Flat rate vs. time and materials

The battery in my car died the other day.  After unsuccessfully attempting to replace it myself (why are cars so hard to work on these days?) I called around to find a shop that had the right battery. 

On the phone they quoted a flat rate for the job, which included the battery and the labor.  They must have created the price “on the fly” by adding the price they would charge for the battery and their estimated cost of labor to change a battery (maybe for my car).  The fact that they quoted a flat rate made me feel much more comfortable than a price for the battery and then an hourly rate for labor.  If they had quoted an hourly rate I wouldn’t know how much the bill would be until it was time to pay, and then it would be too late to do anything.

When I arrived and was waiting to be served, I was looking at their displays.  They were advertising three levels of oil change service, $29.95, $49.95, and $99.95.  Since my car was due for an oil change, I ordered the middle one (of course).  Then I started thinking, they would not have gotten my oil change if they priced based on an hourly rate.  It was the flat rate that made me comfortable.

When does it make sense to charge “time and materials” vs. “flat-rate”?

This question is relevant in so many different situations.  These certainly include auto and other repair shops, along with consulting projects, building projects, and anything custom like logo design.

The flat rate price lets the buyer know the maximum he will be liable for, which is very comforting.  It assures the buyer that he will not get ripped off with padded hours.  It implies that the selling firm is experienced enough to know what it will take to get the job done.  Flat rate pricing is also insurance to the buyer, in case their job is more difficult than most.  Most people would prefer to purchase on a flat rate.

Yet sometimes, time and material is the only way to quote.  A plumber doesn’t know how long it will take to unclog your drain until he shows up and tries (unfortunately I know this is true.)  Yet a plumber can and usually does quote a flat rate to a contractor building a new home because it is more predictable.

It seems that everything points toward trying your best to quote a flat rate whenever possible.  Another reason to quote a flat rate is price segmentation.  If you publish an hourly rate, then you are unable to get customers who differ in their willingness to pay to actually pay different amounts, unless you unethically fudge the hours worked.  However, if you are quoting flat rates, you can easily find ways to segment prices.

One big downside to quoting flat rates is the risk that your costs will be much higher on that job than you estimated.  Hopefully on most of your jobs your costs are less than or equal to your estimates, so on average you make good profit.  Then on the occasional job that is more difficult, you lose a little, but you made it up on all the other jobs.

This is especially a big problem for very large projects.  It even has a name, The Winner’s Curse.  For example, imagine 10 contractors bidding to build a new office complex.  Each one has the exact same costs and profit needs.  The only difference is the person that estimates the cost of the job.  Some people will err high and others will err low.  The company that estimates their costs to be the lowest is most likely to price lower, will win the job and may lose money because they estimated their costs too low.  This is why they call it the Winner’s curse.

The bottom line is – try to quote flat rate prices.  Your customers prefer them and you have more pricing flexibility.  Of course you are taking the risk, but you should be able to charge a little more since your flat rate includes “insurance.”