“Once you understand that customers do not buy hours, you understand that pricing by the hour doesn’t make sense” – heavily paraphrased from “Burying the Billable Hour” by Ronald J. Baker, July 2001
It’s no secret: we aren’t fond of the Billable Hours Model at PA Almanac.
Up until now, we’ve mostly been throwing stones from our glass house. It’s time to propose improvements and open our ideas up to critique.
Some of our thoughts are heavily influenced by Ronald J. Baker’s musings. We recommend a thorough reading if you care at all about pricing strategy for professional services. You probably don’t care, but trust me, there’s dozens of us. The rest of our ideas come from living in the system, day dreaming about its dissolution as the clock laboriously ticks and our inboxes steadily accrue more and more unread EY Checkpoint emails.
That got a little dark. Let’s instead imagine a world in which the billable hours model is permanently banned. What would accounting firms turn to when they needed to track revenue, measure employee efficiency, and determine pricing for their services? If the crutch of relying on SALY is removed, how would accounting firms adapt?
First, the rubric for grading alternatives:
- The proposal must improve on the three main axes served by the billable hours model:
- Internal accounting (includes revenue projection, project management, measures of firm efficiency, etc.)
- Evaluating employee performance
- Pricing strategy
- The proposal can be reasonably implemented (i.e. it’s neither ruinously expensive nor exceedingly complex)
- The proposal must not expose the firm to any undue risks (i.e. your firm’s lawyers, lenders, and insurance providers must approve)
When judging by these criteria, there is but one solution.
The Best Option, The One We Should Choose, All Other Alternatives Are Inferior
We call this approach the Client Service Model because that’s what all accountants claim to care about. It’s what they should care about. Clients pay the bills. Since accounting firms get nearly all of their revenue from client service, the business should be structured to make providing client service as easy as possible, and to make it as easy as possible for clients to pay the firm.
This all sounds like common sense, but believe us when we say that accountants frequently make some miserable business decisions based only on tradition.
The Client Relationship and Pricing Strategy
To start, we change how we approach our client relationships. Clients sign contracts with the entire firm, not the service line (though an engagement letter for each service may be necessary for insurance reasons), in a “subscription adjacent” model. Ideally, the firm and client agree to use a retainer model, where clients pay a monthly fee to the firm. For the firm, this stabilizes cash flow and standardizes billing. It also reduces reliance on timesheets to project revenue and reduces the time spent managing unique billing arrangements. For the client, this provides an expectation that the contracted services will be delivered on time. It also implies that any other services that can be provided by the firm will first run through the retainer, up to a certain amount. It encourages the client to reach out whenever they have questions or problems because they’re paying for the services anyway. This makes follow-on sales easier for the accounting firm.
Certain clients will balk at a retainer model. The beauty of the Client Service Model is that any fixed fee engagement can be structured in a similar way. Let’s look at a basic example:
- New client Acme, Inc. contracted our firm to perform a tax planning study for $50,000.
- Acme, Inc. only needs us to perform the tax planning study; they don’t want any other services.
- They want the study done in 8 weeks.
Under the Client Service Model, we would structure the engagement so that we invoice Acme, Inc. for $25,000 on the first of the month for the two months following the signing of the EL. This way, Acme, Inc. knows when the invoice will arrive, and how much it will cost. Our firm batch invoices all of its clients each month, so we don’t have to devote time outside those 2-3 days on billing matters.
We can feel the engagement managers internally panicking now. “What if my client can’t pay every month?” or “What about time and expense engagements?” or “What if my client is going through bankruptcy proceedings?” To which:
- Then structure it so you invoice them at the first of every other month or every quarter. Changing the standard frequency adds complexity, but as long as billing is done on a regular cadence with a batch of other invoices, we’ve still improved our billing arrangement.
- Eliminate or restructure time and expense engagements whenever possible. Yes, there will be engagements like audit defense where the timeline and outcome are uncertain, but can those not be structured like a retainer model? If you’ve performed some audit defense work in the past, you probably have a rough idea of the effort and time involved. Price your services accordingly, rather than forcing your team to track each hour contributed to the defense. This can be as easy as having your engagement letter read “we will perform all standard audit defense services for $50,000 per year, billed monthly.” Remember, clients don’t buy hours of your time, they buy services. You can’t lose money by invoicing your client, you can just be paid less than your value. So pick a price that is commensurate with the value you’re providing.
- There are some instances, like when a client is going through bankruptcy proceedings, where you have to fastidiously track the time spent working for that client. There’s no way around it. But that doesn’t mean you have to price all of your services based on time spent. Get comfortable with separating how you make money (invoicing clients) from how you manage money (timesheets, for now).
Speaking of…
Abolishing the Timesheet
This is uncharted territory for the majority of public accounting firms. Timesheets have been a staple of the industry since the 1970s, with multiple generations of partners diligently recording their billable hours day after day, week after week, year after year. It’s such a core part of the public accounting experience that many accountants can’t fathom the business working without time tracking. Seriously, ask your managing partner how they would run the business if they couldn’t use timesheets. You’ll probably witness their brains short circuit in real time.
But remember, we made the Billable Hours Model illegal for this thought exercise! We can no longer rely on the same tired operating model from the 1970s. We must adapt. So what do we do with timesheets?
We abolish them. Not all at once, and not without finding an appropriate substitute. But if we recognize that 1. Our clients are buying services, not hours; and 2. We bill our clients based on the value of our services, not the time spent performing them; and 3. Timesheets invariably lead to really shaky measures of employee performance, then timesheets no longer serve a purpose in our accounting firm.
How we phase them out and what replaces them are more complex questions, but both can be answered by identifying what timesheets intend to accomplish for the public accounting firm. This includes:
- Tracking the progress of an engagement;
- Creating and measuring data related to revenue recognition and other internal accounting functions; and
- Providing a means to measure employee productivity.
When you distill timesheets down to their core functions, you recognize that there are plenty of options to satisfy these roles. Timesheets are just a poor but convenient way to achieve them. If you were to start an accounting firm from scratch with no concept of how your competitors run their businesses, we feel confident you would never conceive of timesheets as a solution for your practice. Timesheets require cumbersome software, are loathsome to employees, and—if you price your services properly—do nothing to make or save your business money. What replaces them? If only accountants had access to a diverse swath of businesses from which to draw ideas on how to manage these tasks…
Tracking Engagement Progress
This is the simplest timesheet function to phase out. Your managers probably have multiple tools for tracking engagements and most of them don’t rely on timesheets. Small, nimble accounting teams with short-fuse engagements like valuation work can track their engagements’ progress with emails and an Excel spreadsheet on a shared drive. Large accounting teams with lengthy, complex projects like audits can rely on the software they already have to track these engagements, like Workflow or Engagement or whatever proprietary solution EY cooked up in their Workshop of Horrors.
Accountants may think timesheets are necessary to track engagement progress because they measure work in progress (“WIP”), but WIP is meaningless if we aren’t charging clients by the hour. Remember, with the Client Service Model, we are getting paid the same amount whether we spend 100 hours on the engagement or 1,000. Instead, public accounting firms can do what every other organization in the world does: have a dedicated project manager whose job is to monitor engagement progress and keep things on track. How they accomplish this is open for debate, but timesheets should not be a tool in their toolbox. Timesheets don’t measure progress towards a goal, they simply measure how much time someone says they spent doing something.
Internal Accounting
Timesheets also inform internal accounting, including revenue recognition. Revenue recognition is particularly important because it’s used to determine partners’ distributions on a monthly, quarterly, or annual basis. It’s also useful for forecasting, which can inform hiring and firing decisions, portfolio mix, and employee bonus amounts. Of the timesheet’s core functions, this is the most important. It actually impacts the firm’s decision-making and its workers’ paychecks.
Still, other companies—including those that your public accounting firm serves—have to recognize revenue and make forecasts. They manage to do that without requiring their employees to record time spent making Widget A versus Widget B. With a little bit of effort, public accounting firms can share in these arcane gifts.
We’re not so bold as to suggest that PA firms suddenly switch over to cash accounting. We’ll stick with accrual accounting, and just tweak how we accrue revenue from engagements. For short or small projects, you recognize the revenue when you deliver the service. For lengthy or large projects, you recognize revenue as you invoice the client. For a $60,000 project that you will complete over the next year, you’ll recognize $5,000 in revenue each month when you send the client an invoice. This process is consistent regardless of whether your client is on retainer or a fixed fee engagement.
As for forecasts, partner distributions, employee bonuses, and the rest, the process is unchanged: you rely on your internal accounting to inform all of these decisions. Now your internal accounting runs on your monthly invoicing process instead of your timesheet data and WIP. This makes way more sense for your business because—say it with us now—your clients are paying for services, not hours. Your internal accounting is aligned with your revenue stream, which is aligned with your billing, which is aligned with your customers’ expectations.
Measuring Employee Performance
We’ve beaten this poor horse to death already. Instead of rehashing why timesheets invariably lead to utilization becoming a Key Performance Indicator (“KPI”) and why utilization is a terrible, horrible, no-good, very bad KPI, we propose an alternative way to measure employee performance.
First, employee performance measures must accomplish two things:
- They should strongly correlate with (and ideally be directly related to) employee effectiveness; and
- They should strongly correlate with (and ideally be directly related to) how the firm makes money.
In short, the KPI should provide favorable scores for employees who are effective at their jobs and effective at making the firm money. Utilization is somewhat effective at the first part (good employees typically get put on more projects and therefore charge more hours, and vice versa) but bombs at the second (clients don’t buy hours).
Client Surveys and NPS
Instead, accounting firms can rely on client surveys and Bain’s brainchild Net Promoter Score (“NPS”). Put simply, the NPS is a rating from 1-10 that answers the question “How likely are you to recommend this accounting firm/service/employee to your friends and colleagues?” An NPS score of 10 means “I am literally tripping over myself to recommend this accounting firm to everyone I know,” and a score of 1 means “I would only recommend this accounting firm to my competitors out of spite.”
Why do client surveys and net promoter scores make sense for measuring employee performance? Because clients pay the bills. If they like you so much that they’re willing to recommend you to their friends, they’re probably going to want your services again. And if they want your services again, you get paid more. It’s a virtuous cycle.
Better still, client surveys allow you to keep in regular contact with your clients. Clients of accounting firms generally enjoy regular contact. It makes them feel special. Plus, clients can help identify good employees for you. If a client likes your tax manager so much that they specifically call them out for great communication in a survey, you can feel confident that your tax manager is effective at their job and at making the firm money. The people that bought your services specifically said so!
Each client survey has an overall NPS, which would apply to each person that worked on that engagement. The client can also elect to fill out surveys for individual employees. As your employees work on more engagements, they will develop an individual NPS, which can be used as a rough quantitative measure of their performance.
For associates and new employees, qualitative performance reviews from managers and partners are probably sufficient. NPS ratings for newer employees may swing wildly due to sample size variance, so it’s best to take those scores with a grain of salt. The managers who regularly work with new and junior employees typically have a solid understanding of whether an employee is doing well or struggling. If you’re the type of firm that prefers some quantitative metrics to measure employees, you can still consider the new employees’ net promoter scores, but they should have a low weight relative to qualitative measures.
On-time Delivery Scores
The second metric public accounting firms can add to measure employee performance is an on-time delivery score. This is a team metric, as individuals (usually) shouldn’t be punished for a poorly managed project.
Put simply, practice leaders create simple timelines for each of their major service offerings to determine a reasonable amount of time required to complete the service. For instance, the tax partner would expect the average amount of time to complete a tax planning project is 6-8 weeks; year-end tax forms should take 4-6 weeks; and quarterly adjustments should take 1-2 weeks. These ranges can vary based on client size, client complexity, accounting team size, and a number of other variables. The point is to make achievable and reasonable targets so that the team meets or exceeds client expectations on when a project should be complete. Everyone on the team gets the same score, encouraging teammates to hold each other accountable for workflow.
When we compare on-time delivery scores to our employee measurement requirements, we see it passes both tests. Teams that regularly achieve early or on-time delivery scores are most likely effective. It takes an experienced, organized team to reliably collect the necessary data, process and analyze it, and produce a final deliverable in a reasonable time. And teams that regularly achieve early or on-time delivery scores most likely help make the firm money. Clients appreciate receiving deliverables on time, and are more likely to buy additional services if their first experience went smoothly.
One caveat: we all have those clients that are simply incapable of providing data on time or responding to an email within 128 hours. These clients should be identified early so the on-time delivery score for their engagement can be nullified before it impacts the team’s scores. Practice leaders can have a simple toggle to remove an engagement from the calculation. Is it possible to abuse this toggle? Sure, but that’s true of any metric. Just make sure there’s documentation to support removing a metric from the engagement.
How and When to Abolish the Timesheet
While it would undoubtedly be a boon to employee morale, abolishing the timesheet without planning for its replacement would be shortsighted. We propose the following steps over the course of 1-2 years in order to make the transition go smoothly for everyone:
- Quietly stop measuring utilization. There needn’t be an announcement, or a memo, or an unsubstantiated rumor. Just discretely inform firm leaders that utilization will no longer be a KPI. Employees will continue filling out their timesheets as normal, allowing firm leadership time to get comfortable with the idea of decoupling from that model. Ideally, leaders can spend 2-3 quarters learning how the eventual elimination of timesheets will impact forecasting and distributions. This is better when they can see side-by-side comparisons of how the two systems behave with same-period data.
- Add in client surveys. Many firms already send client surveys after engagements. Tell your clients in advance that they can expect surveys and that the firm greatly values their input. If you’re really struggling to get clients to complete the surveys, you can offer discounts to engagements for their completion. The goal is to have a significant sample size of client surveys to work with when you start step 3.
- Announce NPS will be replacing utilization as a performance metric. By this time, firm leaders should be comfortable with ignoring utilization. They should also have experience collecting and interpreting client surveys with net promoter scores. Employees will have questions about the KPI shift, so leaders should be prepared to address them in a positive way.
- If your firm is well-organized and your leaders are feeling spunky, you can eliminate timesheets entirely at this point. Convincing employees to embrace client surveys, NPS, and on-time delivery metrics will be easier if you also offer the carrot of removing timesheets from the equation entirely. If your firm is more traditional, consider waiting until after step 5 to remove timesheets.
- Start measuring on-time delivery scores by team. Like with the other changes, this will first be done discretely by leadership. Practice leaders should establish metrics for what exceptional, average, and below-average timelines will be by practice line, and then test these initial targets’ reasonability with actual data. Once they have a large enough sample size, they can finalize the target ranges.
- Announce and formally implement the new employee performance measurement system, which includes qualitative feedback from immediate managers and client surveys, and quantitative feedback from clients via NPS and practice leaders via on-time delivery scores.
- Commit to never using timesheets again.*
*Unless you’re performing work which specifically requires it, as with clients in bankruptcy proceedings. In which case, employees will only record time spent on the specific engagement requiring time tracking.
Summary
Tell us how wrong we are in the comments. Tell us about the virtues of the Billable Hours Model that we overlooked or maliciously ignored. Tell us how difficult implementing the Client Service Model would be at a real firm. Tell us how it won’t work at your firm for X, Y, and Z reasons. We love discussing these thoughts. Even if you reject 98% of the ideas above, at least we’re talking about improving on the prevailing business model.
We recognize that the Client Service Model is incomplete. Currently, we believe it’s a better way of structuring most professional services firms. The interests of the owners, employees, and clients are aligned. You focus on the things that matter (delivering great client service!) so you can price your services as a luxury rather than a commodity. Your clients, if pleased, will passively assist your sales efforts, either by purchasing more services or telling their peers. And man, wouldn’t it be nice if we never did another timesheet again? Ever?