The hourly / annual pricing fallacy

I’ve heard from several independent consultants lately that prospective clients are pressuring them to cut rates and justifying it with the old fallacy about how your hourly rate should just be your annual salary divided by 2,000 working hours per year. I have written about how this is utter garbage in a longer piece about how to set rates, one of three “how to” pieces on consulting that I posted back in 2017. The other two were about business development and some basic mechanics of consulting.

TL/DR: As an independent, your top line rate (the first number you say, the starting point from which negotiations proceed) should be approximately triple that garbage number. You should be willing to consider discounting down to merely double the garbage number (a 33% discount from the top line) for steady, committed, enjoyable work. Under no circumstances should you start from the garbage number and attempt to negotiate up. That’s a trap, and clients who start the relationship that way will -always- be more trouble than they are worth.

Talking About Money

Conversations about money can be uncomfortable. Income and wealth (or the lack of either / both) are tied up in people’s minds with concepts of self-worth, success, importance, power, and control. That makes it harder than it needs to be to get good advice about pricing. It also creates a risk that people who feel uncomfortable talking about money will sell themselves short.

Being uncomfortable when talking about money will hold you back – whatever your role or field. It’s well worth your time to get to the point where you can discuss salaries, rates, raises, benefits, potential discounts, promotions, and so on without giggling, twisting your hands together, standing up and walking around, and (worst of all) blurting out something like “okay okay I could do it for half that much is that okay? Wait in fact never mind I’ll do it for free! OMG please like me!”

The pause between when you propose a price and when the other person responds is -super- important. You need to be comfortable giving them a chance to say “yes.” It’s part of a broader truth on the importance of (a) being clear about what you really need / want (b) leaving enough space for other people to understand and accommodate it.

Anyway, back to setting rates.


If you feel compelled to give specific examples on why consultants need to charge more by the hour to avoid shorting ourselves, I’ve listed a few below. I can pretty easily justify a 50% markup on salary just by listing out all the stuff that would usually be part of the package for a salaried employee, but (and this is important) do not fall into the trap of being made to justify every dollar above a notional salary comparison. As I said above, clients who treat you like that before the work starts will tend to nickel and dime every aspect of the relationship. It’s far better to let somebody else have their work and find customers who see the value that you bring.

Anyway, here’s an incomplete list:

  • Self employment tax (15% off the top)
  • Health insurance. The average family “Silver” plan costs more than $1k per month.
  • Dental and vision coverage (which strangely do not count as “health.”)
  • Short and long term disability (you need this even more if you are independent)
  • Professional “errors and omissions” insurance (sensible clients will require this)
  • Tax advantaged retirement contributions
  • Vacation and sick time
  • Equipment (laptops, software licenses, space to sit and work)
  • Training to stay current, attendance at conferences, professional development
  • Non-salary compensation like bonuses and equity (really significant for senior folks)

Independents also do a ton of non-billable work. Personally, I spend the whole rest of my work week (everything that is not taken up with paid work) on marketing (this blog post counts!), reaching out to prospective clients, screening them (do they have money? if they have money, will they choose to pay me or tell me stories?), writing SOWs, negotiating terms, invoicing, reminding people about invoices, listening to excuses about late invoices, and so on.

Consulting firms, like legal practices, usually aim for at least 80% billable. I’ve been in consulting on and off for 20+ years, independent for about half of that. Trust me when I say that maintaining 80% billable is far from easy.

Make Leaving Easy

The singer / songwriter Ani Difranco says, “I leave for a living, music is just something I do on the way out the door.” It’s the same with my consulting practice. One of the primary selling points of consultants and contractors is that we work with little to no commitment.

My standard agreement says that “either party can end the engagement at any time via email notification, for any reason or for no reason.” The recent waves of layoffs should have driven home to everybody that even salaried positions should never be treated as any kind of guarantee and that corporations have no particular loyalty to employees.

For consultants, being easy to terminate is actually part of our value proposition. In return for being available for piece work, on short notice, with no benefits, without a title, and with no commitment of further employment, we get a higher rate.

What To Do?

My rule of thumb is to take the salary based number and triple it to establish a top-line hourly rate for small one-off engagements. That gives lots of breathing room to have a value based conversation. I discount from there down to about double, mostly for concessions that will reduce my non-billable work. Guaranteed monthly minimum payments, good payment terms, long-term commitments, and freedom to use the client as a public reference are all valuable concessions that I will take into account.

However, and this is important, healthy business relationships are not really about the rate. Value is the important thing. In healthy negotiations, most of the conversation centers on identifying a scope of work that will bring so enough value that rates can be almost an afterthought. Often, as consultants, we are in a position to drive changes that (for example) help clients to de-risk multi-million dollar decisions. I ask questions like “can we put a price-tag on getting this right on the first try?”

Finally, a closing thought: The correct rate for your services is a sweet spot where (a) There are no surprises or gotchas – everybody understands the deal going in (b) The client is grumbling a bit but still paying it (this means that you are getting a decent slice of the available value) (c) You can maintain a decent work/life balance -AND- meet your financial needs (d) you break into a smile when your phone rings and your client asks for more of your time – because you’re getting paid well to do something important and you get to do more of it.

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