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Okay, perhaps evil is a bit of an exaggeration, but whenever I encounter an environment where time is tracked and billed, I see tremendous inefficiencies and value-destruction.

Let’s consider why.

Imagine you have something to sell – a widget, say. Tell me, for how much should you sell it?

The answer to that question is more obvious than you think. To calculate the optimal sale price you don’t need to know:

  1. Raw material cost
  2. Labor hours
  3. Overhead allocation ratios

You don’t need to know any of that because the answer is: you should sell that widget for as much as you can get!

That’s right, the optimal sale price is not determined by internal factors, it’s determined solely by what the market is prepared to bear. You cannot – let me say it again, CANNOT – calculate the price of a product.

All you can do it estimate it. And you must recognize that, in most situations (certainly in those environments where we’re most likely to see T&M billing) it’s simply impossible to estimate the the price with a high degree of accuracy.

The primary assumption behind time-and-material billing (T&M) is that you can calculate the price of something by simply counting the number of minutes required to produce it.

But you can’t. Effort does not equal value. In many cases, it doesn’t even approximate it!

One of the problems with time is that it’s inherently measurable. Because it can be counted in intervals as small as a minute, we’re lulled into the false impression that we are calculating (as opposed to estimating) value.

The alternative

How then should we estimate value? And how should we track productivity?

If we use time to estimate, it’s important to recognize that we’re using time as a proxy (a yardstick) for value.  Time does not equal value.

My advice, where time is concerned, is not to estimate time in increments any smaller than half a day. In other words, do not ask, how many hours will this job take?, ask how many half days?

Where short-duration tasks are concerned, my preference is to ignore them altogether. Just factor them into the multiplier you are using for half-day slots!

I’d rather, however, that you find some other proxy for value. We’re working with a bookkeeping firm currently. When I challenged them to identify a better proxy for value than time they came up with a great one – transactions (debits and credits). It’s obvious that the volume of transactions processed is a greater determinate of client value than time consumed.

And how do we track productivity? Well, we start by burning timesheets!

You DO NOT make money out of expending effort. You make money out of delivering value. And the connection (in most cases) between these two factors is very tenuous.

Timesheets encourage team members to be busy. This drives multitasking, and the hogging of work that could otherwise be passed-off to lower-paid people. Both destroy value. Furthermore the maintenance of time-tracking systems, consumes enormous resources and the completion of timesheets insults your team members at 10-minute intervals.

You need to recognize that individual jobs (or projects) do not make you money. Your portfolio of work makes you money. Once you realize this, you can focus on managing the portfolio, rather than the jobs.

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.

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Home Forums The evil of time-and-material billing

This topic contains 14 replies, has 2 voices, and was last updated by  Silvio 3 years, 5 months ago.

Viewing 14 posts - 1 through 14 (of 14 total)
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  • #2271 Reply

    @consultski

    Once again Justin, you have struck a blow for common sense in the sales silo… by smacking the cost-world minded executives up along side their pointy little heads! Perhaps the comic strip Dilbert does it with more humor, but make no mistake, you both deliver a powerful message. Let those that have ears, hear!

    #2272 Reply

    Dick Melrose

    In this context the disciplines of Value Innovation (Kim & Mauborgne) complement TOC-thinking rather nicely.

    Justin, in most places where you use the word “value”, I would suggest substituting “buyer utility”, instead.

    Value, per se, references price. Beliefs about value (“preiswert”, “worth the price”, “good deal”, etc.) involve perceived surpluses (deficits) of buyer utility in relation to prices paid. ‘Buyer utility’ has many possible dimensions associated with the customer experience and, likewise, ‘price paid’ includes more than just the “purchase money” – e.g. ease of doing business, up time, after-sale service levels, social costs, etc., etc. The amount by which all-in buyer utility exceeds all-in price paid corresponds to the value from the buyer’s perspective.

    My semantic recommendation doesn’t change the fact that adding seller’s time cannot increase buyer utility. And since adding seller’s time will not likely lead to a price reduction, then adding seller’s time cannot add value.

    #2273 Reply

    Dick Melrose

    W. Chan Kim and Renée Mauborgne suggest that the recipe for success requires: delivering unprecedented utility, to a mass of buyers, at an accessible price and with a profitable business model. That’s like a Mafia offer on steroids. That recipe for success redefines and refines the “as much as you can get”-price objective and does so in a manner that is clearly focused on Throughput. The right productivity measure remains T/OE.

    We have common phrases that include “time well spent” and “waste of time” and, since it’s often hard to tell the difference, before the fact (sometimes even after the fact), we should certainly avoid using recorded time as a surrogate for buyer utility. Think about time spent at the checkout counter to make a purchase – i.e. the shorter the duration, the better.

    #2274 Reply

    Dick. You are right. ‘Utility’ is more correct. Value is the relationship between price and utility. Or, more correctly, the utility of product A, relative to the utility of the universe of alternative purchases,

    #2275 Reply

    Rajeev

    Hello Justin,

    Thanks for the great article.

    I am curious to know how you would determine the price in Software Outsourcing industry. Let me explain the scenario. Generally, the software related work is outsourced (say from US to India) in two ways – Fixed price for a specified work or Time and Material basis. Many times, the work is related to software maintenance, bug fix, small enhancements etc. At times there are development projects also.

    If it is fixed price contract, many times, the price is determined by the bidding process and typically the vendors calculate their price by estimating the man-days required. Generally, new development work is outsourced with a fixed price.

    For Time and material contracts, the client asks for a specified number of developers, analysts, project managers etc. and the price is negotiated for various skills. In case, the vendor does not put in the agreed number of people for a period of time, the proportionate amount of money is deducted. Generally, Maintenance, bug-fix etc. is outsourced on T & M basis.

    Continued in the next comment…

    #2276 Reply

    Rajeev

    Continued from the previous comment…

    Generally, a client chooses few vendors and negotiates the lowest price with them. The discussions are on the effort rather than the value that the client may derive out of getting the work done.

    This happens between most US companies and Indian vendors.

    What solution would you propose to determine the price?
    What could be the sales process for such companies?
    What could be the Decisive Competitive Edge?
    What could be the unrefusable offer?

    By the way, I am your fan for a long time. I have studied the sales process created by you. I also study your posts on TOC sites.

    Regards,

    Rajeev

    #2277 Reply

    Hi Rajeev

    I wouldn’t go so far as to suggest that you abandon the T&M approach. I suspect many US companies send work to India simply because they can buy the man-day cheaper.

    However, you may wish to change your mix of work to favor fixed price. The challenge here, is that the two modes of operation require totally different management environments and even team structures.

    If you are bidding on a project-basis against others who are bidding on a T&M basis, you may still do the latter calculation to get a feel for the ‘market price’.

    From there, there are two considerations:

    1. What price would you need to quote to have a high likelihood of winning?

    2. What price would you need to quote to maintain or improve the current financial performance of your project portfolio?

    What you are likely to find is that the mode of operation caused by the T&M engagement model is less efficient than the pure project environment – providing you an arbitrage opportunity.

    Justin

    #2278 Reply

    Rajeev

    I guess the fundamental question is, on what basis should you choose to compete. There are three alternatives: low total cost, product leadership, and market intimacy (see Discipline of Market Leaders).

    I expect that Indian sofware companies have entered the international market competing on the basis of low daily rates.

    It would be tempting to assume that you should abandon this strategy as the market becomes more competitive and the playing field more balanced.

    It’s important to remember that your daily rates (ticket price) are only one facet of the ‘lowest total cost’ strategy. Others include, speed, quality, and total-cost of ownership. I’d encourage you to fully exploit this strategy before attempting to change horses.

    Justin

    #2279 Reply

    Scott Jones

    Interesting ideas, but not universally applicable and possibly a bit dangerous. if you essentially sell the time (expertise) of people in consulting, installation, maintenance etc, then yield of staff time is every bit as critical as pricing. If you ignore yield and instead decide that good staff will do as much as they can, then you will have problems pricing lots of services, and particularly any fixed price services. I caused a major profit problem in my business at one point by setting fixed price contracts and then not carefully monitoring every bit of time that was being spent on those contracts. They LOOKED profitable on cursory examination, but because we didnt know exactly where time was being spent, it turned out that many of them weren't profitable at all. You can live or die by yeild.

    #2280 Reply

    Scott Jones

    Furthermore, VALUE may not be able to be determined by a formula involving costs and margins, but doing these calculations will at least tell you the minimum price you can sell that labour for and still make an acceptable profit. if you DONT do this process, and instead price something based on "what the market will pay", you run the risk of underpricing something just because the market place you are in is used to underpricing. Most of my competitors price their labour far too low and say that's what the market will pay. In reality they are slowly going broke or at best building a half-arsed 'business' because they havent worked out their margins properly. (i made THAT mistake before too).

    If you start at the other end, decide what you WANT to sell something for, and then figure out how to bring the value of your product up to the desired sell price, then you are getting the return you want, AND probably creating a hugely valueable product in the process.
    Scott Jones – IT Leaders

    #2281 Reply

    Scott Jones

    Oh, and if you simply CANT sell that product for the price you want/need to sell it for to create a business that doesnt own you – then you need to find a new industry or product.

    #2282 Reply

    Obviously, your work portfolio must be profitable — but this is a constant, regardless of how you estimate. Transactions, in isolation, can neither be profitable nor not-profitable. Profitability is an attribute of businesses, not transactions. Transactions don't make profits: only businesses do!

    #2283 Reply

    This is NOT TRUE! Traditional costing may tell you the price that your competitors are likely to quote — and this is worth knowing. But, I repeat, it will not indicate profit because profit is also a function of utilization. If you sell a piece of work at raw-material cost, plus $1 and that work does not displace another job with a greater yield, then you are $1 better off than you otherwise would have been.

    #24905 Reply

    Silvio

    Hello. Adopting a child with special needs has been on our htears and in searching, I came across this site. I went and looked at the Rainbow website and was so touched. A little girl named Beatrice tugged at my heart in a way I never felt and little Ashlyn. Although we can afford to have them, I had no idea it would cost so much to adopt a special needs child. I am feeling torn as there is no way we could but I feel as though God has led us to. Any advice?

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