Pricing 3: Why freelance fees aren’t as high when you compare them with the true costs of employees.
“You ask what per hour? I only make so and so?!”
When I mention a freelancer rate to people who themselves are in a job and unfamiliar with the freelancing world, the perception is always that those rates seem really high. Perceived with a sense of outcry even. “Wow, that’s easy money. You’d only have to work a fraction of my hours.”
Mainly, this indignation stems from a wrong comparison. Comparing the freelancer rate with an hourly wage of an employee. And yes, (mostly) it’s true that an hourly rate is much higher than what someone in a job earns per hour. But these two figures simply do not resemble the same thing.
Let’s see how these hourly compensations stack up. When we line up the comparison including all the same costs and factors. Apples to apples.
In Part 1, we saw that you can’t straight up compare your revenue with an employee gross wage. As I’ll show you here, comparing your hourly rate with hourly wage severely underestimates the total cost for an employer.
The situation differs in the allocation of costs (who pays for what) and legal, tax and insurance systems.
When you do work for a client (design, organizational analysis, development, etc), he/she has the alternative of hiring someone to do the work internally. The hourly rate you charge gets compared to the true costs of hiring someone.
As a freelancer, this is an important point of comparison. Firstly, because it informs you in how much can you charge. Secondly, because the buildup of costs follows the same steps as your internal budgeting should and thus informs you in how much you need to charge.
Paying all the costs
An employer has to cover quite some costs for an employee (besides wage) that a freelancer pays him-/herself.
Let’s break down how the costs stack up:
- Let’s say the company would hire someone that wants to earn: €2.250 net per month. The corresponding gross yearly income is €36.500. The figure per month already includes holiday money and excludes a possible bonus. For the freelancer, the tax situation is of course different. The profit from his or her business only needs to be €30.000 for the same monthly income.
- Now, instead of you, the company has to carry the costs for pension and insurance: +30% is a common figure when budgeting these costs. I’ve used +20% for freelancers in Part 1.
- The company also carries the costs for the office (building, cleaning, desk, computer, supplies, etc), (possibly) transportation, education/training, etc. Then there are the overhead cost. The company employs people or outsources administrative tasks. And managers and other team members spend time to onboard a new employee and to direct him/her for him/her to be able to do the work. Let’s say these are — conservatively estimated — €15.000 a year. I’ve put these at €6.000 per year for a freelancer because they’re usually a bit more averse to spending. In doing so, I assume no other direct costs for doing the work.
Total costs for the company €62.500 per year. For the freelancer, it’s €42.000 of needed revenue (see part 1).
This difference stems mainly from the difference in taxes and that freelancers tend to keep their cost lower. This last one could be viewed as efficiency. Often it’s more necessity.
Plus, what a company spends on overhead, a freelancer often spends part of his/her time on (administration, marketing, sales, etc).
Paying for all the hours
Of course, an employee is also not always productive.
- He/she would get ill.
- In most cases, an employer pays for part of the breaks taken over a day.
- A good chunk of the employee’s time is spent in preparing to be able to do the work he/she is hired for. Maybe the job requires some (yearly) training to keep the employee qualified to do the work. He/She needs to onboard into the workplace, needs to be directed, has evaluation/developmental meetings, etc.
- Then there is simply time that gets lost in the process. An employee chats with co-workers, has meetings for internal projects, joins the company retreats, etc.
Not all of the examples mentioned above have to be the case. But generally, of the same 1.760 hours a year an employee is “present”, he/she is only doing her direct work for 1.250 hours. And for example, when an employee needs a lot of yearly training to qualify, it can be as low as 1.050.
An employee earning €2.250 net per month, costs it’s employer €50 per effective an hour.
Now how many hours out of the year a freelancer bills will vary. He/she will have to do his/her own marketing, administration, development. So many of the same indirect hours need to be spent and maybe more. Maybe it’s exactly the same at 1.250 a year.
But most importantly for the client, all the other time is on his/her own dime. The only hours he/she will (generally) bill are his/her effective hours.
When negotiating a price, know this is the companies alternative price (all things being equal). This is called a Best Alternative To a Negotiated Agreement (or BATNA).
[You can check out the Handleiding Overheidstarieven where there is breakdown of the costs per effective hour for government employees for different salary levels.]
This is how the costs of hiring a freelancer stack up against a company hiring someone to do the work internally. Besides the costs that can be directly attributed to the employee, hiring a freelancer gives a company two other financial advantages. And that’s without even taking the value you bring as a freelancer into account
Flexibility. The risk of making a disappointing hire is only a fraction of bringing someone on. In some cases, a client can’t even hire new employees (for example due to budgeting rules from above) so that the only choice he/she has is to hire a freelancer.
Even from a time perspective, the client saves money. Because the time spent to find a freelancer is lower than finding new employees.
In the case of the freelancer, the risk is in having to find new clients constantly. Adding a premium for the flexibility this gives the client is more than fare.
Specialty. The company doesn’t have to develop the knowledge themselves. Simply hiring a freelancer can save them that developmental time. And eventually, there might not be enough of that work on a yearly basis to hire someone to do it internally.
Since a freelancer often specializes in a field more, the hourly value goes up. Plus, the freelancer can deliver this value NOW. Adding a premium for the specific skill set you bring is only natural.
CAN > NEED TO
If you know what someone would make if they hire someone to do it internally, you know what their alternative costs are. Add to this number a flexibility and specialty premium and you know what you can ask for. The fee they should be willing to pay (granted that they have the budget).
What you can ask for should be higher than what you need to ask for.
To check that, go back to your calculations from Part 1 (from desired net income to needed revenue) and Part 2 (breaking down a year in hours and building up a portfolio).
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Originally published at www.studiogeorge.nl.