One of the questions that always comes up in learning sessions for start up consultants is, “How do I set my rates?”  The answer is, “It depends.” It depends on what fits your type of consulting business, and your clientele.  In several of my own businesses, I have quoted “project rates,” or, the cost for the entire project, but, you have to take a few steps to know how to set that price.

There are several ways for a consultant to establish a fee structure that will let you establish hourly, daily, or project rates. You should do a little research to find out what your competitors are charging. Check their websites for information. Call their office number and ask for their hourly rate. Ask businesses that use consulting services what they typically pay. The information is out there. Some times you just need to do a little detective work.

If you conform to what everyone else in your industry sector is charging, you may send a message to potential customers that you’re just as qualified as your competitors. On the other hand, you may signal that there’s nothing special about what you provide your customers. It is always a good idea to look at your specific situation to determine what type of rate you really need to charge, and then you can compare your proposed rate to what others in your market are charging.

I recommend that you first work out a Base Rate. Use your base rate to calculate what you need to charge for half-day, day, or entire projects, as detailed below.

1. Determining A Base Rate. To set a Daily Rate, you first have to determine your Base Rate, then a Fixed Rate. Use online salary calculators to determine the annual salary paid an employee, at your experience level, performing the same tasks you will provide, in your community. Salaries vary by community or region, and benefit packages also differ by industry.

This research will help you understand what is a reasonable expectation for a full-time salaried worker in your area. Be sure to look at the entire compensation package, not just salary, because you can easily miss the value of the benefits provided a salaried employee.

Combine salary and benefits to arrive at the value of this salaried worker. Multiply 52 weeks by 40 hour work weeks to arrive at 2,080 available work hours per year. Don’t deduct vacation time from this, because salaried employees are still being paid when they are away from their desk. Here’s an example: ($80,000 salary + $20,000 benefits) = $100,000, divided by 2,080 work hours per year = $48.08 per hour. Round up to the next $5. This would yield $50.

In most consulting fields, the $50 working number in the example above is typically doubled or tripled to arrive at a Base Rate because of what is called the Rule of Thirds: 1) one third of your income will be actual “wage”, 2) one third will go to expenses, and 3) one third to administration, down time between projects, and bad debt. In this example, the hourly base rate would be $150 per hour ($50 X 3=$150).

2. Alternative Base Rate Method Many consultants prefer an alternative way to set the base rate. In this method you determine the base rate by calculating the number of full days you feel you can reasonably expect to be engaged in earning income. Many consultants start this calculation by deducting six weeks leisure time from the 2,080 available work hours each year (2,080-240=1,840 work hours).

You then estimate what percentage of your time will be spent on work that actually brings in money, as opposed to time invested in marketing, administration, and other non-billable work. Typically self employed business people project that 20% of their time will be spent on administration, 20% on marketing (including networking and website management), and 10% spent on other non-billable work. This means that 50% of your time will be spent on tasks that are not billable.  (50% of 1,840 = 920 billable work hours).

Determine the amount of gross annual income you need to make your business solvent, while providing you the personal income required to maintain or improve your lifestyle. You then divide this income amount by the number of your billable hours: ($140,000 annual income divided by 920 billable hours = Base Rate). You can also gain considerable confidence that your rates are reasonable by using both the methods in Steps 1 & 2 so you can compare the results.

3. Calculating Bad Debt Unfortunately, despite your best efforts, not all your clients will pay you. Some will take weeks or months to pay, but a small percentage, (usually around 3%), will never pay the bill. You must also factor in this loss of earned revenue, which is called Bad Debt. You can estimate the dollar amount that needs to be included as bad debt by estimating your annual income by using the Base Rate established in step 1 and/or 2, then calculate Bad Debt as follows: (gross income X 3%=Bad Debt).

The decision of how aggressively you are going to pursue collections is an unfortunate reality for business today. You may have collection costs just to collect a portion of what is owed. Some consultants choose to just write it off as a bad debt after a certain point. You also, of course, risk losing the goodwill of the customer in the collection process. The question becomes, “Do you want them as a customer in the future?” In all cases, you need to protect your business interests by requiring a written agreement for every engagement.

4. Determining Overhead  Regardless of which of the above methods you select to compute your base rate, you then must factor in the cost of overhead to arrive at your Fixed Rate. You must calculate ongoing and contingency expenses into your cost of doing business, such as the example expenses below.

5. Setting Your Fixed Rate You now have the tools you need to calculate your fixed rate. Divide the total cost of your overhead by your projected billable hours. For example, $5,000 overhead spread over 920 hours equals $5.43 per hour. Add to the $150 base rate this yields $155.43, rounded to the next $5 increment results in a Fixed Rate of $160 hour. You can then estimate your annual income as follows: ($160 hour X 920 billable hours = $147,200 gross income)

6. Establishing a Daily & Weekly Rate (per diem) Using your Fixed Rate it now becomes much easier to develop daily, weekly, and “per project” rates. Most daily rates are simply (8 hours X Fixed Rate). In our example, it would be (8 X $160=$1,280).

The weekly rate is set by multiplying your Daily Rate times 5 days. However, some consultants give the client a discount for a full week’s work, often by reducing the overall cost by 5%-10%. Alternatively, this is often calculated by only charging a half day for the final day of the week. The method that best fits your situation is the one you should choose.

7. Project Fees I frequently submit a detailed Statement of Work with a proposal, and establish an overall price for completion and delivery of a project. You can  accomplish this by estimating the number of hours you expect to spend on a project, then multiply by the hourly rate. Here, again, you may choose to factor in a discount that fits the situation.

When estimating the number of hours you are planning to invest in completing a project, you must make certain that you are realistic about the time it is going to require to deliver the project, and you must have firm control over changes made by the client that expand your body of work. New ideas, or twists, or expansion of the original project are going to cost you hours, so you need to be able to charge the client for those changes through what is termed a Change Control Process.  I recommend being cautious about offering project fees until you acquire some experience in the market, and are comfortable working in the project environment.

Pay For Performance

Some clients offer project consultants a share of future revenue, profits or commissions. This is called Pay For Performance. Others offer the consultant a commission, or fee, based on the results of the consultant’s work.

Consulting fees based on performance pose several risks. For example, 1) the company’s performance in other departments or business sectors may negatively affect the area in which you are measured; 2) It may take months to see the results of the work, meaning that the consultant will not see any revenue for an extended period; 3) The company may not fully cooperate in implementing all of your recommendations, compromising their ability to reach the potential you projected.

Most importantly, in a Pay for Performance relationship you shift the focus from high quality planning to essentially becoming a partner by sharing in the client’s risk. It is very easy to lose objectivity. For your own protection, seek a base rate for your work, and then add on the performance pay or share of ownership 

Summary

Setting your consulting fee may at first seem a daunting task. However, once you’ve worked through the simple process above, you’ll have confidence in knowing that your rates reflect your real cost of doing business and can provide you with the profitability you need to succeed. Revise your rates as needed, taking into account your experience, changes in the economy, client feedback, and your competitors’ current marketing strategies and initiatives.

Larry E Vaughn is an Entrepreneurial Consultant based in Austin TX, with over 20 years experience in operating a variety of consulting and marketing businesses. Larry is also founder of the daily internet based The Self Employment Journal, available free at http://paper.li/levaughn.