The Fallacy of Hourly Rates

After decades of working both brand side and at agencies, I've come to abhor the hourly rate. There are many reasons for this, not the least of which is the idea that any person or organization can put a dollar amount on the value of a person's time. From a human perspective, the value of a Senior Vice President's time is no greater than the value of a Dishwasher's.

The key word here is value. Certainly, there is a financial value for leadership, and driving corporate profits, just as there is financial value for the ability to eat off of clean dishes. As a business community, we've come to accept that the business value of a SVP is greater than that of a Dishwasher's, and we compensate these roles accordingly. Not only is this acceptable, but it makes sense from a business perspective.

What's wrong here, is the mechanism for which we attribute this value. Time. We use time as the currency to assess value, rather than the output of that time. As a result, this system promotes inefficiency. We treat some employees as salaried or exempt, and others as hourly or non-exempt from a payroll perspective. For hourly workers, we reward the time it takes to create value, rather than the value that is created. We are actually driving up the cost of value by incentivizing employees based on the time it takes to accomplish a task. Overtime pay is the ultimate paradox. We are actually willing to pay extra for super-inefficient production of value. Know that I am not against higher wages, but the way in which these wages are created.

On the agency side, even though employees are largely considered exempt, they still track their time hourly. Each role in an agency is assessed a different hourly rate, and billable hours are used as a cost efficiency metric. If you are greater than ~75% billable, you are regarded as a profitable product of the agency. If your "billability" is much lower than that, then you run the risk of being layed-off.

From a billing perspective, agencies bundle the cost of their staff with everything from benefits, to real estate, to equipment, to management costs, and then add in some sort of margin whether it be 10% or 50% depending on the role. For every project or program an agency works on for a client, all of the roles who are involved in the development of the deliverable(s) are added to the estimate, along with any non-labor costs, and a final SOW is determined. If you're lucky, this "cost-plus" estimate falls within the range of competing estimates and you win the bid and earn the opportunity to work (or continue working) with the client.

The challenge with this model is that clients can pay very little for tremendous value (the $50K video drives $5M in revenue), or spend a great deal of money without the creation of any real value (the campaign fails, or, the event doesn't drive leads). Agencies are either leaving money on the table, or brands aren't getting what they paid for. At the end of the day, brands are paying agencies to deliver a thing, and a time-based financial model does nothing to ensure the value or quality of said thing.

Enter procurement. Their job is to get the highest level of production from an agency at the lowest possible cost. They often drive down hourly rates using blended rate models to compare and contrast agencies, and insist agencies keep their rates static for multi-year contracts – even though the cost of doing business for the agency increases every year. This forces agencies to hire and use inexperienced, junior-level staff, and / or mark up 3rd party costs at a higher level. I've even worked at agencies that apply multiples to the number of hours it takes to complete a given deliverable to a client so they can maintain a certain level of profitability within procurement rules.

The cost in time and other resources it takes to track and administer a time-based billing system further decreases its profitability, not to mention its accuracy. There are data systems invested in, and operations staff hired for the sole purpose of managing this process. Employees often forget to put in their time sheets, or they are too busy working on deliverables or going to meetings to complete the task. Management hounds them, and by the time they get around to it, they spend non-billable hours entering their time, and they have forgotten how much time they actually spent on any project or client. When time is entered, employees look to see which job has room on it to bill their time to (remember they don't want to fall short of "billability" targets), and enter time against these, whether they worked at that level or not. Or they commit another sin – over-billing on a project which reduces it's profitability. Additionally, the application of time-based business rules is inconsistent. Some may bill in 10 to 15 minute increments, others may round-up to the half hour or hour, meetings are either included or not, and travel time is billed incorrectly.

The final point is about quality. If a senior staffer works on a task, that task should be executed more quickly, and by leveraging the experience and wisdom of that senior staffer, the task will be delivered at a higher level of quality and value. A junior-level staffer will take much more time to accomplish a similar task and provide a lower-level of quality and value. While it is true the hourly rates differ and may compensate for this to a point, it's important to know that in many cases, the agency derives a higher margin from its junior staff than its senior staff. Therefore, they are incentivized to provide lower-level value and quality of deliverables at a slower pace of productivity. This is why you see 80-90% of agency staffs below 30-years of age.

So what do we do? I am a strong believer in value-based pricing. We, as an industry need to get behind this concept in order to improve the quality and value of our work, as well as our efficiency. This is not a revolutionary concept. It's been around since the earliest economies that were based on the barter system were formed. It will require a disruption of sorts, however. Brands need to realize that they don't want to pay for hours but invest in high-quality output that adds value to their business. Agencies will need to change their operational model and hire those employees that can deliver this value, instead of driving toward the lowest-common denominator. Together, we can do this. Will you be so bold as to take the first step?