Justin Roff-Marsh once wrote about the inefficiencies and value-destruction of time-and-materials billing. He recommends that companies avoid pricing their product based on a calculation of minutes worked. Instead, he proposes that we price according the value we deliver to the customer.
Companies that use time-and-materials billing will find this argument difficult to accept, so let’s look at the dilemma more closely.
People sell their products on a time and materials basis in order to protect themselves from the risk of uncertain project times. They are concerned that they cannot estimate the size of the project or that the project requirements will change. They believe they must protect themselves from these risks in order for their company to grow and be profitable.
On the other hand, Roff-Marsh recommends that companies sell their products on a project or job basis. He says they must sell this way in order to increase their project throughput and to lower their operating expenses. He believes a pricing model that emphasizes an increase in throughput and lower operating expenses is a prerequisite for a company to grow and be profitable.
Both approaches share a common goal: to help the company to grow and be profitable. But the methods they use are in direct conflict. A company cannot sell the same project on a time-and-materials basis and on a project basis.
Is it possible to resolve this dilemma, to protect ourselves from project risk and simultaneously increase throughput and lower our operating expenses?
Let’s look at the assumptions behind each side of this conflict and see if we can find any that can be called into question. If there are some incorrect assumptions, we may be able to resolve the dilemma.
First let’s look at the assumptions behind the need to manage our risk. We need to protect ourselves from project risk because:
- The nature of our work is such that we can’t predict how long a project will take. Therefore we cannot estimate the price of our product (the project).
- Neither we nor our customers are willing to take the risk of this uncertainty with a fixed project.
- We need to make a profit on each project.
- Every person needs to meet their billable hours goals.
- We will calculate the price of our product by counting the number of minutes to produce it.
On the other hand, we need to increase project throughput and lower operating expenses because:
- We will price projects based on the value they bring to the client and how much the market will pay, not on our costs or our labor hours.
- We will look for alternatives to time as a proxy for value (transactions, lines of code, words).
- Wherever possible we want to delegate work from expensive employees to less expensive employees.
- We want teams of people to do projects and to encourage relay-race behavior where people sprint to hand off work to the next person.
- We want to make money on our portfolio of projects. We are willing to risk that some projects will make less, some will make more. We will get better and better and estimating and bringing value to our clients.
Now let’s see if we can challenge some of the time-and-materials assumptions.
- Instead of selling the entire project on a time-and-materials basis, can we break the project down into smaller sub-projects? Then we could sell these smaller chunks on a project basis instead of time-and-materials.
- Instead of counting work by the minute, Roff-Marsh suggests that we use no shorter time increment than a half-day. Or use something besides time (like transactions).
- Instead of focusing on making a profit on every project, look for ways to make a profit on our portfolio of projects. We will make more profit on some projects and less (or even negative) profits on others. But we’ll get better and better at pricing and selling project value.
All three of these changes reduce the risk of selling projects. We sell smaller projects (easier to estimate), we use longer time increments, and we spread profit risk across our portfolio of projects.
These changes also make it possible to meet the need to improve throughput and lower operational expenses.
Since we are focused on doing projects as quickly as possible, there is more incentive to spread more of the work from expensive people (like partners) to less expensive people, which lowers the operating expense.
If we spread the work to more people, then we can organize the project like a relay where people hand off their work. This speeds the work as a person waits for the handoff, sprints to do their portion, and hands it off to the next person. Quick handoffs improve throughput.
Roff-Marsh concludes his article by encouraging us to behave more like a Formula 1 pit crew:
You don’t make money by keeping your team busy. You make money by delivering jobs. And the two are NOT the same thing. People work best in fits and starts. And team work necessitates relay-racer behavior (person B hovers, waiting for person A to finish his work – and then sprints to hand-off the job to person C).
You need to mobilize your team to get jobs out. Think of the pit crew in a Formula 1 team. Timesheets are not conducive to this environment.