Time & materials versus fixed price billing

Just before Christmas I had one of my coffee/mentoring sessions with a vibrant young Victorian entrepreneur and an interesting question came up around how she should invoice her services.

Although not an expert in the area of pricing models (I generally recommend Jon Manning of Sans Prix for some hard-core consulting), I have owned and run a number of businesses that billed in a variety of ways and therefore had a general framework for thinking about it that I thought worth sharing.

So her question was “should I invoice for time & materials or fixed price?”

Truthfully the question isn’t either/or, as your entire package can have a combination of the two – eg. a fixed call out fee, then time & materials (T& M). You can also add tweaks such as capped T&M or fixed fee covering a certain number of interactions – eg. “includes up to three redesign sessions”. But each component of your product or service can usually be broken down into one or the other. So let’s look at time & materials

Time & materials

Professional service’s firms love T&M billing and are very good at it. Lawyers and accountants traditionally have always billed that way to generate large incomes, however I have noticed lots of fixed price services starting to creep in.

The pros of T& M are:

• It massively reduces your risk on the job, as you get paid for all the work you do, regardless of whether you run into problems or not.
• It allows you to be more dynamic and instantly respond to a client’s changing needs or priorities, as you are not dependent on specific outcomes for your profitability.
• There is no need to trap and manage client’s variations for billing purposes as it all gets picked up – although you still need to manage your client’s expectations if the job drags out.
• It reduces the effort required in pre-sale design, research and planning, forecasting or writing quotations – all of which may be unbillable or just not desirable for the time pressed or lazy.

The cons are:

• Although your risk is reduced on the project, your client’s risk is increased. This means that they may review every invoice critically and demand a lot of meetings.
• Clients may demand verbose invoicing, wanting to know exactly what you have done, then argue about which components should be billable – eg. “Why should I pay for your learning?” It also means you have a lot of recording to do – think lawyers recording their time in six minute increments.
• It’s not a particularly scalable model as there is a ceiling for the amount of hours you can bill per week. Unless of course you can bill out large teams and it’s easy to put on/lay off resources.
• Its lack of scalability generally makes it unattractive to investors.
• Your pricing is easily compared to competitors and near competitors, which puts a lot of downwards pressure on your pricing.
• Everyone loves to complain about hourly rates.
• In tiny organisations, it may mean you can’t take holidays because if you don’t work, you don’t eat.
• Your motivation to complete the job quickly and efficiently is massively reduced, which is a regular source of client conflict.

So where is it suitable?

If your offering is highly https://www.onesock.net/2008/04/23/hard-or-soft-serve/ malleable and therefore individualised for each customer, T&M provides the simplest way to construct a proposal.

• It suits areas where the people cost is the major component of the job as that is where your profit risk is.
• It suits projects where there is considerable danger of the job dragging out because of unknown factors such as technical risk.
• It suits projects where there is likely to be a lot, and regular, scope creep.
• It suits young organisations attempting to understand their market place before creating products.
• It suits young organisations that need to pad out their revenue from a product with consulting, or even just contracting themselves out.

So what are some top tips when using time & materials billing?

As part of negotiations, get the clock turned on as early as you can. Don’t allow the client to turn “pre-sale” negotiations into unpaid early design work.

Invoice early and often. There is nothing wrong with invoicing on a weekly basis for longer jobs, because clients argue less about small invoices and it has the added bonus of reducing your credit risk.

Trade high prices for longer hours being billed. Clients are almost always more price sensitive than time sensitive.

Avoid spending the majority of the project working at the client site. Harsh clients will audit your every movement and it’s difficult to perform multiple tasks for multiple clients at the same time.

Have pre-set pieces of text you can use in your invoices so you can turn a phrase like “tweaked server” into a paragraph about apply patches, checking logs for errors, applied patches, optimised configuration, etc.

Where possible, and keeping an eye on quality, substitute cheap resources to do the work at the higher rate – use graduates, or even outsource the work to overseas individuals or groups through solutions such as Odesk or Elance.

Next post I will have a look at billing fixed price.

To read more Brendan Lewis blogs, click here.

Brendan Lewis is a serial technology entrepreneur having founded: Ideas Lighting, Carradale Media, Edion, Verve IT, The Churchill Club, Flinders Pacific and L2i Technology Advisory. He has set up businesses for others in Romania, Indonesia and Vietnam. Qualified in IT and Accounting, he has also spent time running an Advertising agency and as a Cavalry Officer with the Australian Army Reserve.