Quick Tip: Aligning Incentives With Milestone-based Billing
One of the most difficult challenges I’ve dealt with as a consultant is approaching the billing conversation with potential clients. It’s critical that customers feel like engaging with my consultancy is worth the cost while still ensuring that I’m respecting the value of my team’s labor and experience. It’s a delicate balance, but over the years I’ve learned that there’s no one-size-fits-all approach to aligning incentives.
Hourly Rate
Hourly rate billing is great for certain kinds of work. I especially like the approach for engagements where a consultant is embedded in a team and acting as an internal staff member or when there’s a clear cap on hours at a predetermined interval. I also like hourly rate billing for maintenance work or ongoing retainer fees. However, for most of the consulting work I do, my team and I are tasked with building a project with a relatively clear endpoint like a web or mobile app with a well-defined feature set.
When I get a project like that, I find that hourly rate billing can create adverse incentives between parties. When a consultant’s income is tied to the number of hours they spend on a project, the incentive is to move slowly and bill for extraneous labor. On the other hand, clients just want their project to be done on time and on budget. To manage costs, companies might resort to micromanagement and strict deadlines. There seems to always be this indelible tension between consultant and client that more often than not leaves someone feeling slighted and can degrade the quality of the final product.
Milestone-based Billing
To more effectively align incentives in a project that has a well-defined scope, I like to use milestone-based billing. While this takes more planning up-front, it has some key advantages over the hourly rate approach. To do this effectively, the project must be broken down into multiple discrete milestones that can each act as their own deliverable. Each milestone should provide real value and the cost should be determined and agreed upon in advance.
This approach gives consultants the confidence that their completed work provides real value to their client and incentivizes them to finish a milestone efficiently to maximize their own hourly rate. For the client, it provides clarity on what they’re buying and allows them to determine whether the deliverable is worth the price up-front. Since the consultant agreed to a date-bound scope of work, they can have more confidence that the project will deliver what they asked for while still being under budget and on time. This makes it acceptable to deliver work before the due date. When working like this, I’m often reminded of the famous ship repair man story; I should be paid not based on how long it takes me to do something, but instead based on how well I know how to do it.
Finally, it gives everyone the ability to plan better. Because so much planning is required up front, it can give consultants the ability to plan how the project will fit into their current workload and confidently estimate their income. It can also give clients a clear timeline and budget that they can use internally. Plus, it’s so much easier to back out of a project that isn’t going well when the deliverables have already been delivered at various points along the way. Each milestone is its own little checkpoint that another team can pick up and run with if the engagement isn’t working out.
Ingredients for Success
Milestone-based billing alone won’t make a project run smoothly. This kind of arrangement only works when the scope of the project and its milestones are deeply understood and well-defined. Here are some tips:
1. Deep Discovery
Deeply understanding the deliverables and requirements is the most important prerequisite of taking on a milestone-based project. In fact, the up-front labor is so critical, it should never go uncompensated. Don’t be afraid to bill a flat fee or an hourly rate just for the discovery phase.
The deliverables of this phase should be technical and research-related documentation, a product timeline with tightly scoped milestones, and any other necessary assets like wireframes. The goal is to deliver a package that any other consulting team could pick up and run with without any additional up-front work.
2. Communicate Early and Often
This should go without saying, but good communication is the key to any good relationship. The only constant in life is change. As each milestone is delivered, future milestones should be adjusted to account for new information. It’s much better to increase cost than it is to under-deliver. If a client wants to end the engagement because you’ve honestly reassessed the project based on new information, then you’re dodging a bullet in the long run; just happily deliver the current milestone and do a warm handoff to the team that will take the project over.
3. Provide Real Value and Track Real Data
Milestone-based billing works best when a client is able to understand the value that they’re getting for their money. Each party should be able to justify the cost of the project based on real, articulable business outcomes. Part of the deliverable should be to track how well the project achieved its intended goals. If the goal is to lower customer acquisition cost, there should be some measurable and attributable data to prove that the project accomplished it. If it’s to increase retention, you guessed it, you should be able to point to the data to prove how the project increased retention. As a client, if I know that I paid $10,000 to increase revenue by $1,000,000, I’m much less likely to complain that it “only took a few days to complete.”
Conclusion
Milestone-based billing isn’t right for every project, but it’s how I like to bill for most of mine. I like the way it aligns the incentives for my clients and my team and I like the structure and confidence it gives to both parties that the project is worthwhile.
If you’d like to see this in action on your next project, let’s work together.