathan, welcome.

Johnathan:
Thanks. Thanks for having me.

Liston:
Absolutely. Now, I’m just going to look at your bio here and share it with the audience. You and I have known each other for a while, but you’re the former or a former software developer who is now on a mission to rid the world of hourly billing. This is quite the mission. Jonathan, you’re also the author of Hourly Billing is Nuts, the host of Ditching Hourly, a podcast, and you write a daily newsletter on Pricing for Independent Professionals. And I do want to point out, Jonathan, when you say daily you mean daily. You’re not skipping holidays. You’re not skipping weekends. Every single day that newsletter comes through. So, thanks for being here.

Johnathan:
Hey, my pleasure.

Liston:
Absolutely. The reason I wanted to have you on is I shared with you that I have an audience of independent consultants, and consulting business owners. I still talk to a lot of them who bill hourly. Sometimes when I ask them why they do that, I get a look that could only reflect being perplexed. Tell me, if you were talking to that person, what would you say to them is so bad about hourly billing in the first place?

Johnathan:
Sure. I’ll start by saying that hourly billing works. It’s pretty much how everybody does it. It’s easy to get your head around, and your clients expect it. It’s probably one of the first questions they ask you. They’ll say, “Hey, we understand that you do this thing that we need. What’s your hourly rate?” And you’ll tell them. It’s just sort of expected. It’s a natural process. It’s not very risky for the seller, because if a project takes longer, they get paid more. So, there’s very little risk. So there are definitely some pros to hourly billing.

Johnathan:
If it’s working for people, I don’t try to convince them it’s crazy. Usually I don’t have to try very hard though, because there are a lot of downsides to hourly billing that many people, but not everyone, experience the symptoms of. For example, if you feel like you’ve maximized your income … so, you’ve been at it for a few years, you started out, maybe you struggled a little bit, and you’ve built up your business. Eventually, if you’re billing by the hour, you are going to max out your revenue, because there’s only so many hours in the air. You’ve either got to start increasing your hourly rate dramatically, not just a little bit, but perhaps as much as doubling it to have any meaningful increase in your revenue.

Johnathan:
You either have to raise your hourly rates significantly. You have to work more, which probably nobody wants to do. Or you have to hire a bunch of employees. Probably about … I’d say if you’re going from solo to having a firm, if you’re going from an independent to having multiple employees, you probably need about between four and six employees before you really start to feel a meaningful increase in your profitability. So, you get a bunch of junior … whatever you do. Junior developers, junior copywriters, and you bill them out at the hour, but you mark up their time, basically.

Johnathan:
I mean, that’s one big problem that appeals to people’s self interest. If I’m talking to someone, I would ask that person … I would ask your listener, and say, “Well, do you feel like you’ve maxed out your income? Are you working more than ever?” Basically just staying in place. You can feel it when it happens. You basically … I call it the hourly trap. You’ve hit the ceiling, and you just really can’t go much above it. There are a bunch of other things too we could talk about, but that’s probably the one that’s the most persuasive to people.

Liston:
Right. I’d like to focus on this also from a sales perspective. One thing you said is you can’t just raise your rates, your hourly rate, proportional to the revenue increase that you want. If I want to make 30% more money next year, I can’t just raise my rates by 30%. I’m going to have to actually raise it substantially more than that. I think that’s really interesting for anybody listening to this to kind of take note of.

Liston:
But I do want to ask, when it comes to selling hourly versus selling a fixed price … and I want to dig into this idea. Let’s assume, dear listener, you have already accepted that hourly billing is in fact nuts, and you’re going to run out and buy Jonathan’s book. The next question obviously is, “Okay. So, what do I do? How do I come up with a fixed price, and where does that come from?”

Liston:
I want to dig into that next. But Jonathan, I’m wondering from a sales perspective, how do you see the difference between selling, say, an hourly rate versus a fixed price for a project or a thing that you’re going to do, even if that’s just advisory?

Johnathan:
In terms of the psychology for the client, or how to actually do it?

Liston:
Exactly. From the side of the client. What are they thinking and feeling when they see an hourly rate versus a fixed price?

Johnathan:
When they see an hourly rate … It depends on the sophistication of the client they hired, consultants [inaudible 00:05:49] so on and so forth. But let’s just say it’s the average kind of client. They’ve paid other people by the hour before to do professional services or some of professional work for them, so they’re not new to the game. They’re used to it. They’re used to it just the same way that your listeners are used to it. That’s what they expect. They go out looking for this first data point, which is find me a bunch of people who do X and get me their hourly rates.

Johnathan:
They’re thinking of all of those people more or less as a commodity that they can successfully compare based on that one number. I’m sure everybody’s experienced this. If you’ve ever been in a sales situation where you submit a proposal, and the client comes back and says, “Oh. Well, we really want to work with you, but your hourly rate is 25% higher than the next one, or 50% higher.” Whatever. It’s higher than the next competitor. Can you do a little bit better? Can you meet their rate? That sort of thing.

Johnathan:
What they’re doing is they’re comparing you apples to apples to the other people in a weird way, because everybody’s giving the client an estimate. It doesn’t necessarily reflect how much the final price is going to be. No one even knows what the final price is going to be at this point. Everybody’s operating in this sort of shared hallucination that a price has been given. What happens … and I think everybody who’s listening knows what happens next. You give a proposal, you try really hard to hit your estimate, but oh man. The client really dragged the scope all over the place, and now we’re going over hours. But it’s your fault, client. Because remember when I told you if we made this change, it was going to take us over the estimate?

Johnathan:
But when the client sees a proposal with an hourly estimate on it, they see that as the price, because they’re forced to see that as the price, because they have to make a buying decision. I mean, if you think about everything else in the rest of your entire life, it is 99% of the things you buy in your daily life has a price. And you know the price before you make the purchase. Before you make the decision to purchase.

Johnathan:
For whatever reason, historically, that isn’t the way that we buy professional services. Everybody’s operating in this weird space where they’re focusing on really the wrong thing before the project starts in the sales process. If you approach the client with a fixed price based on value, at first you’re going to have to kind of snap them out of it.

Johnathan:
They’ll call you up and say, “Hey, we’d love to get proposal. What’s your hourly rate?” What I tell people to say is, “Oh, I don’t have an hourly rate.” And just let the dead silence hang, and the client will be like, “Hmm. Okay. Well, how do you bill for your work?” I would say, “Well, I’ll give you a price for the project, and you can either go for it or not go for it. But you’ll know in advance how much the project’s going to be. Is that acceptable?” They’ll think about it for a second and they’ll be like, “Yeah, that’d be amazing. You have an actual price?” Yes. I’ll tell you how much it’s … so, before you even start, you know this project is going to be whatever. $250,000. We don’t have to worry about time. We don’t have to worry about hours. None of that stuff. That’s how much it’s going to cost.

Johnathan:
They love it, because that’s how you buy everything. Almost everything. And if you think of the few exceptions in your life where you don’t buy things like that, say, maybe putting a big addition on your house … Yeah, there aren’t that many examples of things where you have a large collaborative project where the people doing the work are billing you by the hour. They give you an estimate up front. Some people are good at estimating, and sometimes it’s right, but that takes a lot of experience. If it’s wrong, it’s never too low. I mean, the estimates are always too low. It’s never any amount of money that’s paid is always too high. You get into the typical client from hell nightmare scenarios when you start to go over estimate.

Johnathan:
That was a long answer to your question. But after you snap clients out of it, prospective clients out of it, almost always they love it. They love the idea of actually knowing how much it’s going to cost before they get started.

Liston:
I used to work at a firm where we build everything hourly. It drove me crazy for several reasons. One thing that I thought was interesting … and I know not every firm does this, but some do, is our clients … like you said, would want to know, “Okay. It’s X dollars per hour kind of. So what? How much is this whole thing going to cost me?”

Liston:
We would give them a price, which was a not to exceed price. So, if we finish early, we get paid less and they’re happier. If things go over, or unexpected things pop up and happen, we take on all the risk. I just thought, “What a terrible way to do business.” But no one would get on board with my idea of doing fixed pricing.

Liston:
So, let’s talk about that for a second. If I’m looking at fixed pricing for the first time, or even if I’m looking to improve the way that I’m doing it, my view of it is really there are a couple ways to look at the fixed price and how to set it.

Liston:
One is I look at: what did I use to charge hourly? What do I think is the money that I was leaving on the table? How do I charge enough in order to deliver tons of value, ideally 10 times more value than I’m charging, and still make a better margin on this? And the other one is just purely kind of a value based pricing model. So, two questions for you, Jonathan. Did I miss something? Is there another alternative to doing a fixed price? And secondly, can you talk a little bit about value pricing, and what that means?

Johnathan:
Yeah. There’s a lot there to unpack. I’ll start with this sort of typical way that people will experiment with fixed bids first, because that would probably be familiar to people. If you’re used to doing hourly and then you listen to this show, and you think, “You know what? I’m not going to do it anymore.”

Johnathan:
Usually what people do as a first step is they get a new prospect. They have a sales call with a prospect. They learn about the project, and they don’t change anything about the way they run that sales meeting. What that typically means is that they go in, they listen to the client, the client says, “Hey, these are all the things we want you to do. Here’s a punch list of things. We want you to change this, and update that, and write these.”

Johnathan:
And it’s fairly tactical. It’s usually more than fairly tactical. It’s usually very tactical. They’re very specific about things that … they’re strangely specific about lots of things, which they haven’t given you the overall perspective on yet to even have any context for. They’re way down in the dirt, because they’re used to that. Because everything … the big picture stuff is all familiar to them. They’re sort of swimming in it, so they tend not to share it with you.

Johnathan:
You end up getting focused on, “How much time is it going to take me to do this,” as they’re listing off this scope to you, basically. You’re asking some questions to try and uncover all the landmines, and all the hidden work that might be in there, and you’re trying to figure out how long it’s going to take you to do what they’re asking for. Then you go back to your office, and you crunch the numbers, and you think, “Okay. This is going to take me about a hundred hours times my hourly rate, and maybe I’ll tack on 15% for project management, or just for protection,” because there’s surely some things that we didn’t uncover in this one hour meeting. You’re going to have a six month project. You obviously didn’t uncover every single detail in a one hour meeting.

Johnathan:
You sort of do that math, and you come back to them with a fixed price that is basically a cost plus. That’s what it’s referred to. Some people will call it time and materials, but I think this example is basically cost plus. You come back to them, and you say, “Hey. Okay, it’s going to be $25,000.” That price is way too low for you. You’re almost surely going to feel like you’re losing money on this project. Satisfying the client is probably going to take you twice as long as you expected from that first quick meeting.

Johnathan:
If you’ve tried this in the past, and you’re shaking your head … “Fixed prices are crazy. We tried that a couple of times. We got killed every time.” The problem is you’re setting your price way too low. Now you’re thinking, well, if I had set it any higher, they wouldn’t have accepted the gig. I wouldn’t have closed the deal.” My reply to that is that’s because you’re probably right, because you’re having the wrong sales meeting. You’re having the wrong conversation in that meeting. In that meeting, what you want to do is uncover the value of the project to them to find out if it even makes sense for you to engage with them to do the work.

Johnathan:
There might be very little value in the project that’s on the table. If that’s the case, you should probably walk away from it. But people who are used to billing by the hour, they’re not used to having that kind of a conversation. They’re used to just trying to uncover as much scope as possible. How many holes do we have to dig? Okay. That would take us this long, and then come back with a price.

Johnathan:
You have to flip that concept completely on its head to successfully value price projects at very, very high profit margins, which is completely doable. I’ve done it tons of times. My students do it all the time. It’s hard to get used to, and it’s hard to change the way that you operate in that meeting to uncover the value in that meeting. But once you do it, it becomes obvious. You’re like, “Oh, how did I ever do this another way?” No other way makes sense after you sort of see the light.

Liston:
With value pricing, Jonathan, do you think that that applies in all scenarios? Because one thing that I think about … and I only do fixed prices, and I’ve done lots of value pricing. But one thing that I think about for some people listening to this is there is something out there called the market, and they have competition. Let’s be honest. In most cases, there isn’t one single provider who can fix a problem. So, how does the market factor into this, and what kind of things do you need in place to really make value pricing work for you?

Johnathan:
First, I would push back and say, well, yes. There are clients out there who want the cheapest alternative. But are those the clients you want to work with?

Liston:
I didn’t say that.

Johnathan:
Oh, okay.

Liston:
I didn’t say they want the cheapest alternative. I said there are other alternatives who fall in a spectrum of different prices.

Johnathan:
Okay, fair enough. But I took it as they care about price.

Liston:
Okay.

Johnathan:
And probably most people is they don’t just care about price. But let’s just say we’re talking about price buyers right off the bat. You probably don’t want to work with the segment of that audience who does want the cheapest.

Liston:
Agreed.

Johnathan:
Unless that’s your business model. You’re Amazon, you’re going to do massive volume, or Walmart. But that’s not you. That’s not professional services. You want to race to the top in professional services. First off, let me turn it around like this. There are clients out there who do want the cheapest option.

Liston:
Yes.

Johnathan:
Those are not your clients.

Liston:
Agreed.

Johnathan:
You should be walking away from them anyway. Okay. A more probably common way that this comes up is that you’ll send in a proposal with a fixed price. It’ll be double what the next one is. They get a bunch of proposals in. Yours is $200,000, and the next one in the stack is $100,000. One thing that has worked for me in the past, when they come they’ll say, “Oh. Well, we really want to work with you, but these guys are half the price.” And I’ll say, “Well, is it a price or an estimate?” And they’ll say, “Well, it’s an estimate.” And I’ll say, “All right. Well, if you talk to them and you say, ‘If you guys will stand by this price,’ and they agree, then you should go with them.”

Johnathan:
Of course, that will never happen. So, if they went out and go back to this, “Oh, yeah. Well, we want you to guarantee this price.” Just like you said before, hourly not to exceed, which is the worst possible way that you can … because you’re taking all the risks and none of the reward.

Liston:
Exactly.

Johnathan:
Never ever do that. Never do hourly not to exceed. What I’m trying to do is … speaking of risk, what I’m trying to do is reveal to the client that by accepting an estimate, they aren’t dealing with an actual price, and they’re taking all the risk. When you look at my number, it’s a fixed number. It’s a solid number. I’m not going to hit them with change orders. Nothing. This is the price. And I would say, “You can talk to any client I’ve worked with in the past 10 years. I’ve never gone over one of these prices. That is the price, full stop, period. If it takes me twice as long as I thought it was going to, that’s my problem.”

Johnathan:
That’s usually pretty convincing for people, because I’m essentially offering them a guarantee. Almost nobody out there will guarantee their work. No one will stand behind their estimates. It’s very rare. And if they do stand behind the estimates, they’re crazy, because the estimates are too low.

Johnathan:
Okay, moving on. Let’s say that my mission succeeds, and now everybody is giving fixed prices for everything, and hourly billing is gone. How do you differentiate yourself? How do you catch a premium price? The answer there is positioning. You need to be positioned in the marketplace as the only or one of the very few options for doing what you do, what you are an expert at, what your specialty is. And then you’re dramatically decreasing their options, so you have to de-commoditize yourself through your marketing and your specialization to be the go-to person or agency for this expensive problem that the client needs solved. This thing that they’re losing sleep over.

Johnathan:
When they say, “Hey, we’ve got this problem,” they Google for it, you’re the first hit. You’re the second hit. If there are only like two or three competitors in your space, well, then you’re going to get lots of very high paying high profit jobs, because everybody’s going to be full up. They won’t be able to get … even if you’re not number one, number one is going to be busy. Number two is going to be busy. But if you’re on the short list of people who are world class at … I don’t know. Accessibility design for government websites or … who knows? It could be landscape architecture for public parks. It could be anything. You need to very, very strongly differentiate yourself from the competitors, so that there’s no apples to apples comparison. It’s the polar opposite of being on Upwork.

Liston:
Sort of by definition, not everyone will be able to do this. If you are able to do this, you’re going to have a sustainable and defensible competitive advantage once you do it, and be able to value price on a regular basis, assuming you’re going after the right clients. Did I get that right?

Johnathan:
Yep. That’s all true. Mm-hmm (affirmative).

Liston:
Okay.

Johnathan:
So, value is an interesting thing. It’s 100% subjective. It’s not a quality of the thing, the service, or the product. It’s not a quality of that thing. It’s an amount of money that, in the mind of the person considering buying the thing, that it’s worth to them to trade. One person might look at a 20 ounce Coke and think … to me, in this particular current situation, it’s 90 degrees outside. I’m at a baseball game, and I don’t want to get up. I don’t want to miss any of the game. And here comes this guy walking down the stairs with a $5 Coke. Maybe that’s worth it to me. Maybe it’s not worth it to the person next to me. But that’s the price, and I can make a value based decision about whether or not I want to trade my $5 for that soda.

Johnathan:
The value of whatever your Coke is, whatever your product or service is, will be different to all the different people in the world. Let’s say you do landscape architecture for public parks, and you’re starting … you wouldn’t get out of bed for less than a $100,000. It doesn’t make it worth $100,000 to me personally, because I don’t have a public park. It’s not worth the same to everyone. It’s important to find the people for whom that is valuable. So, there can be skills that you have that no one values. Maybe you’re a Star Trek fan and you teach Vulcan. Probably not very many people are going to pay $100,000 to learn Vulcan from you. You do need to come up with things that are valuable to someone. Let’s put it like that.

Liston:
Right. And the more money they have, likely they are more willing to pay more money for something. Right? It’s also a reflection of their position and their available resources.

Johnathan:
Absolutely. Mm-hmm (affirmative). Even if I think back to my college days rooting around in the car seats in the back of my Pinto Wagon looking for gas money-

Liston:
Good times.

Johnathan:
Right? I would’ve stopped on the highway to pick up a $5 bill, and now I wouldn’t bend over to touch it because I’d be like, “Ah, I don’t know. Something’s probably wrong with that.” The genius of money is not that $10 is worth the same thing to everyone. It’s that everyone’s $10 is worth the same thing to me. It’s an important distinction, because when we talk about money, it’s a number. It feels mathematical. It feels absolute. But its value is 100% subjective. At any given time, whatever you do, whatever service you provide, it’s worth something … maybe it’s almost subconscious. It’s worth something to literally everyone you’ll talk to.

Johnathan:
You could talk to everyone at a cocktail party and say, “Oh, I do landscape architecture.” Oh, really? And if you said to them, “What would that be worth to you for me to come and design your front yard? Do landscape design on your property. What would that be worth to you?” They could give you an answer. It might not be the answer you want, but everyone can give you an answer. They’d be like, “I don’t have a yard. I wouldn’t give you anything for that.” Or, “We enjoy doing that, so we wouldn’t give you anything for it.” Or, “Oh, man. I would love that. My yard is a disaster. I’m super embarrassed. I feel like my neighbors are judging me. I’d probably give you … well, I don’t know. 200 bucks a month for that.”

Johnathan:
Everyone can do it. It’s worth something to everyone. But you need to have these conversations and find people for whom the thing that you do is worth more, and more, and more, and more. That could be a reflection of their situation. It could be their cultural situation, where they are financially. It’s a reflection of everything that makes them up, but they have the answer.

Liston:
Yeah. I think what this is surfacing for me is a question that I get a lot when I do webinars, or live speaking events … which is, “How do I figure out the value of X thing that I sell?” We don’t have time for that unfortunately, but maybe we can reconvene at some point and chat about that topic. Because there are whole books and volumes written on that.

Liston:
Jonathan, you’ve been amazing at sharing your expertise here. You’ve eaten your own dog food, and shared lots of value. I thank you for that. I’m wondering if people wanted to follow up with you, what should they do?

Johnathan:
Best place to go is valuepricingbootcamp.com, and take my six day free email course. You can reply to any of those lessons, and it goes straight to my personal email, and I reply to every single one. I’m a maniac with email. So, if you go to valuepricingbootcamp.com, that is the best way to get in touch with me.

Liston:
Fantastic. Well, thank you so much for being here.

Johnathan:
Thanks for having me.

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