The beginning of this month marked my sixth anniversary of becoming a solo consultant. I don’t regret my decision and cannot imagine ever giving up solo consulting. I was essential in the implementation of some really interesting projects like infotainment systems for cars and driver terminals for sugar beet and forage harvesters. The income from these projects gives me the financial freedom to enjoy life more than ever before.

I took my anniversary as the cause for reflecting about what I should have done differently. I learned three main lessons.

• Hourly billing runs against the best interest of your customers. As a solo consultant, you have no interest in becoming more productive. The longer hours you work the higher your income. You can only change this, if you Don’t Bill by the Hour but charge a value-based fee.
• Charging customers for the value you provide becomes much simpler if you have a strong brand. A strong brand will Make Potential Customers Call You. You don’t have to search for projects any more, but projects will find you.
• Productised Services are part product and part service. The product part is the same for all customers, whereas the service part is specific to each customer. You maximise your profit by minimising the time you spend on the service part.

I will heed the conclusions drawn from these lessons and implement them step by step. How about you?

Don’t Bill by the Hour

In a recent project, I had a revealing argument with my customer and another company X involved in the project. I was billing by the hour. X provided a fairly unfinished software “product” for a fixed price. My software and X’s software had an interface.

The argument was whether X or I should do a change. The change would have cost X one week and me ten weeks. Obviously, X didn’t want to spend one week for free. Their managing director told me – in the presence of the customer: “What is your problem? You get paid by the hour, don’t you? So, just do it and take the money.”

I couldn’t believe my ears. After regaining my composure, I answered: “I regard such behaviour as unethical, because our customer would suffer a substantial and unnecessary loss.” All the customer’s managers including the CEO sided with X, as they concluded that bending the company X to their will was more trouble than an individual. And anyway, I would be paid for the extra work.

I gave up at that time and did the extra work. In hindsight, I should have terminated the project at that point, as similar arguments predictably happened over and over again. I had to bear the extra work most of the time. These arguments didn’t help the mood and motivation of the project team.

The example shows how ingrained hourly billing is. Customers accept it as God given, although they know that they are ripped off. The consultant’s and the customer’s incentives are clearly misaligned. Consultants try to maximise the hours billed, whereas customers try to minimise the hours billed. Consultants are punished for being more productive and for delivering higher value to the customer.

This misalignment leads to fruitless negotiations over hourly rates and makes it hard to increase rates even modestly. Moreover, hourly rates limit your yearly income to roughly € 240,000 – assuming very optimistically that you work for 160 hours per month all 12 months of the year and that you charge € 125 per hour.

Roughly one year ago, I understood that hourly billing is broken. I had never considered fixed-price projects, because the risk of loosing money is far too high. I started looking for advice on billing for consultants. I eventually stumbled over Alan Weiss’s book Value-Based Fees: How to Charge – and Get – What You’re Worth (2nd edition).

My aha moment about value-based fees came when I found a reference to Jonathan Stark’s work in Philipp Johnston’s project proposal template. Jonathan Stark’s book Hourly Billing is Nuts gives a lot of practical advice how to calculate value-based fees. As Jonathan is a software developer himself, I found his advice more applicable to my own situation than Alan Weiss’s.

So, what are value-based fees? Value-based fees are “fixed bids on steroids”, as Jonathan puts it. The value is the maximum amount of money a buyer is willing to pay for your customer’s product that you help build or improve.

Customers pay you a certain price P for your services. The value V is the return customers get from investing P into you. Your cost C is your hourly rate times the number of hours that you need to produce the required results. Your profit as a consultant is the price minus cost (P – C). Your customer’s profit is the value minus price (V – P).

As the price P is fixed, consultants have every incentive to reduce their time spent and to be more productive. This is also very much in your customer’s interest. The misalignment of the consultant’s and the customer’s incentives is gone.

The next step is to find a price P, the value-based fee, that gives a fair and healthy profit to both the customer and the consultant. Jonathan Stark gives the following formula as a rule of thumb:

P = max(1.85 * C, V / 10)