Liz Strauss at Successful Blog

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September 10, 2008

Loss Aversion: Should You Charge Hourly Rate or a Flat Fee?

ME Liz Strauss wrote this at 8:04 am

Hourly Rates

I took my first freelance job in the 80s. It didn’t take me long to realize that charging by the hour works against us in a three key ways:

Very soon, I decided to negotiate a flat rate for any work I took whenever I could figure out an appropriate algorithm.

This week in the book, Sway, The Irresistible Pull of Irrational Behavior,
I got new insights into the buyer’s view of flat rate fee structures. Now, I’m even more convinced that when I can define a task or an operation clearly, I’ll be choosing a flat fee for a scope of work.

Why People Opt for a Bundled Minute Phone Plan

iPhone

Think about your phone plan . . . have you ever bought more minutes than you need, just in case . . . ?

Who want’s a huge unexpected bill? We don’t want to worry. We don’t want to worry so much so that we’re willing to pay a more for the peace of mind. Even when those minutes rollover, the phone company has already sold them to you.

That’s called loss aversion.

Loss aversion is what gets us to buy insurance on a rental car too.

The word *loss* alone, in fact elicits a surprisingly powerful reaction in us. Companies like Avis and Hertz, facing the challenge of selling a product that is both useless and overpriced, have capitalized on this powerful effect. When we rent our cars, our credit cards — not to mention our own car insurance — automatically cover us should anything go wrong with the vehicle. But the rental companies push additional coverage that not only is redundant but also would cost a whopping $5000 on an annual basis. Normally we’d scoff at such a waste of money. But then, as the sales rep behind the counter is about to hand over the keys to that newish Ford Taurus, he asks whether we’d like to buy the loss damage waiver. Sway, p.22

We don’t need to be selling useless insurance to use this fact of human psychology.

Focusing on Gains

Loss aversion can bring negotiating sense to a conversation about charging for the work we’re doing. It’s good business to show potential clients the gains in quality, schedule and budget realized when we clearly define and bundle our services so that they can see what they’re getting.

Comparing an hourly rate versus a flat fee plan is one way to do that. The communcation that happens around that subject is also a great way to get more information about the scope of project. Naturally, defining the work and working roles clearly is critical to this process.

Most importantly, client conversations are best focused on the value of our work, not the cost of an hour. When clients understand what we do, rather than thinking only in terms of time we’re saving, the partnership and our brand both get stronger.

How do you see loss aversion at work in your situation?

–ME “Liz” Strauss
image: Apple iPhone
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Related:
The Chameleon Effect: Can Others’ Perceptions Hurt Your Success?

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8 Comments to “Loss Aversion: Should You Charge Hourly Rate or a Flat Fee?”

  1. September 10th, 2008 at 8:29 am
    Whitney Hoffman said

    Hi Liz!

    In the scheme of things, I like Predictably Irrational by Dan Ariely over Sway, but both cover similar territory- Dan’s book is more in depth.

    Pricing is tricky- I am reading another book called “Why Popcorn costs so much?” and it’s all about that algorithm of price and how you get one. In essence, you always want to find that balance between supply and demand, even for your services- when is the price too high so you lose business, or too low, so you know you aren’t charging enough? When is the price tempting? And more importantly (and a subject of a blog post over at http://www.whitneyhoffman.com) is the price “flexible” because what really matters is the relationship you have with clients, and they may be willing to pay a bit more if there is perceived quality, and less likely to try to negotiate you down and down in price?

    These are key to those of us doing freelance and consulting work. What a great post!

  2. September 10th, 2008 at 8:32 am
    Karin H. said

    Hi Liz

    Drew McLellan had a very interesting post only last week on the same kind of subject:
    “Are you leaving money on the table?”.
    Hourly rates versus defined ‘charge per project’.
    Like him I agree with being more clear and honest to your client when he/she knows exactly what will be done for the money agreed - no hidden extras, no trickery. In the long run this brings in the most WOM = bottom line profit.

    Karin H. (Keep It Simple Sweetheart, specially in business)

  3. September 10th, 2008 at 8:47 am
    ME Liz Strauss said

    Hi Whitney!
    I’m working my way to Dan’s book. Irrationality is a pet topic of mine. Following the way people thing to see how we really are predictable is the essence of marketing and, well, survival.

    Naturally all depends on the job and the client. Still the focus shift to value not time is what’s crucial. Heading over to read what you say about the same things. Thanks for the link!

  4. September 10th, 2008 at 8:48 am
    ME Liz Strauss said

    Hi Karin!
    I think most clients want us to earn a reasonable living and look for people who provide good value to support in that way. I’m with you — if we do that well, people will do our marketing for us. :)

  5. September 10th, 2008 at 9:45 am
    Alex Cristache said

    Hi Liz, this is an excellent post. From my experience, most of my clients were not interested in my hourly rates, but rather in the final price (flat fee) and value for money, as well as in the project deadline.

    The hourly rates are more of a tool to estimate your own investment in the project, rather than a decisive factor in the clients’ decision. They basically analyze 3 factors: quality, end date, overall price (most times in this order).

  6. September 10th, 2008 at 6:13 pm
    ME Liz Strauss said

    Hi Alex!
    Well said. In certain industries like writing, sometimes a choice is offered. Project work raises value to charge by the project. Retainer work is hourly. Both need a great eye for scope creep with new clients. :)

  7. September 12th, 2008 at 7:52 pm
    Andrew Flusche said

    Well said, Liz! Alternative billing is really catching on in the legal world, since it can really work for both parties. Attorneys don’t want to screw with tracking time, and clients want to pay for the value they’re receiving, not the time the attorneys are spending.

    I try to charge flat fees wherever possible. It makes everything so much easier, and I don’t have to worry about whether or not the client will have a stroke when they see my invoice. :)

  8. September 14th, 2008 at 8:01 am
    A Little Mid-September Weekend Link Love | Freelance Writing Jobs said

    [...] Loss Aversion: Should You Charge an Hourly Rate or Flat Fee? at Successful Blog [...]

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