Hourly Billing System Cheats Agencies, Clients, People
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Hourly Billing System Cheats Agencies, Clients, People

The hourly billing cheats clients, by rewarding agencies for working longer rather than smarter. It cheats agencies, by forcing them to give away their most valuable product—their thinking—and charge instead for their time. And it cheats employees, by rewarding long hours over productivity.

Paul Holmes

A brilliant young public relations executive keels over of a heart attack at age 35. When he arrives at the pearly gates, he’s furious. He asks St. Peter why god would take someone so young, someone with so much to live for. St. Peter takes a look through a huge stack of papers, peers at the young man over the top of his glasses, and says, “Because according to all these hours on your time sheets, you have to be at least 108.”

A quick search of the Internet will turn up variations on this old joke in which the victim is an accountant, an advertising executive, a lawyer (by far the most popular permutation) and even a NASA aerospace engineer. Chances are, executives at international public relations agency Fleishman-Hillard don’t find any of them particularly funny, because—as anyone who reads either the Los Angeles papers or the PR trade press is probably aware—the firm has been at the center of a major controversy over alleged over-billing for its work on behalf the Los Angeles Department of Water & Power

According to former FH executive Diana Greenwood, “The attitude that was handed down to us was that you get as much as you can because these accounts may dry up tomorrow. There was a monthly billing figure that we needed to hit, so if it meant making up stuff, we made up stuff.” Said another former employee, quoted in an L.A. Times article, “The need to increase the hours was communicated pretty bluntly. Different people were approached and told how many hours they needed to add.”

The L.A. District Attorney is investigating the alleged fraud, and Fleishman-Hillard is conducting its own investigation. If the charges turn out to be true, a massive blow would be dealt to the reputation of one of the industry’s most respected firms, and to the industry as a whole. And serious, long overdue, questions should be asked about the hourly-billing system that has become ubiquitous in the PR business, despite its obvious shortcomings.

No one would suggest that the hourly billing system causes dishonest and ethical behavior—most PR firms conduct their business with integrity—but there’s no doubt it provides a powerful incentive for the kind of practices detailed in the charges against Fleishman-Hillard, that it creates an inherent conflict of interest between agencies and their clients.

And even if there were no ethical issues, the hourly billing system would still be open to criticism. It cheats clients, by rewarding agencies for working longer rather than smarter. It cheats agencies, by forcing them to give away their most valuable product—their thinking—and charge instead for their time. And it cheats employees, by rewarding long hours over productivity.

The Ethical Questions

The enthusiasm of professional service firms for hourly billing is a relatively recent phenomenon.

During the 50s and 60s, the American Bar Association started encouraging its members to keep hourly records. At first, hourly billing was seen as a baseline, to be adjusted for other factors including a project’s success, but by the late 70s, hourly billing had become standard.

At the same time, law firms began to require attorneys to bill a specific number of hours each year. Says Niki Kuckes, a partner at Washington law firm Baker Botts, writing in Legal Affairs magazine, “It seemed like a harmless enough step—until the number of those hours began to rise steadily beginning in the 80s.” By 2001, many large law firms typically asked associates to bill between 1,950 and 2,000 hours each year.

Under pressure to bill so many hours, “there are bound to be temptations to exaggerate the hours actually put in,” as Chief Justice Rehnquist observed of the legal profession in the mid 80s. In 2001, the ABA assembled a Commission on Billable Hours, and this August it conceded that “required hourly minimums… can lead to questionable billing practices ranging from logging hours for doing unnecessary research to outright padding of hours.”

Says Kuckes. “The standard invites inefficiency, not to mention fraud. The potential for conflicts of interest is obvious—it’s in the firm’s financial interest for lawyers to spend as many hours as possible, while the client’s interest is best served by limiting the time spent.”

Perhaps the most well-known recent case of billing fraud involved Webster Hubbell, a former chair of the Arkansas Bar’s ethics committee and a partner at Little Rock’s prestigious Rose Law Firm, who went from the number three in the Clinton Justice Department to prison. Hubbell was convicted of stealing $394,000 from his clients and his own law firm by billing for time he never worked

It’s clear that simply lying about the number of hours worked on behalf of a client is wrong, but the hourly billing system has its grey areas. If you spend time traveling to a client meeting working on a press release for a different client, can you bill them both for the time, the first client for the travel time and the second client for the work you put in? Perhaps surprisingly, the legal profession was of two minds on this issue until relatively recently, when the ABA announced that billing two clients for the same time was flat-out wrong.

But what about this? If you spend your morning commute writing a press release for a client can you bill that time? Most agencies would consider that appropriate. But what if you spend the morning commute just thinking about a client’s problem? Most firms say no. Why? Is thinking really less valuable than writing a press release?

PR firms—like other professional service firms that use hourly billing—need to spell out in clear, black-and-white terms, what’s appropriate and what’s not. That’s something Fleishman sought to do in the wake of the L.A. scandal. A new time entry and billing certification process has been introduced, and every staff member must now certify that he or she has reviewed and understands the firm’s time entry policy, and that the time being entered is an accurate account of time worked.

In addition, managers who are responsible for approving invoices must sign a statement certifying that they understand the firm’s billing policy, and that all time being charged to a client is accurate.

The firm also announced a hotline giving not only employees but also clients and suppliers the ability to anonymously report any questionable or unethical behavior 24-hours a day, seven days a week.

Some PR agency leaders expressed surprise that such measures were not in place before the L.A. controversy.

“People in every office are trained in the appropriate way of time keeping,” says one top-five agency president. “They understand what’s billable and what’s not billable. It’s front and center in our orientation processes, and every timesheet has to be signed by the individual filling it out, certifying that the information is accurate.”

But other agencies concede that they had taken the integrity of their staff for granted. “Anyone who doesn’t look at what’s happening to Fleishman and think ‘there but for the grace of god’ has their heard in the sand,” says the president of another top tier firm. “We are all vulnerable to employees who inflate their hours, or managers who encourage that kind of behavior in their workers. There’s only so much an ethics program can achieve.”

But what an ethics program can do is insulate a company against charges that such practices were an extension of—or encouraged by—the culture.

According to Maurice Schweitzer, professor of operations and information management at Wharton, managers need to be “vigilant in establishing an ethical climate, because that matters a great deal. If you are running a consulting company, you are likely to create problems when you set goals for billing a large number of hours, convey the impression that billable hours are the key to earning rewards such as promotions or bonuses, and rarely check on your employees’ self-reported hours. This type of environment creates a breeding ground for unethical behavior.”

But even when there’s no intent to deceive, hourly billing is often sloppy and inaccurate says Steve Honig, a former GolinHarris executive who recently launched his own firm, The Honig Company, and announced his intent to eschew hourly billing.

Says Honig, “A lot of people who work at agencies that bill hourly do not track their time very accurately, but instead estimate how much time they think they spent on an account, either at the end of the day or the end of the week or, believe it or not, at the end of the month. While they are not intentionally trying to do anything wrong, their numbers are often far from accurate.”

How Hourly Billing Cheats the Client

In some businesses, there’s a strong correlation between time and productivity. In the manufacturing sector, it may be possible to calculate the number of widgets a worker can efficiently produce in an average hour, and to base the worker’s compensation on that calculation. But in a creative business such as public relations, there’s no direct correlation between the time invested and the eventual outcome.

For example, an agency might bring together six people together in a room to brainstorm on behalf of a client. The “eureka” moment might occur just half an hour into the session, or it might take five hours of back-and-forth between participants. At the end of the day, the firm has the big, breakthrough idea that will differentiate the client’s product from the competition and position it as the undisputed leader in its category. But an idea generated after five hours of debate is worth ten times as much (to the agency) than an idea generated in 30 minutes, regardless of quality.

Honig says one problem with the hourly billing system is that “the client pays more for slow people: if it takes someone three hours to write a press release instead of one hour, it costs more. Why should the client pay more because it takes someone extra long to write a release?”

Worse still, an agency with its eye on the clock may stop work altogether.

“The client can never be assured the job is going to get done,” says Honig. “Agencies don’t think twice about calling clients to say ‘time is up; we’ve reached our allotted monthly fee budget.’ The agency will either ask for more money, shut down for the rest of the month—or continue to work and write-off the extra time, which defeats the whole purpose of hourly billing.”

Not surprisingly, clients start watching the clock too.

“It creates stress on the client side,” says Honig. “I have been in client meetings with the entire agency account team, and the client was looking at his watch. Why? Because the combined billing rate for everyone was around $850 and their fee budget was $15,000 a month. So a two-hour meeting eats up $1,700—about 10 percent of the monthly budget.”

“The client should know what results it’s going to get and the agency should be focused on delivering those results,” says Bob Wheatley, president of Chicago-based Wheatley & Timmons, one of a handful of public relations firms that eschew hourly billing. “No one on either side should be worrying about whether they are taking too much time to deliver those results. We don’t want anyone here to ever think they are running out of hours, that they have to choose between not delivering the results we promised or over-servicing the account.

“We don’t want the client to ever think, ‘it’s costing me $3,000 an hour to sit in a room with these people,’” says Wheatley, who sees yet another problem with hourly billing. “It creates pressure to get senior people off the business,” says Wheatley. “You typically get better margins from younger people and so there’s pressure to push everything down to a junior level.”

Honig agrees. “Hourly billing pretty much eliminates senior-level involvement for accounts that are in the below $20,000 a month range. As a senior vice president, I’m billing around $275 an hour. Realistically, how many hours can I devote to an account paying, say $15,000 a month, without totally eating the budget before other staff time is added in?”

At its worst, the need to bill as many hours as possible can even lead to agencies holding on to bad practices long after better alternatives become available.

The president of a leading public relations services company tells of the reaction when he developed his first software product for the PR industry, a tool to automate the compilation of clip reports in a fraction of the time it took to do it manually. He thought he had a winner But when he demonstrated the product for a PR agency president, he was quickly brought down to earth.

The product would reduce a process that previously had taken two days and accomplish it in two hours, the software developer bragged. The agency president was horrified. Why, he wanted to know, would he use a piece of software that would significantly reduce the amount of time he could bill the client?

How Hourly Billing Cheats the Agency

Joey Reiman, chief executive of BrightHouse, which describes itself “an ideation corporation,” tells a story that illustrates one of the major problems with hourly billing, which is that PR people charge—and clients pay—for the least valuable element of the service delivered

“There was once a famous celebrity hairdresser who got a frantic call from a woman needing her hair styled immediately for an important event,” Reiman wrote in Advertising Age earlier this year. “The hairdresser rushed to the woman’s home, asked for a ribbon, and proceeded to create his masterpiece, using only a brush and the ribbon.

“When the woman’s hair was finished 30 minutes later, she was dazzled beyond belief. ‘How much do I owe you?’ she asked. ‘$2,000,’ he replied. She was stunned: ‘That’s outrageous. I’m not going to pay $2,000 for a ribbon.’ He looked at her coolly, gave the ribbon a tug, and watched his masterpiece instantly unravel into a shaggy mop of unruly curls and locks. ‘That’s fine,’ he sad. ‘The ribbon is free.’”

The lesson, according to Reiman: “Today, marketing is primarily based on the value of ribbons and not the hairdresser’s talent…. Advertising agencies have become an antiquated broker business, selling space to clients with creativity thrown in for free,” says Reiman, making an argument that could—with some changes in nuance—be applied with equal validity to the public relations business. “The result is a marketing world that is ad rich and idea poor.”

Edward L. Bernays used to tell of being called in to counsel a trade association. The group was fearful that criticism by some competitors would cause consumers to turn away from its product. Bernays listened to the association’s leaders explain their problem, and when they were finished he told them that for a flat fee of $100,000, he would tell them how to make it go away. This was back in the days when $100,000 was real money, but the trade association was extremely concerned, and so it agreed. Bernays then told them what to do: nothing.

They did nothing, and sure enough the problem went away. Did Bernays earn his $100,000? Not if you believe in hourly billing, since he spent only a couple of hours listening to the client’s problem. But Bernays always claimed that the trade association wasn’t paying for the two hours he spent with them; it was paying for the countless thousands of hours he had invested in understanding the dynamics of public opinion. And the group had believed it was worth $100,000 to make the problem go away—a perfect case of value billing.

Imagine a client facing a serious crisis. A reporter for a leading trade publication is about to run with a negative story that could cost the company millions of dollars in lost sales. The reporter doesn’t believe the company’s corporate communications department’s denials, but he trusts the senior guy at the agency, because they’ve known each other for a decade and the agency guy has never steered the reporter wrong. The agency guy spends 10 minutes on the phone and gets the story killed.

If you believe in hourly billing, that phone call was worth at most a couple of hundred dollars, even though it saved the client millions. It would, of course, have been worth much more if the agency executive didn’t have a good relationship with the reporter. Then it might have taken you a couple of days to get through to him, and the firm could have billed for 10, 12, maybe 16 hours.

The hourly billing system encourages agencies to charge for execution rather than strategy. Indeed, many of them give away their thinking—often before they are awarded the account—in the hope that they will get rich off the execution. But Reiman believes clients should be—and in some cases are—willing to pay for ideas.

“Advertising agencies have always been awarded jobs by pitching ideas,” he says, “in effect, giving rheir ideas away for free. To become a thinking partner for your clients, you must first start placing value on thinking. Conventional corporate structures discourage employees from thinking properly because they are penalized for incubation, a slow process where ideas percolate.”

When he worked in the agency world, Reiman says, he was often the target of jokes because he spent time thinking instead of writing. But today he makes his money by selling his ideas, not his time. He sold his first idea for $35,000, his next for $75,000 and his next for $450,000. Today, he says, each idea costs over $1 million.

“Never before has the world been more willing to pay for thinking,” he says. “Ideas have become the difference between winners and losers.”

How Hourly Billing Cheats Employees

According to the Council of Public Relations Firms, the average PR agency account executive is expected to be 87 percent billable, which means billing about 1,750 hours a year. The good news is, that’s less than most lawyers are expected to work—law firms routinely set billability targets of 2,000 hours for ambitious employees. The bad news is, it’s impossible to accomplish without working the kind of hours that make work-life balance an impossible dream.

A target of 2,000 billable hours might sound reasonable—it’s just 50 weeks of 40 hours each—but studies have consistently shown that lawyers need to spend at least three hours in the office for every two hours of billable work. Lawyers—like public relations people—have to read and respond to interoffice e-mails, attend team meetings, read professional journals, and attend professional development conferences. Some even do pro bono work.

(In 1958, the ABA estimated that a productive lawyer who also expected to have a life outside his or her firm could bill about 1,300 hours a year.)

The billability target of 1,750 hours a year means a public relations account executive needs to put in about 2,600 hours a year. If you don’t take any vacations, that means 52 weeks at 50 hours a week: 10-hour days, five days a week, every week of the year. Of course, most firms give employees—even account executives—holidays on Christmas Day and New Year’s Day and Labor Day and half a dozen other dates throughout the year, so there are probably a few 12 hour days needed to make up for all that lost time. No wonder PR agency employees complain about the difficulty of achieving any kind of work-life balance.

“Employees should not be judged on the basis of how billable they are,” says Honig. “It’s not a good indicator of worth or performance.”

So Why Is Hourly Billing So Popular?

The hourly billing system has two supporters: agency managers who want some way to track the productivity of their employees, and procurement people, who like to have a mechanism for breaking down what PR firms do to its component parts.

It’s not difficult to see how hourly billing became the norm. The larger PR firms get, the more difficult they are to manage, and the more important it is for managers to have an accurate method of predicting income and expenses. So like law firms before them, PR firms turned to billable hours, which allowed them to measure realization rates (a comparison of hours worked to fees collected on those hours) and the productivity of individual employees.

“You have to have some way of tracking whether each individual employee is contributing, whether each individual account is profitable,” says the president of one top 10 agency. “Keeping track of the hours people work, the time you put in on each account, is the only way to do that in an organization with 1,000 or more people.”

Procurement people apparently agree, since they demand detailed information about billing rates.

“The hourly billing system is more in vogue now than in the past,” says the president of one of the top five public relations firms, speaking off the record. “The idea of the flat retainer has fallen by the wayside, because procurement people all want to see hourly billing because they believe there’s more accountability there.”

Says another, “Procurement people aren’t particularly interested in value, because they don’t understand it, because we as an industry have done a lousy job of explaining it and demonstrating that we can deliver it. Procurement people care about cost. And they can look at hourly billing rates and know the cost of something to the agency—it’s right there in black-and-white dollars and cents—and the cost to the client. They figure they can’t measure the PR output effectively, so they measure input instead, and that’s what they pay for.”

So big agencies, in particular, find themselves locked in to the hourly billing system, even though many would like to change it.

“We have always preferred to work on a fixed fee,” says Richard Edelman, chief executive of Edelman Public Relations Worldwide. “We believe it’s a better value for everyone concerned, because it puts the focus on the output, not on the amount of time we spend. And it’s better for the client, because if there are inefficiencies, if things take longer than they should, the agency has to eat that expense. But we have found the procurement people, and our pharmaceutical clients in particular, are increasingly pushing for hourly billing.”

Edelman believes hourly billing may be better for professional service firms, including law firms, than it is for creative businesses like public relations.

“We like to look at it over a six month period,” says Edelman. “If we have a $30,000 a month retainer, we might do $20,000 of work one month, and $40,000 the next month.” But the income flow is steady and predictable, and the firm doesn’t end up trying to generate an extra $10,000 worth of hourly billings at the end of one month—as Fleishman is accused of doing in L.A.—because it didn’t meet the hourly “target.”

New Thinking on Billing

But if large agencies are increasingly locked in to hourly billing, many smaller firms are experimenting with new pricing structures.

Last year, an article in Law Firm Partnership & Benefits Report opined that “the billable hour… has become an artificial device that ill serves both professionals and clients. It divides the time of the accountant and lawyer and consultant into parts, turns each professional into a bookkeeper, and creates such profound guilt for every working hour that’s not billable that important non-billable firm needs are inadequately addressed. It affords the opportunity for the worst kinds of excess, such as padding hours, thereby increasing revenue without supplying value. It makes no distinction between the hour spent on trivial activities and the hour spent on substantive matters.”

It suggested an alternative: “The best approach to fathoming the value of a task may be found in a client’s answer to the question, ‘If your problem could be resolved, how would it help you?’ It is a subtle but powerful question. It asks the client to think of the value of the solution, not just the cost of it, an important shift in emphasis.”

In other words, professional service firms should base their fees on what a particular outcome is worth to the client, not the amount of time it takes to complete a task.

“The hourly billing system fosters utter lack of accountability for results on the agency side,” says Honig. “With hourly billing, an agency is not promising to get the job done. The agency is promising only to keep working until the monthly fee budget is up, whether or not the job is complete or the results are satisfactory.”

On the other hand, “Working on a retainer basis makes the agency accountable for getting the job done. If I commit to a client I will do something for a certain monthly fee, I will get the job done no matter what. The client knows it will get certain things done for a certain price. It takes the pressure off the client relationship. When I spend time with a client, I don’t want them worried what it is costing them.

“Retainer billing also encourages efficiency and high performance on the agency side. If someone is taking three hours to write a press release that should take an hour to write, guess what? That person is not going to work for me very long. In the hourly scenario, I’d actually be making money off that person’s lack of ability. In the retainer scenario, it is costing me money. That’s the way it should be.”

In addition, “all the time consumed by tracking hours can now be used for finding new business and spending an extra few minutes on existing clients.”

Accountant Rick Gould of StevensGould Partners, who works with many small and midsize public relations firms, recommends an approach he calls “matrixpricing.”

Says Gould: “Hourly billing does not work. Time-based billing does not work. Hourly or time-based billing focuses on the effort you put in, not the result you get out. It substantially limits your firm’s income potential. There must be a new paradigm of personalized, customized pricing that is based on results and on the value of those results.”

One reason, he says, is that price-sensitive clients resist increases in hourly rates. For that reason, many firms went for several years during the recent downturn without raising their rates at all. But clients care about results and about value and are more likely to accept increased fees if they are directly related to results.

Some firms are already using retainer and value-based pricing models.

“We rarely bill clients on an hourly basis,” says Andy Cooper, principal at New York boutique PR firm CooperKatz. “Most PR accounts are fixed retainer-based. And most projects are flat fee-based. We find that literally charging by the hour is unacceptable to most clients. In the marketing PR space, clients want to know—going in—what a program will cost. Open-ended time billing is unmanageable from their standpoint.”

The CooperKatz approach doesn’t ignore the amount of time the agency expects to spend on a project—Cooper describes his partner, Ralph Katz, as “the world’s most detailed program budgeter”—but it builds it in upfront. If the agency works more efficiently than expected, it wins. If a project takes longer than anticipated, the agency is penalized.

Says Cooper, “We operate with this philosophy: Define a specific scope of work. Create a detailed budget—a fixed monthly retainer or flat project fee plus out-of-pockets, which are spelled out in detail. Then do whatever it takes to get the job done and deliver great results. For employees, this approach rightly puts the emphasis on meeting client needs rather than meeting internal billability standards. For clients, it eliminates surprises and contentious billing problems.

“If the scope of work significantly changes, or if new projects are added, we’ll identify the new costs to the client or suggest ways to adjust our workload to stay within the agreed parameters. But in most cases the thoroughness of our upfront work definition and budget detail results in smooth sailing. I can hardly remember an invoice being questioned in eight years.”

Fast Horse, a Minneapolis-based consumer marketing public relations firm, recently announced a major restructuring of its billing and staffing model, abandoning the traditional billable hour model in favor of a project fee approach that—according to president Jörg Pierach—“keeps experienced staffers involved in all aspects of client service, from strategic counsel to day-to-day execution of account work.”

The new approach, which Pierach calls Fast Track, “will ensure that we are able to maintain our advantage by formally eliminating and safeguarding against some of the fundamental industry barriers to great client service and revenue growth, such as an over-reliance on inexperienced staff and billable-hour pressures,” he says.

Fast Horse will work closely with clients to clearly define and agree upon appropriate project objectives, deliverables and budgets, and once those parameters have been agreed upon, staff members will be free to put the full weight of their collective experience and available resources into meeting and exceeding program expectations. Project budgets will continue to reflect competitive market rates, but will be established through a formula that allows more seasoned staff to efficiently accomplish appropriate work often delegated to more inexperienced staff in traditional agency models.

“The Fast Track model will not make us more expensive than our competitors, it simply allows us to be more efficient and effective,” says Pierach

Steele Rose Communications, headquartered in New York, will change its pricing approach this month, for similar reasons.

Starting this month, SRC will switch existing clients and introduce all future clients to their new results-driven pricing strategy, which means clients will be charged a pre-agreed fee based on mutually-determined goals rather than an hourly rate and/or a monthly retainer with no guarantee of quantifiable results.

Says Karen Barnett, SRC president, “We have been listening to our clients and assessing their needs and have concluded that it is time to completely revamp our pricing policy to bring it into line with modern business practice. It is no longer sufficient to take on clients even in the PR industry without a deep understanding of their goals and a commitment to provide a guarantee that these goals will be met.

“Current practice means that a client pays a fee for a set number of hours per month. When that limit is reached, work stops. Our new [pricing] policy means that monthly goals are agreed with the client and we work on that account to achieve those goals rather than to a preset time limit.”

Honig believes the decision to eschew hourly billing will be a major point of differentiation and a competitive advantage when approaching clients. “It fosters a real relationship between client and agency,” he says.

For now, alternatives to hourly billing look like a niche strategy, a way for firms that like to swim against the tide to differentiate themselves.

But it’s a strategy that will increasingly attract savvy and sophisticated clients who understand that the value of public relations is defined by outcomes not inputs, by results rather than effort. And it’s a strategy that should foster improved client-agency relationships, eliminating the inherent conflicts of interest inherent to the hourly billing system.

We should all hope that the firms quoted in this article enjoy success with their alternative pricing models. If they do, they could liberate the entire industry—clients, agencies, and employees—from the crushing tyranny of hourly billing.

TITLE   HOURS TARGET UTILIZATION %

Account executive  1748   87%
Account supervisor  1714   86%
Account manager   1706   84%
Vice president   1652   75%
Executive vice president  1570   66%

Source: Council of Public Relations Firms

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