How To Set Your Consultant Billing Rate
I was asked recently on Facebook:
“Was wondering how you work your consulting business? Is it per project? Per month? etc. I have had a few people ask for my help and I just am not sure where to start.”
Good question. There are two methods for assessing your fair billing rate, and both are important, the floor and the ceiling.
Your Floor Minimum Billing Rate
Here’s how to judge your minimum billing rate. This is the rate you must charge in order for you to justify your time and the project you’re working on. First, you need to know what your mandatory annual income is, the money you must earn in order to be able to survive and reasonably thrive. As a consultant, there’s a good chance you will be a 1099 consultant as well, so you’ll need to budget between 30–50% extra for health insurance, self employment tax, etc.
For example, let’s say you have $40,000 in actual expenses for the year, including rent, food, etc. Your IRS tax bracket is 25%, so tack on an additional $10K for federal taxes and $5K for state and local taxes. Health insurance for a small business owner varies wildly from state to state, but call it $10K to be safe. You’re now at $65,000.
Once you have your mandatory annual income, divide that by 2,080, the number of work hours in a year. (52 weeks x 40 hours a week). That’s your effective hourly In this example, your required hourly rate is $31.25/hour.
Now here’s the part almost every consultant I’ve ever talked to gets wrong. They assume 100% utilization, meaning every hour they’re clocked into work, they’re doing billable work. That’s far, far, far from the truth. The reality is that consultants are lucky to get 2/3 utilization, and a better, safer estimate is 50% utilization. The other 50% of your time will be spent building your business. Thus, apply the appropriate multiplier based on what you think or know your utilization rate to be. If you’re just getting started out, assume 50% to start. That would mean your billable hourly rate would be $62.50/hour. That’s the floor.
Don’t accept any project under that rate unless there’s some massive leverage that comes with the project, like the opportunity to move up the food chain somehow. If you’re billing a project with a “Set Rate”, decide how many hours it will take you to accomplish it, multiply times your hourly rate, and be sure to specify in your contract that the project is restricted to X hours, with additional hourly charges for every hour after that point.
Your Ceiling Maximum Billing Rate
The ceiling is where you make the big money, but it’s much harder to judge, much harder to assess without a lot of experience. The ceiling fundamentally is based on how much your work is worth to your client. For example, let’s say you’ve been asked to speak at a conference and you’re a popular speaker. You know that you can put 50 butts in seats just by telling your fan base that you’ll be there. You know that the conference is charging $495 per ticket. Effectively, your value to the conference is $495 x 50, or $24,750. If you don’t speak, the conference may or may not fill those seats.
It’s reasonable, therefore, to ask for a percentage of that ticket fee as your pay. How much should you ask for? Some conferences are offering up to 50% of the ticket price as a commission in their affiliate programs (Jason Keath’s SocialFresh is one such excellent event), so it’s reasonable to ask for that as your fee outright or in an affiliate program if you’ve got a great audience/community.
Think about the contrast there. If you charged your floor rate of $62.50/hour, even if you billed for an entire day for the conference, you’d only make $500 at floor rate. If you got 50% of ticket under your affiliate program (assuming 50 seats at $495/seat), you’d get $12,375. That’s a really, really gigantic difference, and it’s why you should look to finding your ceiling as quickly as possible.
In order to develop a fair ceiling rate, you have to know and understand deeply the industries and companies you’re serving so that you know the economic value of the work you’re providing. As another example, say you know a particular method for looking at Google Analytics, a way that can instantly increase the ROI of a company by 30%. If you know the company’s industry and know that 30% more in their digital marketing ROI is worth X, you can justify charging a percentage of X and explaining how your pricing works.
A third example might be a graphic designer whose work increases website conversion from 2% to 5%. What does a 3% increase in conversion mean? Well, if the designer understands the companies he works with, he or she can say, “you’ll earn more with my design because my methods improve conversion from 2% to 5%, and that’s worth X to your company in additional revenue, thus my fee is a percentage of X’s value over the first year my design will be in operation as long as my design hits 5% conversion. After that first year, 100% of the increased value will be profit to you”.
That’s the power of ceiling pricing — it goes far beyond day labor rates because you know what your work is worth, and once you explain that to your clients, chances are they’ll be okay with it. Why? Because it demonstrates your understanding of their business and the value you are providing, and you have a performance target built in. If your client reaches 5% website conversion, you get paid a large fee because you created the value they were seeking.
Your goal in doing any kind of consulting is to get to your ceiling rate as soon as practical, while never violating the floor rate. That means developing a strong, deep understanding of the value of your work to your clients and moving away from the floor where you’re just another hired hand whose work quality may or may not impact their business.
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Originally published at Christopher S. Penn Blog.