Is charging by time damaging your agency? Value-based billing could be the solution.

Billing by time is something that agencies have been doing for years. It has become a widely-accepted way of pricing agency services, but does that mean it’s the

best way to charge clients? The time-based billing model that agencies normally use has seen agency return “per unit of work” fall by 40% during a steady 20-year decline. This signals concerns that billing by time might not be working for agencies anymore. This billing model also has a lot of draw-backs for clients too. In this post, I’ll look at the dangers of billing by time, and provide actionable tips to transition to value-based billing.

I was browsing Facebook recently and this video appeared in my news feed (sorry I can’t embed it, it’s in a Facebook post and I can’t find it on YouTube – I won’t do the story justice if I try and paraphrase it, so please go and watch it – you don’t need sound).

The message behind this video really resonated with me, as the method of billing for time is something that has increasingly troubled me recently.

I’ve been working in Biddable Media / PPC (and SEO) for over eight years now, and the experience I gained during this time is invaluable. It means that I’m often much faster than average at planning, creating and optimising campaigns. If I’m getting work done in less time than average and generating good results, does that make the value of my work less? Of course not. Should my agency charge the client less, simply because I did the work in less time? No. Instead, we should charge the client based on the value of the work we have provided.

What are the dangers of charging your clients based on time?

There are a few drawbacks of billing based on time;

You limit your revenue and profit

Steve Penfold, Elucidat Director nailed this point when he said:

“The biggest issue with selling services based on hourly or daily rates is that you will always be confined by the number of hours in the working day. The most money you can make in a day is: day rate x number of billable staff.”

If you’re billing by time, the maximum you’ll ever be able to bill will depend on how many staff you have, and how many days work they are doing. If you bill based on value, the amount you can charge is essentially limitless.

Who is paying for the time it costs to achieve new business?

As the market is becoming increasingly saturated, it is becoming harder to get new clients because of increased competition, and as a result, the cost of acquiring new clients is increasing.

As the level of competition from other agencies increases, the time and resources spent on acquiring new clients is only going to increase further. If you’re still just charging clients for the time it takes you to do their work, but you’re spending more and more time to win new business, how are you covering the additional time spent on new business? Unless you’re constantly hiking up your day rate (which would probably price you out of the market eventually), the chances are you are not efficiently charging for this new business time.

Experienced employee salaries

More experienced digital marketing specialists command higher salaries. This is particularly true at a time when there is a shortage of highly experienced PPC and SEO specialist and more demand than ever for them. If these experienced agency staff members are able to get their client work done in less time because they are more experienced, you could end up charging the client less because work is taking less time, but you are paying the specialist more because of their salary. This doesn’t make business sense.

Automation is here

The most time-consuming tasks are becoming automated. This is true within PPC in particular, evidenced by the rise in popularity of automated reporting tools, AdWords scripts and automated bidding and campaign management tools. This kind of automation saves agencies a ton of time, but the value of this work is still huge. If it takes less time, it does not mean that they should be charging less for it. The value of the work output is still the same (if not greater) than it was when these tasks were being done manually, therefore the cost should be the same (if not greater).

Employee mindset

Charging and allocating work to your team based on time creates an internal employee mindset that can be detrimental to productivity, particularly amongst your top performers. For example, if your top performers know they have been allocated eight hours to get some work done, but they are so skilled/experienced/talented that they can bum around for seven hours and get the job done in the last hour of the day, they probably will – unless you are motivating them. If even just four of those other wasted seven hours had been spent on other client work, your agency could be a significantly more profitable.

Time doesn’t account for the cost of tools

The arsenal of tools required by digital marketers these days is ever-increasing. As you use more tools, the cost for these tools mounts up. Unless you keep upping your day rates, you won’t be effectively accounting for the rising costs of tools, and the result will be a dent in your profit margin.

Everyone works at different speeds

Everyone works at different speeds. If your account managers or new business team quote a project or retainer as requiring four days per month, but actually it goes to a less experienced team member who needs more days to generate the value required to maintain and grow the client, the client either gets a bum deal and gets slower results, or the agency loses out because they are putting in time they aren’t billing for. If neither of these happens, then the chances are that the less experienced specialist starts doing work in their own time to make up the shortfall, which will ultimately lead to an unhappy employee.

You can’t always accurately predict how long things will take

I’ve been pitching and writing proposals for years now, and my experience of creating, running and optimising campaigns means that I am generally quite accurate at estimating how long things will take. If you have a new business team or account managers who are making these estimates of how much time things will take and how much time should be billed, you cannot expect them to be able to accurately predict this, because they do not have the hands-on experience of doing the work which is required to do this with reasonable accuracy.

The nine-to-five is dying

The 9am – 5pm workday has been around for hundreds of years, and whilst so many other things in the world have changed in this time, the traditional working day has not.

The digital marketing industry is slowly starting to buck this trend, thanks to technology allowing us to work remotely and at any time of the day. Agencies, in particular, offer some great benefits such as flexitime and working from home as a way to attract the best staff.

This flexibility is brilliant in my opinion, as I believe we should all be working to manage our energy instead of our time, and working when we are most productive and inspired, whatever time of day that might be.

If you are working when you are most productive and energised (for example after a good sleep because you were able to start work later), you can generate great results and value in a shorter space of time, than if you forced yourself to come into an office and work 9am-5pm when you are tired because you had to get up early to commute.

If you are managing your energy and getting work done in less time, you should not be charging less time for that work. The value you output is the same, if not better when you are fully energised. If you bill by time, and you’re taking advantage of flexitime and working when you’re most energised, you will be getting work done more quickly, and so you would be billing less for this work on the traditional time-based billing model.

We also now live in a world where not everyone really completely ‘clocks-off’ at 5.30pm, so you might have a great campaign idea whilst having a shower! In the traditional agency time-billing model, that time might not be billed, even though it might have created a brilliant idea and provided huge value.

What are the alternatives to time-based billing?

We’ve established that billing by time could be damaging your agency, so what is the solution? There are a few different billing models besides billing for time;

Billing based on a percentage of media spend

After billing by time, the second most popular billing model for media agencies is probably billing based on a percentage of media spend.

This model does not work for SME clients, because their ad spend is so much smaller than big companies, and so agencies make less money from them, and those clients are often the recipients of second class service from the agency as a result. It’s fine for the Coca-Cola’s and GSKs of this world, but smaller businesses should avoid this if they want the best quality of work on their accounts.

This model is also hugely flawed because it does not incentivise the agency to use the client’s media spend in the most effective ways, it simply incentivises them to spend more media spend. This could result in agencies spending more of the client’s budget on campaigns that they know might not work very well, because they know if they increase spend, they’ll make more money. This creates a conflict between the client and the agency’s goals.

Value-based billing

I believe value-based billing is the billing model agencies will probably eventually end up using, because it more closely aligns the agency’s goals with the client’s goals in most instances.

What is a value based billing model?

A value-based billing model is where you consider the value of the work you are producing, and charge the client based on this, rather than strictly billing based on the time it took for the work to be achieved.

It’s essentially just naming your price for a piece of work, based on a consideration of what it’s going to cost you to do the work, and the value of the work that you are providing.

There are three main kinds of value-based billing:

1. Flat fee agency billing model

The flat-fee agency billing model is where you set a price up-front for a project or retainer, and that price is based on the value you think the project or retainer will deliver, rather than the time it will take for you to deliver it.

This model is probably the easiest to switch to if you’re currently using time-based billing because it’s the most straight-forward alternative and the least risky.

2. Payment by results agency billing model:

Payment by results does what it says on the tin. The client pays you based on the results you deliver.

This is a rare model, although I have had a few clients approach me to see if I would consider billing in this way.

The draw-backs of this model are mainly that as an agency, you need to be incredibly confident that you can deliver the required results.

It can ruin client/agency relationships when disagreements arise over whether results have been achieved. The key to using this model successfully is to set out incredibly clear and tangible KPIs upon which payment is based.

With the whirlwind of often unpredictable changes to digital marketing (for example losing ads on the right-hand side of the search results pages (SERPs) or organic search algorithm changes), this billing model is very risky for an agency. If your team is quiet and you have no other work to fill the time, then taking on work using this model can be effective. Likewise, if it is a client which will make an incredible case study to help you win future business, it could be a viable risk to win the business.

3. Combined flat fee and performance incentive model

This model is a blend of the flat fee and the payment upon results model. It is where you set out a flat fee for the retainer or project, and also have performance-based bonuses which your agency can unlock when specific performance targets are achieved. The flat-fee part of the price might need to be very slightly lower than you might have made it if there were no additional performance-based bonuses because otherwise, the client might see the cost as too steep. This completely depends on the client though, as in many instances clients are happy to pay above and beyond if the results you are achieving are also above and beyond!

The targets should be defined and agreed by both the agency and client and should be clear and tangible, with considerations going into what will be used to measure them and what attribution models will be applied to measure them.

You could create a sliding scale of these KPIs so there are different stages to be met as progress is made. This ensures your staff and agency remain motivated because if an objective is seen as too distant or too hard to achieve it can be demotivating rather than motivating.

As an agency, you should consider how you are going to incentivise your team to meet these targets, and it may be that they have bonuses or rewards linked to each of the stages in the target. Exactly what these rewards are should depend on the target reached and what motivates them. For example, it could be additional time-off, vouchers, public praise, events such as going out for lunch, or monetary (this is an interesting read if you’re thinking of exploring what motivates employees.

This model arguably most closely aligns both the agency and client goals, because it ensures the agency covers their costs but also incentivises them to deliver good results for the client in order to make additional revenue from the work. It’s also obviously a lot less risky for the agency than the payment on results model.

What are the benefits of a value-based billing model?

It is a billing system which can make agencies more money by allowing you charge based on value and no longer be limited by the number of staff and hours you have in the day.

Value-based billing has a key benefit for clients too because it incentivises agencies to spend time working on the areas of the project or retainer which are going to generate the best results, rather than just those which take the most time. It also incentivises agencies to reach KPIs and generate results more quickly, because it is in their interest to achieve maximum value for the client.

Value-based billing carries the additional benefit for clients, which is that they never have to be concerned with scope creep or being billed for the additional time which was not originally agreed.

Value pricing makes your agency stand out because so few agencies are doing it at the moment.

What are the challenges of a value-based billing model?

Value-based billing is not without its challenges and downsides.

As an agency, be prepared for some clients to try to game the system! Be clear on not only what your targets are, but also how results will be measured and what attribution models will be used to measure them.

The biggest challenge of introducing a value-based billing model is the shift of mindset required from both the agency and the client. It’s not simply about delivering work, it’s about generating performance results.

Deciding what to charge is tricky because value is subjective. Hopefully the tips in the section of this post titled ‘how to decide how much to charge when you’re using a value-based billing model’ will help you decide on a method for setting your prices.

Change is scary. Clients are used to being billed based on a time-based model. They understand and expect it. When you change to a different billing structure like charging for value, they will not always understand it and might be skeptical that you are trying to overcharge them.

Sometimes you won’t add much value, and that’s okay. Some tasks are simply time-consuming and don’t require much technical skill, or add a huge amount of value. For these tasks, you could end up charging less than you might have otherwise on your time-based billing model. For example, a recent client did not have an automated Google Shopping Feed, and asked us to manually create one in the meantime while their new website and automated feed was being built. This would have taken us a tonne of time, and although it would have been useful to the client, the amount I would have had to charge them to cover our time would have been excessive compared to the value the task would have provided. In instances like this, I try to get the client to use someone from their team internally to do the time-consuming ‘leg work’ (with some guidance from us) so that they mostly use our time on things where our skills and experience really provide value. You never want your client to start thinking ‘well I could do that!’ and start questioning why they need an agency when they could employ a full-time person in their team for the same price to do those menial tasks that don’t require agency skills.

You will find yourself pitching against other agencies who are still billing based on time, and it might be hard for your client to compare prices when billing is done so differently. Explain clearly to your prospect how you bill, and why you bill this way. Once they become aware of the benefits that value based billing has for them, you might even find it helps win the pitch for you.

Value-based billing might not work for some small projects or retainers, where the time required and the cost to your agency to do the work could well be greater than the value generated by the work. In these instances, time-based billing could be a better option. You could try flat-fee billing which doesn’t itemise the time the work takes, but where you work out what that flat fee is by estimating the time the work will take, combined with any other costs you have.

Value-based billing can be tricky in instances where clients aren’t sure of what their targets and KPIs are. It sounds silly, but I have met many a client who doesn’t actually know what they want to achieve. In these instances, you can either work with the client to identify their targets or stick with time-based billing.

How do you decide how much to charge when using a value-based billing model?

To explore pricing based on value, let’s take a look at how other industries price their products/services:

A retailer would make a few considerations before they decide how much to charge for their product. They might consider:

  • The factory running costs
  • The staffing costs
  • The cost of the materials which the product is made from
  • The cost of the machinery maintenance
  • The cost of delivery/packaging

The considerations above would allow them to arrive at a decision for what their break even cost needs to be.

Once they know this, they can then estimate how much more they can reasonably add onto that break-even cost, justified by the value of their product and other factors such as:

  • How much are competitors charging for similar products
  • How ‘in demand’ the product is (the more in demand, the more you can get away with charging)
  • Is their product superior to other products and therefore could it cost more?
  • Are they a new retailer/brand that needs to enter the market at a lower price to start encouraging people to shop with them?
  • What is their brand? If they have created a high-end brand they might need to stick to high-end prices.

After considering factors like this, they could determine what they think the value of their product is and how much they are going to charge for it.

In a similar way to a retailer, you need to consider all the costs of your service (staff, buildings, tools etc), and know what your break-even cost would be for a project. Part of this exercise will be estimating how long the project is going to take in order to get to this cost. Once you know your break-even cost, you then need to consider the value you are providing to your client and why your service is different or better than others, as well as what your competitors are charging for similar work. At this point, you can make a decision as to the value your work is going to provide and how much you can charge the client for the work.

How to get started with a value-based billing model:

Moving away from charging for time and into charging for value is a huge change that should not be underestimated.

Here are some tips to overcome some of the challenges of value based billing:

  • Define your objectives and goal posts clearly at the start of any project, so that when you measure the success of the project and the value you have created, they match-up to the objectives you started with.
  • Be completely transparent with clients, and explain the changes you are making to your billing model. This honesty will help them understand why they no longer see days on their invoice and reduce any fears that you might be overcharging them. If they ask about why you are making the change, explain some of the factors that will benefit them with the new billing model, and also be transparent and explain why you need to move to this model as an agency. This openness will strengthen your relationship.
  • Phase your agency gently into value-based billing by quoting new projects and retainers in this way. This allows you to road-test this method with new clients and encounter and devise solutions for any issues that might crop up before you roll it out to your existing clients. It is your existing clients who will find this transition the most difficult.
  • Talk openly with your clients to get them to do the lower value tasks that don’t really need your skills and expertise. If they still want you to do those tasks anyway, then explain to them that they will be charged with the old time-based billing model because the value you’re providing them won’t cover the cost of your team’s time to do the work.
  • Explain your billing model in your proposals/pitches if you’re up against value-based billing agencies.
  • Remember that you’re charging for value, so if you’re coming up with big ideas or strategies as part of the pitching process, those ideas and strategies have value, and if the client chooses to then use them internally or with another agency, they should be charged for them. You provided value, and you should charge for that value. We need to change the culture of freebies, which has lead clients to expect a lot for free before they commit to an agency.
  • Clearly communicate the change to your staff so they are aware of how they can best do their jobs based on what you are expecting of them. Consider how you schedule your work internally and how you motivate your staff, as this may need to change when you move to value-based billing.

If you’re sticking with time-based billing:

I understand that moving to value-based billing is a gigantic change. If it’s not right for you at the moment and you are sticking with time-based billing, here are some tips to try and make that system as effective as possible for you:

  • Incentivise your employees so that if they can get the same standard of work done in less time, they get some kind of reward. That reward will obviously depend on what motivates that particular employee and what your company resources are, but it could be something like a financial bonus, additional time off, or more personal development time. The time they save can then be used working on other client work, and voila, all of a sudden you have increased your actual achieved day/hour rates.
  • If you are using a new business team, or have account managers making decisions for time estimates in quotes and proposals, make sure they run their estimates by experienced specialists in the field. They can then be guided by the specialist as to how long these things will actually take, and educated on the considerations they should be thinking about before making these time estimates. Better still, schedule some of your specialists’ time to be used on proposals/pitches so they can be more involved in this. Here at Etch we don’t have a new business team, it is the department heads who do new business and pitches and proposals. This is one of our biggest selling points, because the work is sold into the prospective client by people who are highly skilled and experienced in the services they are selling. This means that their knowledge and passion for their area of expertise builds confidence in the prospective client’s belief that we are the best people for the job!
  • Don’t itemise your invoices by the time spent on things, if possible. Simply put the total and the service name, and only itemise the time if the client specifically asks for this. By not focussing on time, the client will be more receptive to moving to a value-based billing model one day if you should decide to do so.
  • Make sure your day rate is high enough to account for the rising costs of tools and training that are needed to do the job.
  • Include space for ‘wiggle room’ in your time estimates for proposals. Even the most experienced specialists can’t always predict bumps in the road which might take more time than expected.
  • Make your day rate high enough to cover the costs of the time you’re not working on client work, and are focussing on acquiring new business or training.
  • If you work on a retainer based model, make sure you build in some time so the first retainers are at a higher rate to account for the work you will have to do upfront.

Should your agency switch to value-based billing?

There is a lot to consider when moving away from time-based billing. It’s not a decision you should rush into or take lightly. My advice is to take it on a case-by-case basis once you have an understanding of the potential client’s business, and what they want to achieve.

Have you already moved to value-based billing? What are the challenges you have faced? Please feel free to comment below.

 

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  • Kate H

    Interesting read and always great to read examples from first-hand experience. Thanks for including a link to my post “The Rise Of Subscription Billing In Marketing & Digital Agencies” — it looks like we covered some similar ground and points 🙂 Digital agency project-based billing is certainly ripe for disruption and at Chargify we’re seeing many agencies moving to recurring revenue models. I talked to the leaders of many digital agencies who are already utilizing a recurring billing model and got their tips for agencies who are looking to make a similar transition. You may find that post interesting, as well: https://www.chargify.com/blog/agency-leaders-share-tips-for-transitioning-to-subscription-billing/