Setting rates

This is a post about money – specifically about how to set consulting rates. It builds on two prior posts about the legal mechanics and some business development practices of my one person consulting shop.

People tend not to talk about the specifics of compensation. Because of this, most of the advice that I’ve read over the years has been vague to the point of uselessness. There are various reasons for that – mostly centering on cultural squeamishness about money. My opinion is that while discretion and humility around the absolute numbers are good things, we need to be able to talk about this sort of thing far more openly than we usually do.

The majority of this post is about figuring out what you need – a minimal baseline that will cover expenses. At the end, I offer a bit of a vague tease about figuring out what the market will bear. It amounts to “until you have data based on your own experience, you have to ask your friends.” This will take emotional energy and trust – especially at first – but it’s absolutely essential to go into negotiations knowing both common practice and your baseline requirements.

As usual, this is based on my experiences and those of a few trusted friends. Your milage will almost certainly vary. I’m curious to hear your comments.

The Salary Comparison

A consulting rate is very different from a salary. In fact, comparison with a salary is among the worst ways to figure out an appropriate rate to charge for your time:

Consider the old shorthand:

There are approximately 50 weeks in the year, and 40 hours in a work week. That means that there are 2,000 hours in a work year. If your aspirational annual salary is $100,000 (a round number makes the math easier) you can just divide by 2,000 to get an hourly rate of $50.

The problem with this approach is that it’s misleading and causes you to under-charge.

It is unwise to bet on being 100% billable, particularly over the long term: I’ve been consulting for a while, I’ve got a strong professional network, and I treat business development as a core component of my job. My experience is that I can sustain between 70% and 80% billable time (against the arbitrary 40 hour week). A safer assumption until you have data on your own network and capacity is 50%.

Vacation: Even if you personally decide that you don’t need to take breaks – many customers will go completely dark on you during national holidays and also from mid November through early January. It’s also challenging to get the right people in the room during the summer.

There is a lot of non-billable work in consulting: I’ve written before about “business development Fridays.” If you want to have billable work, you must do non-billable work. This inevitably cuts into your ability to meet that notional 40 hour, 50 week schedule.

There are a lot of non-salary expenses that an employer would usually cover: Health insurance is the big one, and the self employment tax works out to about 7.65% right off the top. Also consider any sort of employer contribution to a retirement fund, transportation benefit, funding for education or conferences, and so on.

Business expenses: Distinct from the non-salary benefits, you also incur direct expenses. Even the small ones add up: Computers, printers, shipping, an attorney to review contracts, an accountant to prepare taxes, liability and other insurance, a co-working space to host meetings … these things all need to be funded out of the consulting rate.

Multiple budgets

A better approach is to start with a budget, or rather at least two budgets. Even though I’m a one-person shop and the IRS doesn’t really care whether I keep dollars in this checking account or that one – I still make a strong distinction between my personal and my business finances.

Start with a personal budget. Keep it high level, and be sure you get all the major expenses in there. Housing, health insurance, utilities, transportation, childcare, saving, etc. In order to keep from getting distracted by the details, I set an arbitrary requirement that it had to fit on one sheet of paper.

Note that taxes are not in the personal budget – I’ll get to that in a second.

The bottom line on the personal budget was the number that I decided to transfer from my business account to my personal account every month. That’s what I decided to pay myself.

With that in hand, I had the first line for my business budget.

This second budget is similarly high level. It includes liability insurance, all the expenses listed above, and also a line for taxes based on an assumption that a little less than 50% of every dollar I receive will somehow go out the door to the city, state, and nation.

The bottom line of the business budget is the actual amount of money that I need to bring in every month in order to make this independent consulting thing work.

That’s my number.

The tyranny of the number

When I started out with BioTeam in 2004, Stan insisted that each of us work to a ‘number,’ an amount of revenue attributable to our work. At the time I resisted it – how could a number capture the grace and beauty of my engineering contributions to the team? How base and unseemly for a software person to be tied to a (yuck!) sales goal.

Technical people, I am speaking to you, are you listening? Get over that squeamishness and learn to love your number. It is how you get paid.

Now the only thing left to do is to figure out how to turn that number into a rate.

Setting a rate

Having done the work above, you know the total amount of dollars that you need to bring in (on average) every month. The next question is how to chop that up into hours, days, and deliverables to make it work.

I made a little chart breaking out my required rate under various assumptions. This gave me a baseline – the minimum that I could possibly charge, under various conditions. Because of the bottom-up approach, I also had a good feel for what I might need to charge for fixed fee deliverables like blog posts and technical assessments.

Then I went out and did some market research.

What the market will bear

Of course, you shouldn’t simply charge the minimum. Instead, you should charge an appropriate and fair rate for your services. There are several ways to define “fair” in this context. All of them involve talking to people about money.

The very best thing to do is to ask peers who either provide or consume consulting services about what rates seem reasonable and common to them. This is best done one-on-one with people you trust. Over time, you will get more comfortable both asking and offering this level of detail.

Negotiation is a whole different topic for a different blog post, so I’ll just summarize here:

Figuring out if an exchange is “fair” requires that both parties understand the relative values involved. If you’re going to be an effective partner in negotiations, you must understand your requirements before walking in the door. The whole top portion of this post was required just to be able to hold up your end of the business conversation.

If you don’t have information both on your needs and on the common practice in your industry, the other person might suggest that you take a reasonable salary number and divide by 2,000. Seems “fair,” right?

1 thought on “Setting rates”

  • We have usually used an 1820 or 1840 hour conversion in order to demonstrate an equivalent hourly:salary conversion. This takes into account holidays you won’t be paid for, some personal time for vacation, unexpected illness, etc. On top of this, I have always encouraged people to consider the risk which is inherent in a consulting role (and potentially reward too – afterall, it is my job!) and to “price in” the risk into their consulting rate.

    “Time” is also an important factor correlated to risk as a consultant. That is, the longer the project, the more likely your rate should be moderated on that basis. You’ll need to find a new gig soon if the role is short, and there is a cost associated with the risk (especially if you don’t find a role, or end up passing up a better one because you jumped too soon). The opportunity cost of time has to be built in your pricing.

    There are two sides to this coin though, first, I am sure that you are aware of the potential tax and ‘write off’ advantages of having your own business. Most consultants have claimed this is 10% extra money in their pockets. This doesn’t necessarily factor very well into a persuasion argument on setting a rate but it is probably worth mentioning just to be even handed.

    Additionally, no matter what you need to charge for your services, your client will probably have a good idea about what they can pay at a maximum. Avoid clients who want ‘Google talent on a McDonald’s budget’ but be ready to have to negotiate if possible. I try my best to set expectations clearly up front about rates with consultants to ensure everyone can be happy and we don’t get into acrimonious late stage negotiations. I completely agree this should not be a taboo process, as a consultant you are more a “vendor” than an employee and I think from an ethics perspective both parties should be transparent from the get-go on price expectations as you would have a good idea of in any commerce situation as a well-informed seller or buyer.

    If “know thyself” was good wisdom from the ancients, I think “know your value” is good wisdom for modern consultants.

    I completely agree with this post with the exception to define that people who have few other options would be wise to consider the divide by 2000 number as a W2 consultant as a bare minimum. Budgets and markups for many contracts which have not been awarded on a prime vendor basis are not that lucrative. It really depends on whether the role requires your unique skills and specializations. (In your case I might suggest you deserve a very high rate for short term services due to the specialization of your background.) But dividing by 2000 it is not an acceptable method for a professional consultant (“corp to corp”).

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