For many SMEs in the business and professional services (BPS) sector, fees are built based on billable hours. But changing customer demands and a desire for more income certainty, is accelerating a move toward alternative billing structures.
The latest Capify SME business confidence survey of Q1 2023 has revealed that 44% of Business and Professional Services companies were concerned about securing new customers. This compares to an all-sector average of 40%. But with this desire to win new work, SMEs in the BPS sector may have to rethink how their current charging models work.
A recent report by Lexis Nexis, for example, found that a growing number of legal firms are moving away from the billable hours model – driven by changing customer demands and BPS firms’ desire for known costs and revenue.
And this is true in other business types within the BPS sector. As customer demands change – sharpened by growing cost-consciousness – accountants and architects, for example, are finding that customers are demanding services on a fixed cost basis.
At a business-to-business level, meanwhile, clients are increasingly demanding that RFP processes are run on an easily comparable, like-for-like basis. Accordingly, firms that charge on a billable hours arrangement are struggling to compete.
Transitioning from an existing billable hours model does not come without some significant hurdles to overcome, however. Firms considering moving away from billable hours need to carefully consider their pricing strategy and reconsider how they manage capacity.
Getting the price right
Stephen Denyer, director of strategic relationships at the Law Society said: ‘You can’t just conjure up prices off the top of your head – there’s got to be some real science where you can demonstrate…how you’ve calculated the fee.’
This is important to ensure that the fee attached to any work returns profit on the amount of time incurred in delivering the service. Recognising how much staff time is likely to be involved in delivering a project is also helpful in understanding the capacity of your business to deliver new revenue-generating work.
In modern working operations, there are many roles that may lend themselves to being fulfilled by a remote worker or contractor. Depending on the sector you operate in, there will be specific positions that may be suitable to talent who doesn’t need to be tied to an office. Some of the central functions that naturally lend themselves to remote or even overseas workers might include design and web development, social media management and certain admin support and finance roles.
Incentivising efficiency
One of the principle benefits of moving away from billable hours is that it incentivises the firm and its employees to complete their work within the budgeted hours allocated to the work. It changes the commercial dynamic from one that rewards input, to one that rewards output. The downside of this, of course, is that if a project over-runs or is more complicated than anticipated, the firm may have to absorb the cost.
Funding the models
Historically, a BPS firms’ ability to generate revenues may have been limited by the amount of work it can finance – in other words, by the amount of capital attached to unbilled work-in-progress and in fees that have been billed but not paid. This ‘locked capital’ may impact a firm’s ability to scale unless it can access profit reserves or access external finance.
A further complication of the billable hours model comes from contested fees and client negotiations which impact the amount firms reclaimed from the work – sometimes called the ‘recovery rate’. These challenges can often affect a firm’s cash flow position and overall profit level.
It is important to remember though that alternative billing arrangements do not suit all work. A significant project with a multitude of unknown variables might be better costed on a rolling, billable hours basis, to protect your firm from over-exposure. Whether you are serving businesses or customers direct, though, it is clear that buyers are seeking more cost-certainty. Whilst, for firms, new pricing models can help with more robust revenue and profitability forecasting.
Making a transition to any new pricing and capacity model is likely to require an investment in new systems and processes. There may also be an impact on your cash flow as you move to a project-completion invoicing schedule.
At Capify we offer a range of business loans to help support small businesses throughout their growth journey. Check to see if you’re eligible for one of our loans with our online eligibility checker. Or, if you’d prefer to talk to a member of our team, we’d be happy to guide you through the process. Give us a call today on 0800 151 0980.
