Lump sum or by the hour?

At a recent workshop for small business owners and entrepreneurs interested in obtaining minority, women or disadvantaged business certification, I heard the following advice from a Small Business Association counselor: To secure your first and future contracts, show up on time, offer a high quality service or product and do it at a fair price.

The fair price advice has stayed in my memory because “fair” is relative.  In procurement projects, the organization sponsoring the project has a budget for the products or services.  Vendors offer bids, and the price is “fair” if the quality of the product or service is high and the price of it is within the pre-determined budget.  The vendor can build on top of someone else’s idea of what’s fair.

Someone else’s idea of what’s fair isn’t always so easy to gauge when a business owner isn’t bidding on a project, or when the scope of the project is relatively small or is not ongoing.  A business owner might have a set hourly rate for all services and offer an estimate to help prepare her client for the final invoice, or to help a potential client budget for the services in a proposal.  Another option is for the business owner and client to agree on a lump sum.

When I do a project for which I have a set hourly rate, I offer an estimate and send the client a notice when the time I’ve spent on the project is approaching the maximum on the estimate.  But I also offer a set fee for certain services.  Both methods have their respective risks.  I could scare a potential client away with by overestimating or anger a potential client by underestimating a job’s time.  If a client pays me a lump sum for a project and then it takes more time than anyone ever could have foreseen, my profit margin dwindles.

There are risks for the client, too.  Just as an employer cannot monitor an employee all the time, a budget-conscious client may fret over whether or not his vendor is really spending as much time on his project as he says he is, or why it’s taking so long.  But he could be getting something with the hourly rate that he’s not in the lump sum: service of the highest quality.

A client may think she has lucked out with the lump sum method.  She knows exactly how much money she’s spent on the project, but so does the vendor, and to maximize his profit, the vendor will finish the job as quickly and with as little effort as possible.

One of my business mentors says he consistently gets lower-quality work when he pays a vendor a lump sum for a service instead of paying by the hour.  The business owner who is the vendor should always do a first-rate job, no matter the payment method; that’s how you build your reputation as a technician, right?  But let’s consider the situation, do the math and be honest: If some unexpected things have come up – anything from a technical glitch to a client changing his mind about what he wants or expects – and it has taken you 25 hours to complete a $1000 project that you thought would take 15 hours to complete, and your normal rate is $50 per hour, you are losing money.  You will want to either convince your client that you deserve more money, or to do the remaining work as quickly as possible to salvage the loss, your dissatisfaction with the entire affair increasing all the while.  On the other hand, if you have managed to cut corners and complete a thousand-dollar project in five hours, you’ve made out like a bandit.  Your client may even be satisfied in the latter scenario, but if you compare it to other work you’ve done for an hourly rate, you probably wouldn’t add it to your portfolio.

Lump sum or hourly rate?  Which do you prefer and why?


© Mariam Williams and Research Works, 2009. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Mariam Williams or, with appropriate and specific direction to the original content.  Any use and/or duplication of any photo contained within this blog without express and written permission from researchworks and Mariam Williams is strictly prohibited.

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