Imagine a hole-buyer and a hole-digger met at the local hotel to discuss a much-sought after hole.
After a few drinks the job is agreed with the digger starting as soon as possible.
Next day the digger is on site unloading the digging gear out the back of the digging truck.
After a long day of effort by the digger, many loads of shifted dirt, and the essential clean up, the digger is done.
The buyer turns up for inspection and payment.
The hole is misplaced.
The digger has dug the wrong hole in the wrong position.
The buyer still needs the right hole and the wrong hole filled in.
What’s happened?
Possibly too much drink the night before.
Fundamentally all the hole-digger’s efforts, expertise and tools failed to meet the outcome desired by the hole-buyer.
The digging work (i.e. inputs) didn’t produce the buyer's desired outcomes (i.e. needed outcomes).
For all the input - the digger’s expertise, digging equipment, digging truck and day's work - the output was a wrong hole in the wrong position.
The buyer had agreed a fixed amount but wasn’t paying until the wrong hole was filled in and the right hole dug. A settlement was negotiated.
Confusing inputs and outputs is common.
Particularly for experts providing expertise as the vast majority price their services based upon their inputs - i.e. their effort and hours.
Why?
As the hole-digger and hole-buyer discovered, working hard or long does not ensure value.
Worse. Pricing on an input such as hours creates imbalances.
The most concerning for advisers seeking trusted relationships with clients is the conflict of interest caused by pricing models based upon effort or hours. A hourly rate model means the more hours worked, regardless of efficiency, effectiveness or value of the work performed, the higher the fee. The expert gets paid more when inefficient and rewards slow, poor work as equally as good work. A ridiculous basis for determining value let alone fees.
Another imbalance is the client disincentive to seek advice. Aware their advisers charge upon hours, clients are more prone to act as their own advisers, or their issue is probably not worth the cost. Expecting clients to be able to determine the value of advice objectively versus the consequential cost of forgoing the advice is similar to expecting a child to objectively value the benefits of continued schooling versus the consequences of dropping out.
Another issue for hourly rate model is one of success. Hourly rates cause greater adviser dependency.
Charging on hourly rates naturally educates clients to place the value on their adviser’s efforts.
While flattering for good advisers, it actually guarantees a flattening of earnings and growth for professionals seeking to grow a firm that delivers consistent, valuable and profitable advice. The hourly rate model educates clients and their referrals to seek out a particular adviser. This then creates an imbalance in firms and in fact is detrimental to the client’s long term best interests as it inevitably creates an unsustainable and ultimately a disappointing dependency as the adviser’s client base naturally generates more work on over-worked adviser.
The new team members appointed to support the new workloads eventually realise that their career plan is better guaranteed starting their own firm with a section of the firm's clients frustrated with falling quality. Unfortunately a few years later the new start-ups find themselves in the same founders trap as their old firm. All created in large part to hourly rate charging.
Conditioned by the long established practice that pricing is linked to a service input like effort may be common practice for advisers, accountants, lawyers, engineers. However, once professional services firms like these are beyond their establishment phase, growth is better aligned with client value not the number of holes being dug every day.
What do you reckon?
Cheers,
JIM
THE ABOVE IS A PART EXTRACT FROM MY NEXT BOOK - WHAT PRICE VALUE - DUE FOR PUBLICATION MID-2021
