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the billable hours dilemma

EPISODE #177 TRANSCRIPT

A number of industries are built upon the billable hours model. Supplier companies exist to deliver services to client companies in a range of areas, and the billing's generally done with an exchange of time for money. This is often known as billing on a time and materials basis. This is the dominant business model in legal and accounting firms, and consulting businesses of all varieties. I know that we have many people in our community who work in these industries and virtually everyone uses external services in some way to run their business. When we talk about the No Bullsh!t Leadership principles, particularly the elements of delivering value and working at level, the culture of service companies can make it difficult to look past the current billing cycle. It's hard to think long term when you're a slave to utilisation rates and billable hours. 

Today, I want to talk through some of these dynamics from my perspective. I've worked inside consulting firms and I've also hired my fair share of consultants over the years, so I feel pretty well placed to talk about how to achieve better long term performance. I'm going to take a very holistic view today from both the service firm and the client perspective: 

• I'll open by examining the dynamics of a money-for-time culture.

• I'll give some special attention to one of the common variations on the theme, which is fixed price contracts.

• I'll move on to some of the issues that occur for both the company and its clients in the billable hours culture.

• I'll finish with a few ideas for changing the way your firm approaches the problem while not killing the goose that laid the golden egg.

So let's get into it.

Let's just quickly cover off how it works: services are delivered and billed by the hour. Now, lawyers are a classic example, they have an hourly rate, but they actually bill in six minute increments. I'm sure most of you have had to procure legal services for one reason or another during your lives, but it can really leave you questioning whether or not the service represents value for money. In large firms, you tend not to notice it too much, it’s just part of doing business - but when it's your own money, it becomes a lot more obvious. This can have unintended consequences: it's actually a disincentive to using the service. I’ll tell you now, I don't want to ask my lawyer a question via email - it can cost me hundreds, if not thousands of dollars. I'd rather just find the answer out myself if I possibly can, but this limits the effectiveness of the advice because the relationship quickly becomes transactional - we’ll have more on this later. 

INSIDE THE BILLABLE HOURS MODEL

The dynamics of how these firms work internally is especially interesting. Profitability often comes down to utilisation of the people in the firm. Now utilisation's just a measure of the percentage of time that one of your people is actually billable for. Every month, the company has to pay a hundred percent of its salary obligations, but can't necessarily bill a client for a hundred percent of that time. There are times when a consultant isn't assigned to a client engagement at all, and at those time the utilisation is zero per cent. This is often referred to as “being on the bench” and no service firms want their people on the bench. 

On top of this, there are roles inside the company where only certain activities are billable to clients. The more senior people, for example, might only be able to bill 70% of their time of clients, with 30% taken up by internal non-billable work, and those are typically the more expensive resources. All of these costs have to be recouped in some way, so the overhead costs and utilisation rates are factored into the company's business model and rate card. 

In this world, smart, hardworking people tend to pretty well. Why? Because they churn out the work and they bill lots of hours. If they also have the added capability of being able to form human relationships, they'll generally progress through promotion. So, the people that typically end up as partners in big consulting firms have a combination of technical smarts and sales capability - and these are not necessarily the dominant attributes you want in your top leaders. Now, I'm not saying there isn't decent leadership in many of these firms - and I'm not sure that it's any worse than any other company - but it's certainly different in terms of the dynamics. 

Many consulting firms that take on longer term engagements offer daily rates. As a client, you'll get a rate card at the start of an engagement for different levels of capability that you can employ and what they'll cost. The daily rate gives a client the perception that they'll get more for their money as the typical juniors in consulting firms work many more hours in a day than the standard nine to five. But as we know, time spent on a task is a very poor measure of value. If you have any doubt at all about this, look at your current team and compare the output of the strongest performer with that of the weakest performer. If you want to get a perception of value, the only way is to measure the outcomes delivered, not the time spent delivering them. And remember you are dealing with more than just the cost of the individual to your company. The day rate of any person that's actually visible to you has been bulked up by a factor of somewhere between two and ten times to cover their company's corporate overheads, utilisation rates and partner profits.

In the quest for more outcome focused engagement with service providers another model is the fixed price engagement. Now the concept of this type of engagement is to essentially de-risk a project in the eyes of the client by guaranteeing a certain outcome for a fixed amount of money. But even a fixed price engagement with a supplier is only removed from the billable hours model. The fixed price is still calculated using the proxy of time for resources, including utilisation rates, but on top of that, there's also a risk premium added in. 

THE ILLUSION OF RISK TRANSFER

A good detailed example of this is the use of liquidated damages clauses in fixed price contracts. Basically these are penalties that the supplier will have to pay to the client in the event of project overruns. So, it looks like the supplier is taking on that risk - but just remember, you’ve already paid for these. The risk of incurring liquidated damages has already been factored into the base price offered by that supplier. So fixed price contracts are more expensive overall, all, but at least they're focused on the outcomes - and they do offer some small protection against supplier failure. We're gonna have more on this later. It feels like a better way to do things, but there is an illusion of risk transfer that you need to be really mindful of. It's one thing to say, the supplier carries the risk for delivery but that's not always how it works. 

Years ago, as a CIO, I oversaw a major core systems redevelopment for a company I worked for in Australia. We engaged a bespoke software development business that happened to have some of the best technical people in this particular field. They were superb people, incredibly gifted and highly committed to the pursuit of excellence. Unfortunately, their ability to manage the project was not quite up to the same standard, and the fixed price model was not their friend. We'd originally intended to pursue a time and materials contract with them, but things got a little sticky. 

The founder and CEO of this tech company was invited to the final board meeting, where I was presenting the paper to seek formal approval of the funding. In this meeting, one of the directors put a simple but powerful question to the tech company CEO: What happens if the project runs late? What does this do to our funding envelope? In his over-exuberance, the CEO shot straight back with “We won't run late. We never run late.” Well, the director paused and tried again, saying “No, no, no. Just humour me. What happens if the project runs late?” At this point, the tech CEO had a serious rush of blood to the head and decided to double down. He said to the board slowly and emphatically, “What can I tell you? It just doesn't happen.” So, of course the board asked him to put his money where his mouth was, and commit to a fixed price contract to protect our company from any cost or time overruns. 

Well, the project was approved, the funds were allocated, and the contracts were executed. Now, as we were to find out not long after this, there was a lot more technical risk in the system design than anyone had anticipated. As it turns out, the estimates provided by the tech firm were underdone to account for this level of risk. So the timeframes started to slip. And when this happens, and the service provider's profitability vanishes, shortcuts begin to emerge - and this can quickly become a war of attrition. Enter the illusion of risk transfer. 

A service firm in this situation basically has four choices, and probably any combination thereof:

1. They can continue to burn cash as their costs exceed their expected profit margins.

2. They can start raising variation notices and seek compensation for work that they deem to be outside the original scope of the contract. This means trading endless project variation notices - which guarantees that you'll spend more time arguing about the original scope, and therefore who is accountable for the additional cost than you do actually delivering work.

3. The service provider can simply walk away, lick their wounds and hope that they don't end up in court. This can be used as leverage for option four:

4. Renegotiating the contract under new terms in order to get the project completed.

To his credit, the CEO of the tech firm held true to his word on a project that clearly wasn't profitable for his company. To this day, I have a huge amount of respect for his commitment and his integrity. But in retrospect, I would've much rather avoided such a difficult experience for him and for his company.

FIVE TRAPS in billable hours FOR CLIENT COMPANIES

Now there are a range of problems with the billable hours model. First, let's have a look from the client side. There are five key traps here:

1. The link to value is tenuous

It's often really hard to discern where the value lies, and paying for time spent work is a very poor proxy for value, as we've already seen. When things don't go well, compromises tend to occur in areas that are difficult to measure: scope, risk and quality. Now this happens on most projects, and it's much easier to cover up than messing with timelines in a way that pushes a service provider into an unprofitable position. That's why when people use that hackneyed quote, claiming that their project delivery was “on time and on budget”, it tells you almost nothing about whether or not the value that was originally promised was actually delivered. 

2. It reinforces short-termism 

Very often the relationship, which is fundamentally an exchange of effort for money, becomes transactional. Remember my lawyer, who - no offence - I have zero interest in talking to unless absolutely necessary. Decisions can actually be made to preserve budgets rather than to achieve the best outcome - and this isn't necessarily the best way to do things.

3. It’s rare that an external service provider does anything to assist with building your own internal capability 

This means that if you manage things really well, you can capture value by attacking the low hanging fruit, but it's ultimately just a short term sugar hit. It's almost impossible to capture any value going forward, because you don't have the internal capability to do so. As soon as the service provider leaves, so too, does your opportunity for value capture.

4. It can lull you into a full sense of security 

For example, because you don't have to worry about staff retention, capability, building and talent management in an area that you've outsourced to a service provider,  it’s easily overlooked. One less headache, right? We assume that the big service firms are doing this diligently and competently - but trust me, that is a big assumption. 

The final client issue is as insidious as it is widespread:

 5. Failure to deliver the outcomes, cost overruns and lack of value delivery, and consulting engagements are often either minimised or covered up 

No manager wants to admit that they made a mistake by bringing on the wrong external provider or that they mismanaged the engagement itself. Both result in a client company not getting value for money - and service firms rely on this behaviour, to an extent. If you're a leader higher up in the food chain, you've gotta be really aware of these dynamics. Very few managers who appoint a consulting firm actually manage them really well. Why would they? Many of the principles are identical to leading your own team. 

Having said all of that, your ability to tap into and hire skills that you don't have internally, is absolutely critical to being able to build and grow a profitable and sustainable business. In these days of Airtasker and Upwork, expert services are readily available and affordable to any business, regardless of size. When Em and I started Your CEO Mentor, if we didn't have the ability to tap into expert legal, accounting, HR, digital advertising, and graphic design skills, we wouldn't have been able to grow the way we had.

THE PROBLEM WITH BILLABLE HOURS FOR SERVICE PROVIDERS

Let's just quickly whip through the issues with this billable hours model from the service provider's perspective. Number one 

1. Rewards follow billable hours as this relates directly to utilisation and profitability

Financial rewards and promotions tend to float towards the hardworking high billers. Because of this, many companies are inclined to tolerate all sorts of bad behaviour by the people who actually bill the most. But billing volume is not necessarily a good proxy for leadership capability, so you can tend to get an absence of leadership at the top. The question as to whether or not this is any different to any other firm is debatable.

2. You can tend to be very activity focused 

What gets measured gets managed and what gets rewarded gets done. When you're rewarded for activity, that's exactly what you're going to pursue, and it doesn't necessarily provide value to a client. At the end of any engagement, a client may feel satisfied with the outcomes or they may not, but they're unlikely to tell you because they don't make it public - they’re just unlikely to hire you again. I’ve got to tell you, there are times in my past where I felt weirdly violated having spent company money only to get a bunch of non-value-adding activity.

3. Leaders find it difficult to work at level

Now, it may not be any more-so than any other technically based business, but being drawn into the detail of client contracts, engagement and negotiations happens all the way to partner level in many firms.

4. Short term profit often outweighs customer satisfaction

Once again, no big surprise, but this can drive some really interesting issues in long term sustainability of relationships, and long term value. 

The $64,000 question is, can these problems be mitigated or overcome while still recognising the necessity for focusing on the things that makes these companies grow and survive - billable hours?

GETTING BETTER OUTCOMES IN THE BILLABLE HOURS MODEL

What can we do to change the dynamics of billable hours firms to get better outcomes? Well, let's face it, you can't escape the fundamental dynamics of the business model. Time-for-effort is a well worn path that dominates many sectors. Whether you're a client or a service provider, there are a couple of key focal points that will help you to maximise the opportunities that these engagements present. 

The number one thing for a service provider is to ensure the focus on long term relationships and customer value is emphasised, despite the short term pressures.

The very best service engagements that I oversaw were the ones where the principals of the firm took time to really dig down on what would create the most value for me, and for my business. Now, in fact, on many occasions, they didn't even try to sell me anything for the first six months or more as they built a relationship that enabled them to better understand my pain points. To keep the long term focus, you need to put the metrics in place that give you a window into this: 

• What are the long term drivers of value?

• Would a customer engage you for a service that is tangential to your core service delivery? That opens up the possibility of growth through product development.

• Would a customer recommend you to other business units in their organisation that you haven't yet had access to? For example, a successful engagement in a client's New York office might lead to a new engagement in their Chicago office where you haven't worked before.

• Of course, there's the good old Net Promoter Score. Would your client recommend you to other professional contacts in either a solicited or an unsolicited manner?

The number one thing for a client firm engaging a service provider is to ensure a focus on value delivery and outcomes rather than activity - however you can achieve that. 

The really high-end consulting firms have come up with value based approach that takes this to the next level. They use an overall fixed price pitch factoring in every cost and risk focused on a very clear, high value outcome. Now, as a diligent manager, if you would look at some of these proposals through the lens of daily rates for time spent - the billable hours thing - there's no way you would even consider pursuing one of these engagements. On paper, it just looks ridiculously overpriced. However, if you can look past this, you might see an opportunity to acquire skills, capabilities, experience, smarts, and know-how that your company doesn't possess, and is unlikely to ever possess. It can really be worth it.

If I asked you to spend five million dollars to have a small consulting team come in and work with you for six months, what would you say? Hell no! But what if you knew that this engagement, if successful, could save your company one billion dollars in capital investment? Well, of course you’d take that up every day and twice on Sundays. Even if you apply the optimism bias discount, and you thought you might only capture a small percentage of that billion dollars, say a hundred million, would it still be value for money? Well, absolutely! The opportunity to spend five million dollars to save a hundred million dollars -  well, that's unbelievable value for money. But first you have to have the five million dollars to spend and you have to have the one billion dollar opportunity to chase. Now, I must say, this is the ideal way to work in the billable hours environment. Many of these firms would argue that this isn't really a billable hours model at all - and they may be right - but it is the peak evolution of the gun-for-hire consulting model that drives many industries.

I've only ever worked as a client on these types of engagements, but it enabled me to learn a huge amount about value capture, and how to make systemic changes sustainable so that the value doesn't dissipate over time. Not every company can afford the ante to engage the top-end-of-town consultants. And those that do, often fall into the trap of feeling like it's just monopoly money. The price tag can be eye-watering! So, if you ever engage a consulting firm in this manner, you have to have a mindset where you treat the money as your own and become single-mindedly focused on ensuring the value delivery is tracked, measured and verified.

We've covered an awful lot of ground in this episode. The benefits of flexibility and access to capabilities that you don't have are obvious in the billable hours world - otherwise, the business model wouldn't have endured so successfully over the decades. But if you really want to make sure any service provider engagement delivers value, think carefully about how some of the issues and opportunities might apply in your context. If you're a service provider, don't just think about the monthly billable, make sure the client will still be there to bill in one, two, ten years from now. That's how to really grow a sustainable bill of hours practise.

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