by Adam Juda on Monday, September 21, 2015
It's become very fashionable for consultants to claim that hourly pricing makes no sense. They say that it misaligns the incentives between service provider and client. These constant attacks on hourly pricing need to stop. Hourly pricing is not evil. It's not morally wrong. It should not be stopped. It is merely one method of charging a customer that may or may not be appropriate for a given type of work.
I agree that, for some businesses, it makes more sense to charge for value delivered rather than hours worked. But for many others, piece work pricing or hourly billing makes far more sense.
As I noted earlier, the most popular argument against hourly billing is that it misaligns incentives. I agree that this can be a significant problem. When I get paid by the hour to complete a task, I have a very strong incentive to work slowly. The longer I take to complete my assignment, the more money I earn from my customer. Unfortunately, there is no billing methodology on earth that doesn't misalign incentives in some way.
When a contract specifies fixed price billing, workers are incentivized to cut corners on quality. Why should they expend resources to improve a product when they won't earn additional compensation for their troubles? Even piece work billing can create perverse incentives. The aptly named cobra effect refers to an infamous British plan to decimate the cobra population in India. The government offered a bounty for each snake killed by the local populace. The result? Snake populations went up as locals began breeding them to earn greater and greater bounties. Clearly, a misalignment of incentives had occurred.
The problems with value pricing don't end there. While hourly pricing is simple for even the least educated among us to figure out, value pricing can be very challenging even for those with a grounding in business and economics. Value pricing not only requires significant information about the buyer, it also requires significant quantities of time and the ability to analyze and interpret relevant data. For many workers who perform small tasks, the expense of coming up with a suitable value-based price far outweighs the additional earnings that could arise from the use of fixed price billing.
Furthermore, many workers have significantly less pricing power than those who employ them. As such, these producers are unable to dictate how much they should be paid for their labor, much less the appropriate billing methodology. I could stand outside of a McDonald's or an ExxonMobil station, instructing the business that I would only man its registers for a fixed fee. Do you know what would happen? Nothing - if I were lucky. More likely the police would arrest me for creating a public nuisance. In any case, I can guarantee that neither business would pay any attention to my demands.
Value pricing doesn't always make sense in the real world. Don't believe those who tell you that hourly pricing is an evil blight upon humanity. The truth is that different pricing strategies are appropriate in different situations. Sometimes you just need to ask an expert to discover which is most appropriate.