The false economy of hourly rates, Part 1

May 18, 2018
The false economy of hourly rates, Part 1

Fee Structures in Professional Services Firms

In this post, we discuss which fee structures your clients prefer, and what your competitors are doing about it. We surveyed over 6,000 clients of Law, Accounting, Bookkeeping and Coveyancing firms. 

Introduction

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We often hear firms saying “We offer our clients alternative fee structures, but many of them prefer to stick to hourly rates.” In terms of clients’ stated preference before a project (aka matter) begins, this may be so. However, strong evidence gathered during FirmChecker’s research for the NAB Professional Services Awards 2017 indicates that this is a myopic view of client relationships.[1]

The short-term benefit of quoting an hourly rate can be winning a client with a seemingly more attractive fee. As a bonus to the firm, the client bears the risk of a project’s scope creep. In the long run, however, hourly rate clients perceive the value of a firm’s services as lower than those on fixed fee arrangements. Importantly from a micro-economic perspective, they are less likely to recommend a firm than clients who pay fixed fees.

This post will explore the current use of fee arrangements by professional services firms. We examine client satisfaction associated with the use of different fee structures, concluding that fixed fees are clearly preferred by clients in nearly all cases.  In an ultra-competitive buyer’s market, transitioning to fixed fees will be increasingly necessary. It will also be favourable to firms that do so earlier.

Current use of fee structures across the professions

While we do not yet have tracking data from which to infer trends, anecdotal evidence suggests that small to medium firms in the professions are, to varying degrees, transitioning towards fixed fees.

Our quantitative evidence suggests this trend is, and will continue to be, client-driven.

Accountancy firms

Two-thirds of nearly 3,000 Accounting firm clients surveyed indicated they were charged fixed fees. Only a quarter were charged an hourly rate. The remaining 10% were on retainers, charged success fees or ‘Other’, which was made up largely of hybrid fee structures.

Figure 1: Use of fee structures by small to medium Accountancy firms

 Law firms

In Law, of over 2,500 respondents, the discrepancy was much closer. Just under half of the clients were charged fixed fees, 40% hourly rates and the remaining 11% were a mix of retainers, success fees and ‘other’.

Figure 2: Use of fee structures by small to medium Law firms

Bookkeeping

The other professions had smaller sample sizes, but the results can be viewed as illustrative. Just over half of Bookkeeping clients were charged fixed fees, compared to 41% hourly rates.

Figure 3: Use of fee structures by small to medium Bookkeeping firms

 Conveyancing

As expected, conveyances were primarily done on fixed fees (90%), with only few clients charged hourly rates (3%).

Figure 4: Use of fee structures by small to medium conveyancing firms

 The impact of fees on client satisfaction

Whichever way you cut it, fixed fee clients are on average happier with their service than hourly rate clients. Our findings were comfortably statistically significant across all respondents at a 1% significance level, as well as when we segment the responses by Accounting and Law.[2]

When we drill down further into the type of client, whether Private or Business clients, we get the same overall story.[3] In both cases, in both Accountancy and Law, those receiving a fixed fee were demonstrably more satisfied.

For the purposes of this post, we will focus on average Value ratings from clients. Because Value correlates closely with clients’ willingness to recommend a firm, it is a good indicator of how firms are performing in their client service. Results for other outcome measures such as Propensity to Recommend and Overall Experience ratings are very similar. [5]

Law firm clients

Private clients, Law firms

Figure 5: Value ratings from Private clients of  small to medium Law firms

Among Private clients, those on fixed fees give higher value ratings to a statistically significant extent. Tellingly, there is a much higher variance in value ratings among hourly rate clients. We speculate this is the result of the effects of (often unpleasant) surprises when hourly rate clients get their bill at the end of a matter. These surprises make hourly rate clients’ ratings of value much more volatile.

Note that far more Private clients were charged fixed fees than hourly rates. We speculate this could be the result of firms responding to higher variance and lower average satisfaction among hourly rate clients.

Figure 6: Value ratings from Private clients of  small to medium Law firms

 Business clients, Law firms

Among Business clients, the difference in value ratings was statistically significant and plainly in favour fixed fees. However, these differences were less stark than with Private clients.

Figure 7: Value ratings from Business clients of small to medium Law firms

 

The result has been less cut-through in the change towards fixed fees among Business clients. In fact, fewer Business clients indicated they were charged fixed fees than hourly rates, despite hourly rate Business clients being less happy on average.

Figure 8: Fixed fee vs Hourly rate usage for Business clients of small to medium law firms

There are several possible reasons for the slower uptake of fixed fees among Business clients. Firstly, the variance and mean differences aren’t as severe among Business clients, which could mean less motivation for change. It could also reflect a client base that is more experienced in using professional services, so fee expectations are more realistic from the clients’ point of view. Business clients may also be less price sensitive. Whereas in private areas of law such as family law, legal fees are a somewhat of a grudge purchase, Business clients are more likely to view legal advice as a value-adding necessity. All of these factors would reduce bill surprises at the end of a matter.

Nonetheless, fixed fee business clients are still happier and less volatile than hourly rate clients. These differences, while small, are statistically significant. The argument for fixed fee adoption in Law firms is compelling.

Accounting firm clients

Private clients, Accounting firms

Among Private clients of Accountancy firms, fixed fee clients are again more satisfied and less volatile in their value ratings. These results are once again statistically significant.

Figure 9: Value ratings from Private clients of small to medium Accountancy firms

 

The findings suggest the discrepancy in the variance and mean values of satisfaction metrics may be one cause of the dominant use of fixed fees (with other possible causes being more routine/commoditised work in the Private clients sample, for example).

Figure 10: Fixed fee vs Hourly rate usage for Private clients of small to medium Accountancy firms

Business clients, Accounting firms

Figure 11: Value ratings from Business clients of small to medium Accountancy firms

 

Business clients in the Accounting profession were the only cohort who didn’t have a statistically significant discrepancy in value ratings between hourly rates and fixed fees. That said, there was still a nominal difference which was consistent with our findings in other client segments. The difference simply wasn’t large enough in the sample to reject the null hypothesis of equal mean ratings at a 1% or 5% significance level.

Similar to our reasoning in other client segments, we speculate that this has led to less fixed fee cut-through when compared with the Private clients segment of Accountancy.

Figure 12: Fixed fee vs Hourly rate usage for Private clients of small to medium Accountancy firms

Bookkeeping and Conveyancing clients

In Bookkeeping and Conveyancing, sample sizes were not sufficiently large to draw distinctions between fixed fees and hourly rates. For Bookkeeping clients there was no apparent difference, statistically significant or otherwise.

In Conveyancing, the substantial majority of projects were done on a fixed fee basis. There were too few hourly rate comparators to be included in this discussion. Given that Conveyancing is nearly completely commoditised, it makes sense that fixed fees would be the dominant fee structure.

Summary

It’s clear that clients prefer fixed fees to hourly rates. This conclusion survives segmentation at the levels of profession, client type and even practice area. We have not included practice level data for the sake of brevity, but the relationships between fixed and hourly rates reported here hold true when we drill down to specific practice areas, such as family law. While in some practice areas our samples were too small for statistical significance, there were none in which the average rating for hourly rate matters was as high as the average rating for fixed fee matters.

The message for firms is therefore quite clear in a hyper-competitive market – use fixed fees whenever it’s feasible to do so.

The false economy of hourly rates, Part 2

In our next post, we will discuss the reasons for the stickiness of the hourly rate. We will argue that most reasons for keeping it aren’t very good ones.

Author

Ben Farrow is a Co-Founder and Director of FirmChecker. You can connect with Ben on LinkedIn and contact him at [email protected]

[1]  Our research involved an online survey of clients of small to medium Law, Accountancy, Conveyancing and Bookkeeping firms, for which we had over 6,000 respondents. Fieldwork was conducted from October-November in 2017.

[2] The significance level is the probability of observing this result if the null hypothesis is true. The null hypothesis repeated throughout this post is that the average value rating for fixed fee clients is no different to the average value rating for hourly rate clients. So, if it were true that clients on hourly rates and fixed fees rated their firm’s value equally on average, there would be a 1% or lower chance of observing the differences in averages that we observed given the same sampling method. We therefore have strong evidence to reject the null hypothesis. Note that statistical significance does not imply practical significance. 

[3] This is based on clients self-nominating as ‘Business’ or ‘Private’ clients.

[4] Results are similar for our other measures of quality, including ‘input’ variables such as Reliability, Understanding of client needs, Expertise and Care for clients.

[5] ‘ * ‘ denotes statistical significance at 1% significance level

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