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Time based billing is unethical – what rubbish!

April 19th, 2008

I was recently sent a communication that was published by a consultant to the profession in Australia in which he asserted that time based billing is a conflict of interest and unethical. He advanced several arguments in support of his position on this issue. I have been asked for my reaction to his suggestions so here they are.

He suggests: You are directly rewarded for how inefficient you are – the longer you take the more you get. That is not fair for your clients.

My thoughts: This is a gross generalization for which there is no empirical support. It implies that the profession has an incentive to be inefficient which, of course, is ludicrous. The writer seems to be ignoring the reality of intense competition in a fragmented industry between firms with low entry costs and high exit costs. Inefficient firms exhibit high write-offs and/or relatively low average hourly yields.

Empirical evidence supports the fact that technology has improved productivity and that this, coupled with an intensely competitive industry, has resulted in efficiency gains being passed on to customers. My research indicates that inflation-adjusted net profit per partner has dropped by 1% drop over the past 30 years (see my June 2007 blog called Missed Moments.)

In my opinion one of the main reasons for this has been the use of time sheets as a basis for billing, so rather than it being unfair to clients it could be argued that it’s actually been unfair to firms that have invested in labor saving technologies.

He suggests: It does not value the job properly. It assumes that the rate per hour is correct and the time to do it is correct – nothing could be further from the truth. That is not fair on you or your clients.

My thoughts: What on earth does “value the job properly” mean? If a seller chooses to price on a job based on how long it takes to complete then that is its value from the seller’s perspective. The buyer can take it or leave it and to say it’s an unfair price is absurd.

If the buyer accepts it then he obviously places a “value” on the job that equals or exceeds the price, if the buyer rejects it then he either does not buy it or if the service has already been delivered he has the choice of negotiating, or simply paying, a lower price (which is how post-invoice write-offs occur.) If he’s really unhappy he may never deal with the firm again.

The value reflected in a transaction is the price agreed between a willing buyer and a willing seller. How the seller determines the price he’s willing to sell at is irrelevant. All that’s relevant is that it is his assessment of the “proper” value and if a buyer decides not to pay that price then the seller may want to consider revising his pricing model or find other buyers who will will pay the price.

The statement about the time and the rate being “correct” or “incorrect” is absolutely ridiculous and irrelevant. The ONLY thing that is relevant is that the vendor sets a price for the service on whatever basis he chooses and the customer can accept or reject it. What can be fairer than that?

But there is one situation where the use of time based billing is unfair if not unethical that would reasonably fall within the context of this statement. That is where a fee is charged for time expended but no valuable outcome at all was delivered to the client. For example, an Australian colleague of mine was working in the US and needed some advice on his tax situation.

In the first instance he spoke to his US CPA who ultimately came back to him and said that he should seek advice from an Australian accountant. He did that at a cost of more than $6,000 (which he gladly paid) and he then advised his US CPA of the outcome and sent him a copy of the advice letter so that he could prepare his US tax return accordingly.

He was therefore very surprised to receive a bill from his US CPA for more than $1,900 “for time expended on researching his tax status.” When he challenged the fee he was told that “a lot of time went into the research”. What that CPA should have said right up front is “we don’t do this type of work so you should get advice elsewhere.” I submit that situations such as this are not the norm but they are the ones that get remembered and talked about.

He suggests: You do not have your client’s best interest at heart – you do not (generally) spend the time needed to solve your client issues because you are fearful the client will not pay the bill. You also do not recommend to your clients what they really need because you think they will not pay for it. Not fair for your clients again.

My thoughts: Another unsupported assertion. This rejects the very notion of professionalism and is a gross insult to the profession. There may be some practitioners who do not have their clients’ best interest at heart but they don’t generally last long in business. I do agree that accountants could and should do a lot more for their clients but this is not because they use time-based billing and are fearful that the client won’t pay. It’s because they are too busy doing other necessary things, often for clients who they should not be working for, they are faced by a serious talent shortage, they do not invest the time needed to determine how their clients could benefit from the work they do and they are reluctant sales people.

He suggests: You put a barrier between yourself and your clients – they are sometimes frightened, intimidated and concerned that every time they speak with you, they will be slugged with an invoice. You become untouchable and I know that’s not what you want. More client unfairness.

My thoughts: Of all the statements made this one does have some merit but it does not arise because of time based billing. It can be easily addressed by simply alerting clients that as part of your service protocol you do not charge them for any contact they make with you unless it gives rise to a service request that takes more than a specified period of time. Further, if that is the case you should also make it clear that you will give them an estimate of the cost and the opportunity to accept or reject it.

He suggests: You put a salary cap on your personal and team earnings. Many of your team can earn up to two times what you pay them in commerce or government. You think they are not worth it (well they are because others are prepared to pay it) because you think that you cannot get a charge rate out of them, there will be to many write offs and the clients won’t wear it. Not fair on the entire industry.

My thoughts: This is a bizzare and totally unsupported assertion. Does the writer seriously think that people will stay with a firm if they could command a salary twice as high in another job. Slavery was abolished a long time ago. Who is he kidding? Notwithstanding that, I’m confused by the rest of the paragraph. It seems to me the writer is saying “… you should be charging these people out at a higher rate (because they are worth more to another employer) but you’re reluctant to do that because you think there will be write-offs, clients won’t wear it and that’s not fair on the industry.” The writer now seems to have switched position from worrying about the profession’s conflict of interest and the ethics of time based billing to worrying about the welfare of the profession.

He suggests: In the majority of cases, your clients have no idea how much they are paying until after you have done the job. The work has already been completed, you send them a bill and they have no choice to pay it or you will sue them. Not only is that a raw deal for the client, it is completely unethical.

My thoughts: The adoption of time based billing is NOT the reason clients do not know what the fee is going to be until after the job is done. If this occurs it’s because of a failure on the firm’s part to discuss the scope of the job and the expected fee with the client at the time the engagement is accepted. If the service provider can see that the fee estimate is likely to be exceeded then the client should be advised accordingly and given a reason why. This is standard operating procedure in best practice firms.

Having been in practice, I know many (I’d be willing to say the majority) clients are quite happy for the fee to be based on time expended and are fine with the fee outcome because they trust the person they’re dealing with and the firm—and why shouldn’t they? It is customers, not practitioners, who have been the principal beneficiary of technology driven productivity improvements in the past 30 years. For the writer to suggest that this practice is unethical is absurd and is not consistent with the relationship most firms have with most clients or with industry economics.

My other observations:

The most successful practices I have seen in terms of fee growth, profit per team member, profit per partner, client loyalty (as measured by referral-generated fee growth and client retention), and team member retention, use a blend of time based billing in conjunction with fixed price agreements, they understand the value of what they can do for their clients and the importance of a strong communication channel with their clients.

These firms use time sheets to determine where their resources are being deployed and they embrace a value-pricing philosophy which cuts both ways—namely, value to them and value to their clients. Many of the jobs they do for clients are billed on the basis of time expended but a substantial proportion (from 30-70%) of their revenue is based on FPAs. I submit that these firms behave ethically and that there no conflict of interest with their clients. To suggest otherwise is an insult to them and to the profession.

I am not suggesting that the use of time based billing is the key to practice success. I do strongly believe, however, if you decide to move away from time based billing you must replace it with a robust and carefully designed and implemented alternative. It is dangerous in the extreme for example to move away from time based billing and replace it with a system such as “let’s take last year’s fee and add 10% and build that into a FPA.”

A case can certainly be made for the elimination of time-based billing but not on the grounds that it is unethical—if that were the case I believe the professional bodies would have banned it long ago. Time based job costing is an easy-to-use system (which explains its almost universal appeal) for determining a price based on resource cost that is underpinned by the economic concept of opportunity cost.

In my opinion, the problem with time based pricing is not that it rewards inefficiency, it’s that it penalises efficiency because the faster things get done by lower level people, the lower the price paid by the customer. Furthermore, the seller will, on average, be worse off than would be the case if he was able to find a simple way to capture more of the consumer surplus—that’s the price some people would have been willing to pay that is higher than the firm’s standard hourly charge rate.

Capturing the consumer surplus is what value pricing is all about but it’s easier said than done particularly for small one-off open-ended jobs. This is not the place to discuss this issue other than to say that a robust value pricing system calls for a focus on outputs (a customer perspective) rather than inputs (a firm perspective).

It also requires attention being given to workflow together with the systematic development, retention and management of intellectual capital rather than time expended and this mandates different management processes. Traditional time based productivity monitoring software does not lend itself to this process which is one of the reasons so many firms struggle to successfully implement value pricing.

However, some firms have successfully adopted value pricing and have implemented a business strategy and related management process needed to make it work. One such firm is O’Byrne and Kennedy, a UK practice at Goffs Oak in North London. Paul O’Byrne will be talking specifically about how they have done that at Principa’s Practice 2020 Annual Conference in Brisbane this May 12–13.

I have a feeling that the most successful firms of future are going to adopt an OBK customer-centric strategy as customers become more aware of the value their accountant can deliver and more aware of firms such as OBK who are delivering that value.

  1. Ric Payne
    September 30th, 2008 at 19:09 | #1

    Ed Kless posits: “If you suck at scope, suck at setting customer expectations, provide little or no exhanced value to your customers, suck at communicating with your customers then billing by the hour is for you!”

    In my opinion, how you bill would have to be the least of your worries if you exhibited all of these challenges.

    One more thing Ed, your “communist” comment is made in jest, correct?

  2. Anthony Berkman
    September 30th, 2008 at 19:09 | #2

    Hi Ric
    Looking forward to attending your conference in a couple of weeks.
    I enjoyed your above response to RN’s thoughts on this subject.
    I think like so many things in life it comes down to balancing the different things we must consider.
    I remember asking a ski instructor once a few years ago about some technical point and her response was “it depends”………….I’ve never forgotten that…we can use value pricing , we can use time sheets , we can pluck a figure out of the air in some cases based on feel and experience…..”it depends”…..so long as the client is satisfied they have been treated fairly and received value it’s ok.
    See you in Brisbane.

  3. Geoff Richmond
    September 30th, 2008 at 19:09 | #3

    Hi Ric,
    I previously read the article you referred to and must admit I circulated it around my office suggesting it reinforces the position I have been preaching to my team. Obviously the author got up your nose inferring that the profession may be acting unethically, but we both know the marketing approach of the author.
    The important issue, I believe is that to simply add up the time on the clock & multiply it by a dollar value is not the proper way to set the price. If anything, time cost systems should be used to measure performance against a bench mark determined by the business owner but not to determine the price of the assignment. Your comments above “The ONLY thing that is relevant is that the vendor sets a price for the service on whatever basis he chooses and the customer can accept or reject it. What can be fairer than that?” are spot on and infact I would suggest the majority of your commentary supports the propositions put forward by the author but not in such a controversial fashion.
    I realise that you get to mix with a large number of successful firms who have embraced the concept of FPA’s but I am also aware that many firms are conducting business on a straight time sheet basis without any prior discussion on what the end fee will be. They are then constantly trying to guess the “client value proposition” after the job has been done only to be faced with a write-off because they are scared to charge value or potentially loosing the client due to their perceived lack of value. I also believe the system of time sheet billing does encourage the profession to cut corners, especially if the job has already exceeded time expectations. Many firms measure, reward & in fact rebuke team members & partners based on recovered chargeables with many of the team having no say in the final bill. I know my team has had a completely different approach to jobs since working on an FPA – they aim at getting the best result rather than getting a result within an acceptable price. The end result is we end up uncovering separate assignments which can be put to the client in a value proposition before embarking on the new job.
    I hope we do see more firms following in the footsteps of O’Byrne & Kennedy.
    Keep up the good work.

  4. Mark Lennon
    September 30th, 2008 at 19:08 | #4

    Ric, it is great to read a “balanced” view. By “balanced” I mean not trying to push a particular theme or trend. I have heard so many, if not all, the arguments for not billing on the basis of time (and I DO NOT confuse this with value pricing, which are two separate issues), and I get sick and tired of the “over the top” approach, instead of a balanced, well-considered approach.

    For instance, I know that airlines don’t charge on the basis of time, but they also certainly do not charge on the basis of what the trip may be worth (or else we would be each paying a different fare; and you would not be able to book over the internet because your price would be different to the next person), nor on value (how do you value a holiday, versus a honeymoon, versus a business trip, versus a family separation, versus the transport of a prisoner under arrest. It’s all nonsense. The trip is based on market forces, but with a very wary eye on costs, and cancelling flights to fill others if need be.

    Anyhow, I’ll leave the on-going debate to those more learned than I, and I certainly do appreciate your detailed and well-considered views.

    Mark Lennon

  5. September 30th, 2008 at 19:08 | #5

    What you are failing to understand is that billing by the hour allows the poor practices you have outlined to continue. If you suck at scope, suck at setting customer expectations, provide little or no exhanced value to your customers, suck at communicating with your customers than billing by the hour is for you!

    The reason billing by the hour is unethical is because it allows these practices to continue. As you know, billing by the hour is based on a flawed economic theory. No matter how you pretty it up, billing by the hour is a form of the labour theory of value. This theory was posited by Karl Marx. Anyone who bills by the hour is a practicing, de facto, communist.

  6. September 30th, 2008 at 19:07 | #6

    We could certainly have another debate about this. I do believe time-based billing is unethical, and I can prove it in a manner far more intellectually than the “writer” you are citing. But I don’t think I have the energy to engage in another debate with you!

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