Art of Accounting: Where Time-Based Fees Were Not Equitable
IMGCAP(1)]Equitable is not the same as equivalent.
I use the word “equitable” since I have charged three completely different fees for the same result. “Equitable” refers to the value delivered and charged to the client.
One time a compensation plan project was requested by a client for his soon-to-be-hired CEO. I spent considerable time developing and refining the package and billed the client $12,000 based on the time incurred at my rate.
Immediately after completing that project, a second client asked me to do almost the exact same project. I adapted what I did and charged $6,000 based on the time. And just after that, a third client requested the same consultation and the time came to $1,500, which I billed. All three received the same lengthy and thoughtful memorandum.
Question: Did I charge the right fee to each client? The third client got something for $1,500 for which someone else paid $12,000.
This occurred many years ago, before the “science” of value or fixed-fee pricing was developed. Soon afterwards I had some time to reflect and discuss this with my partners. We figured there were three alternative pricing methods we could have used:
1. What we did;
2. Provide a fixed fee before we started based upon a discussion with the client of the value to them and the efforts we would expend, plus the value added by our experience;
3. Provide a bill when we were finished based on what we thought we could get.
One of the constraints we had at that time was our fee arrangement with those three clients. Each one was billed based on our time charges. That being so, method 1 was the only way to do it, irrespective of the value added or what the price would be had we started from scratch for each client (which was impossible once we completed the first assignment). The billing model and rates somewhat took into account our experience and expertise.
A rationale of this method is that while the third client got a bargain, there would be enough work over the years with each client where this would all balance out. It seemed right to assume that on some other project they would be the first to request it, with the other clients realizing the benefit.
If you group each client’s fees over an extended period, say three or five years, this would work out just fine. The reality is that everything we do beyond the basic services draws on our experience, which was garnered from clients paying the full-time charges at some point.
Method 2 creates a conundrum in that it was not known how much time would be spent, where our research and work would take us, how the results would benefit the client and the perceived value to the client. As it turned out, our recommendations were much more far-reaching than could ever be anticipated, the work more extensive, and a model for a complete package was developed that could also be applied by the client to other executive-level hires.
In retrospect, I feel the time-based method was the only practical way to bill the first project, while a fixed fee determined in advance would be the better way for future application of this specialized knowledge. I could see arguments made that we “charged” the first client for our education. I don’t buy this since, even though we worked in uncharted areas, our experience was applied to the process, and our creativity was drawn upon, as was our knowledge of the client’s situation and the goals he was trying to achieve.
The first fee was the right fee, and since it was a new endeavor, no consideration, bonus or discount was applied to recognize the value (or, ugh, lack of value) to the client. Both we and the client benefited and received offsetting value in this situation. That seemed fair to me.
I think method 3 is an invitation for dissention from the client. Regardless of the fee, it is likely to be greater than the client thought it would be. The basis for the fee would seem subjective (which it would be), and I believe clients resent professionals justifying value after the fact on what the clients perceive as services consistent with an ongoing fee arrangement.
To close this discussion, I generally feel that in new ground, it is hard to define the project’s scope even when the end goal is clearly stated. The value is also undefined. In cases such as this, it is a vague concept. Only when it is completed is the value appreciated or understood.
In uncharted areas, when you provide a time-based fee, and the client trusts your judgment and ability, it becomes a go. With a fixed fee, it becomes an unknown shot in the dark, leaving questions about the point at which the work would exceed the agreed-upon scope and price adjustments are in order.
Edward Mendlowitz, CPA, is partner emeritus at WithumSmith+Brown, PC, CPAs. He is the author of 24 books, including “How to Review Tax Returns,” co-written with Andrew D. Mendlowitz published by www.CPATrendlines.com and “Managing Your Tax Season, Third Edition” published by the AICPA. Ed also writes a twice-a-week blog addressing issues that clients have at www.partners-network.com. Art of Accounting is a continuing series where Ed shares autobiographical experiences with tips that he hopes can be adopted by his colleagues. Ed welcomes practice management questions and can be reached at (732) 964-9329 or email@example.com.