How to Know When Fixed-Fee Pricing Isn't Working
With all the valid discussion about firms moving away from hourly billing, sometimes it just doesn’t work out. Take for example SmartBooks, an outsourced bookkeeping and accounting firm who predominantly used fixed-fee pricing but found difficulty doing so. Here is their story about why and how to know when it may be time to switch:
In my 10 years of running SmartBooks, we used a fixed-fee billing model due to the belief that it was predictable and something desired by clients. We believed that it would simplify engagements, avoid the friction associated with disputes with clients regarding hours billed.
Moreover, we thought it would facilitate value-based pricing where we could charge a premium price based on the value of deliverables above and beyond what we would be able to charge in an hourly billing model. We were wrong, at least with a significant number of clients.
One would think that after working with hundreds of clients over a 10-year tenure that we’d have sufficient ability to successfully price new clients. Unfortunately, that has not been the case. This failure has largely been driven by a few main factors.
Scope creep is an inevitability when working in a service business. Client needs change regularly and a natural tendency of service providers is to say “Yes” to each new client request for fear of damaging the client relationship or out of reluctance to renegotiate pricing.
The more impressive your work, the more clients ask of you. Unless your account managers are regularly tracking transaction volumes and scope of service for each client and comparing them against the original contract assumptions, your team is likely doing more work than they are compensated for.
The faster a client grows and the more work you perform to support their increasing needs, the worse this problem is for you as a service provider trying to play catch-up with your pricing to reflect the work actually being done.
An unfortunate fall-out of pricing that’s out of alignment with actual service delivered is that service personnel suffer employee burnout at alarming rates. When pricing does not accurately reflect the service delivered, employees suffer the dual-edged sword of being overworked and underpaid.
They are tasked with supporting a certain number of clients with a certain volume of work. The reality is scope creep often results in staff having to support significantly larger volumes and scopes of service, without a corresponding increase in revenue or hours credited to staff.
Considering the high costs of recruiting and training new bookkeeping and accounting specialists, firm owners are smart to pay close attention to anything that negatively impacts employee retention.
Largest Clients Can Erode Profitability
In our case, we’ve recognized that our largest clients can have the largest discrepancy between the fixed monthly fee we are charging them and the services we are delivering to them. This can result from a larger company placing demands on our staff as if our people were full-time internal staff at the client instead of fractional outsourced staff.
This can also result from rapid growth in a venture-backed company. Rather than realizing increased profits on these large clients, our profits can erode with them. Again, this is tied to the reluctance of service personnel in telling clients “No”, or setting a reasonable (non-immediate) response time SLA, or letting them know that they’re happy to support additional client requests for an additional cost.
Some Clients Require Flexibility
Certain clients with venture capital investment backing who are growing rapidly or iterating their business model have dynamic needs to support their rapid expansion. Neither we nor they can predict exactly what their needs will be six months into the future.
Clients naturally do not want to pay a monthly price today that is based on their expected needs six months from now. Yet six months from now, we must get the job done without pausing to re-define scope and re-negotiate pricing. At any given time, their CFOs just want the bookkeeping and accounting to get done without delay and are not interested in continual contract renegotiation.
Friction and Misalignment
Initially we believed a fixed monthly price would remove friction and align us with our clients. We would all be interested in using the most efficient processes and technology. We would seek to produce good accounting with efficient use of low cost resources.
Instead, clients may cling to having the most senior people do everything for them, even though for example there is no need for a CPA to be posting bills. Instead of utilizing efficient technology like QuickBooks Online and Bill.com, some clients prefer to stay on QuickBooks Desktop despite all the IT headaches and inefficiencies, and use their online bank bill-pay service despite security risks and inefficient double entry of data.
If clients pay a fixed monthly price, there is no incentive for them to adopt efficient systems and processes. Clients can cling to what they are accustomed to doing, which increases our costs and is not reflected in the quoted price which assumes the use of efficient SOPs and technology.
Fixed Fee Perceived as More Expensive
While our hypothesis was that clients would prefer the predictable nature of fixed monthly billing, the reality is that many small business owners experience sticker shock when seeing a monthly sum and are psychologically more open to paying by the hour for “just what they need.” This has negatively impacted us during the sales process when going up against firms who simply quote hourly rates and inevitably low-ball their estimated number of hours.
Ultimately these competitors end up spending as many or more hours to deliver the service as SmartBooks at comparable hourly rates and at a comparable ultimate cost to the client. The difference is our competitor has won the business and we have lost the business. Meanwhile, the client has made a buying decision based on erroneous cost estimates rather than based on which firm is best suited to meet their needs.
Changing Landscape Highlights Need for Change to Pricing Model
During my time at SmartBooks, there have been some key changes to the outsourced bookkeeping and accounting landscape that highlight that the time for reconsidering the pricing model is now.
The emergence of a true cloud-based accounting tech stack coupled with a supply of inexpensive international bookkeeping and accounting resources means that client work can be fulfilled from anywhere. However, many firms have been reluctant to tap into international resources for fear of client pushback.
With the transparency that comes with hourly billing, clients can make their own decision on whether they’re comfortable with a division of labor whereby international team-members perform the bulk of routine bookkeeping work at a cost-effective price while domestic resources supervise that work and provide value-added thought leadership more in line with their higher hourly rate. And, if clients decide they want their work performed entirely by domestic staff, they can opt for that higher priced option in an eyes-wide-open fashion.
Promise of Artificial Intelligence
Over the last several years, technologists have predicted that AI will replace traditional bookkeeping work. While reality has not yet lived up to that hype, the technology does continue to improve such that more work can be automated each year.
This fear of automation has pushed many firms to adopt a fixed monthly fee model so that if suddenly their staff was able to be 50 to 75 percent more efficient with their time by relying on technology, the firm’s revenue would not disappear in an equally sharp curve.
Perhaps there’s a combined pricing model to account for this eventuality whereby the lower-cost routine bookkeeping work that will eventually be automated is priced on a reasonable fixed monthly fee and the tasks that require more manual human intervention can be priced on an hourly basis.
So Where Does This Leave Us?
My firm is approaching our own pricing model like most CFOs would: letting the numbers guide our strategy and refining that strategy as more numbers become available. For now, we continue to bill most of our clients following a fixed monthly fee model if fixed fees keep us aligned.
Fixed fees make sense for the majority of clients, and provide an opportunity to eliminate friction and for value pricing. For clients where fixed fees do not align with actual needs and are likely to introduce friction, we introduce an hourly billing model.
For new clients likely to prefer hourly billing, we are offering them the option of transparent hourly billing, while still providing them visibility into what we anticipate their monthly costs to be.
Calvin Wilder is Founder and CEO of SmartBooks. He is responsible for leading the company’s growth including vision and strategy, successfully scaling internal and external operations, and innovation initiatives. He has designed and managed accounting and HR policies, operations and...