The end of the hourly rate....?

As businesses emerge from the devastation of COVID19 they will face many challenges. From managing the staff return from furlough, to adapting the office, factory and shop environments to cater for social distancing, to dealing with increased debt and to dealing with the potential loss of customers and suppliers - the challenge all businesses are going to face will be significant.

Inevitably businesses are going to need to review not only how they generate and maintain work but also how they can reduce and control their cost basis.

Like all businesses, professional advisors will need to adapt to this changing client environment. Professional advisory firms are notoriously slow in adopting technology and changing business practice. However, if there was ever an opportunity and need for professional service firms to listen and work with their clients – it is now.

One area where advisors can and should consider change is the continual reliance on the hourly rate. If there is a phrase that brings dread to a client and a smile to a professional services firm, it is….“my hourly rate is….”. Despite continual client pressure on fees and a greater drive for transparency, the hourly rate remains stubbornly entrenched in the professional advisors psyche.

The argument in favour of the hourly rate is simple - if you carry out work and it takes you 10 hours you should be paid for each of the hours worked. Professional advisors operational costs are high and, unlike most product focused businesses, it is predominately selling an individuals expertise. As such its “productivity” is restricted by the number of hours available in a working day. It cannot easily scale up and invest in more efficient machinery in order to decrease production costs and at the same time increase productivity. This is not to say that there are not ways of increasing an advisors efficiency, the emergence of blockchain, the smart contract, sophisticated document checkers and precedent banks inevitably help but the room to manoeuvre is more limited that a product focused business. For professional advisors, the primary cost is staffing and there is only so much return that can be achieved from each member of staff.

Professional advisors will usually increase profitability by either recruiting more advisors (and hence increase the number of “hours” it can sell), improve (albeit limited) efficiency or increase its charging structure. What is generally missing from all of these calculations is the client. For all of the continual benign “unique selling points” that professional advisors market including being commercially minded, plain speaking and client focused – each hour spent by a professional advisor costs and so the hourly rate remains as the focal point for revenue generation by a significant number of firms.

Even the recording of the number of hours that an individual works is more complex that it sounds. A number of professional advisors still record time in 6 minute units meaning that a phone call lasting 3 minutes will trigger a charge of 6. Individual rates will also vary significantly depending on the position, the level of qualification and the specific expertise of an individual.

It is against the above background that the hourly rate continues to thrive.

The pros of the hourly rate

The hourly rate feels like it has existed for ever. Clients have accepted it as much as professional advisors have enforced it. Why? The reasons are numerous and include:

It reflects the work done: To some extent it makes sense – the client is paying for the time that the job takes and the advisor is being paid for the time they have incurred. To that extent it is a win-win;

Transparency: It is evidence based – when time is recorded it allows a client to have a detailed breakdown (and as a consequence question or challenge) the work that has been done. In a time of transparency, time recording becomes the ultimate evidential base for showing the work that has been done, who it has been done by and how long it took;

Neutral: there is a concern that fee structures that are tied to results can encourage bad behaviour. When an advisor has a vested interest in the result then there is more of a risk that they will pursue a behaviour that reflects the benefit for them as advisor as much as that of the client. Whilst the same can be said about time recording, when it is coupled with transparency, the risk of muddying the waters between “client” and “advisor” interest declines;

Job pricing: recording time spent allows an advisor to get a better understanding of the likely cost of the work it is undertaking. This does not necessarily have to mean that the work itself is charged by the hour but maintaining time recording helps price the work even if it is on a fixed fee basis.

The problem with the hourly rate is, however, significant. In particular:

Lack of certainty: even with the obligation to provide estimates, the hourly rate creates uncertainty for the client. It provides an environment which restricts an ability to budget the direct cost as well as control cash flow. Whilst there are inevitably clients where the hourly rate is not an issue provided the advice is trusted, there are also a significant numbers of businesses that do not have the luxury of being able to ignore their advisor spend;

Client tension: there is an inevitably a tension between a firm that builds its revenue stream on charging by the hour and a client that is trying to limit or cap its advisory spend;

Value: the recording and charge of time by the hour does not necessarily equate to value. Quick jobs can result in a low charge but be critical to the client whereas time intensive jobs can result in high charges whilst not having a reflective value to the client. The problem with this is that it helps create dissatisfaction with a client who will inevitably see the larger charges as being “over charged” whilst ignoring charges levied that are arguably too low;

Over-charge: charging by the hour is always at risk of a job taking longer than anticipated. The expertise of the individual and their relative experience in doing the job they are being asked to undertake will impact on the amount of time that is recorded. Many firms will review the time recorded before billing to try and offset against any over-charge due an individual taking “too long” on a matter. However, this is always going to be subjective;

Bad behaviour: individual hourly and billing targets remain (sadly) common in professional firms and inevitably this causes a tension. This is not saying that individuals are deliberately recording inaccurate time, but having a business model where “performance” is linked to what you record encourages individuals to hold on to work that may be better (and more efficiently) dealt with elsewhere;

Client relationship: the fear that every minute spent on a matter is resulting in a commensurate charge undermines the relationship between client and advisor. Advisors need to understand their client, their objectives and how they want to work. Chat and banter about the weather, what people have done over a weekend and what the business is up to can be as important in building trust between the parties as the advice itself. The fear that the “clock is ticking” can damage relationship building.

Way forward

With the economy in freefall and the pressure on costs inevitably likely to increase, all businesses are (rightly) going to review their expenditure. In times of crisis, certainty becomes far more important and as such businesses have an opportunity to encourage professional service firms to adopt more innovative and commercially reflective approaches to pricing. This is a “two way street” and so any solution and approach to pricing has to work for all parties but there are a number of options open to clients, including:

Fixed fee: fixed fee arrangements give both the client and the advisor certainty. However, it will usually place most of the risk on the advisor especially if they are competing for the work and being forced to push down the “fixed fee”. As such, it is important that both client and advisor have an open discussion on the fixed rate and that the client recognises the importance of agreeing a rate that works for both parties;

Parameter fees: parameter fees will use the hourly rate but will operate within an agreed lower and upper cap. This enables some flexibility for both client and advisor if the level of work either exceeds or falls short of what was initially anticipated;

Risk and reward fee structures: structures that link to some forms of success matrix (for example, deadline dates or successful signature/completion of a project) enable both parties to benefit and be linked to a successful conclusion;

Value fee structures: value fee structures will link the value of the transaction to the client to the level of charges levied. For example, routine work may result in a much lower return for the advisor than work that is critically important;

Non-transaction linked fee arrangements: clients that have long term relations with their advisors should also consider decoupling the charging structure against a particular job. Monthly or annual retainers can be agreed that are then reviewed on a regular basis to ascertain the benefit to both parties. Retainers are not necessarily linked to a particular transaction but allow both parties to undertake work and then adjust the level of charges to reflect any increase/decrease in work;

Open-book: open book arrangements can be used to encourage both advisors and clients to work together to ensure that the fee arrangement is working for everyone.

The relationship of client and advisor is always finely balanced. Client’s must understand that the advisor is also a business that needs to make money and so the race to push the charging rates to the lowest possible level is counter productive. For example, too many tenders see “price” as the primary scoring mechanism without considering what this means in practice. If a business is to make money, forcing the charges it levies constantly down may save money but it will not always reflect the level and quality of service that the client needs and deserves. Any move away from the “hourly rate” is dependent on the strength of relationship between the client and their advisor – the stronger the relationship then the more flexible the charging structure can be.

The hourly rate has its place but professional advisors need to work more closely with their clients to put in place arrangements that work for all parties. Being “open and transparent” is not just about how much a matter will cost – it is about the objectives and needs of all parties involved. Just as advisors need to understand the business objectives of its clients, so does the client need to understand the pressures and needs of its advisor. The best advice and the best result will be driven by a relationship that works for everyone.

For all of the challenges we are currently facing, the opportunity to change and adapt to the current surroundings has never been so relevant. In the post COVID world, businesses have an opportunity to readdress how they work with and how they are charged by their professional advisors. Any charging structure must work for all parties but an open and honest discussion can remove the ambiguity of the hourly rate and provide both client and advisor with a charging model that reflects value and provides certainty.

There are other factors including structure and reward that inevitably impact on an advisors desire to maximise their return but we will explore these in future articles. Up next – innovation (or the the lack thereof ) and the advisor…