22 – When time based fees should and should not be used
When to use time based fees
Put simply, time based fees should be used whenever they are needed. Ultimately, this will depend on the remuneration system that clients are prepared to participate in. If clients insist on time based fees, and the alternative is the client will not use the service, there is little point in using any other type of fee base.
Many advisers use time based fees for one-off pieces of work where there is no ongoing involvement with the client. They also use time based fees for lower-wealth clients for whom an FUM-based fee is not immediately calculable, or for which a FUM-based fee would be insufficient.
Similarly, many advisers use time based fees in the early days of their practice. This is done to ensure that each piece of work at least breaks even in terms of the time spent on the client file.
Often, time based fees are lower than fees derived according to other bases. Again, this can create a good reason to use time based fees in the early days of professional practice. Time based fees suit practices that are not busy. One of the maxims of a successful small business is to cover its costs as quickly as possible. The easiest way to do this is to calculate the marginal cost of delivering an hour of service, and then charge something in excess of this marginal cost. Revenue in excess of marginal cost creates profit (or reduces losses, which is just as important).
The simple idea here is: get busy and then get expensive.
When time based fees should be avoided
There is not really any wrong time to use time based fees. They are transparent and, provided the fee is sufficiently high, a practice will not go broke charging them.
That said, time based fees are often avoided when a practice’s time is fully booked. The objective of any business is to increase income. Once an adviser becomes so busy that he or she has no more time available, there is only one way to increase the practice’s revenue: increase the time-based fee.
This introduces the idea of ‘elasticity.’ That is, how much can fees be increased before a client stops using the service. There will always become some point at which the ‘rubber band’ that is the client relationship breaks and the client decides to stop using the practice.
So, instead of increasing the fee per hour, it can often pay to convert the client to another form of fee calculation, such as a project fee, and then use efficiencies to reduce the amount of time spent on a client’s file. These efficiencies often arise naturally: as you get to know a client’s situation you become more efficient at managing your advice to them. They can also be introduced via technology or by engaging more junior staff on the client file. So, the client’s fee can be kept the same, or similar, by moving them to some form of fixed fee, while less time (or less expensive time) is spent on the file.
This allows the practice to see more clients and thus to expand the number of clients from whom it collects fees.
Some people argue that time based fees do not suit businesses that are looking to sell their business (or part of their business). The idea here is that the buyer of the practice will pay more if they receive an income stream that is not limited by the amount of time the buyer has available. If the buyer already owns a busy practice, for example, they may not have much time available to service new clients. They would then be likely to want to pay less for clients who have traditionally been billed on a time spent basis.
Time based fees may not suit clients with larger amounts to either invest or insure. This is because such clients may represent a greater risk to the adviser. Should an adviser face a negligence claim, for example, any penalty imposed will be based on the client’s loss, not the adviser’s fee. Assuming that clients with larger insurance or investment needs will experience greater losses if something goes wrong, this means that the risk to the adviser is greater for clients with more wealth or greater insurance needs. But, when using a time based billing system, the adviser does not receive any extra remuneration for this increased risk.