Photo from digitas on Flickr (cc 2.0)

How to charge for your work

How much should you charge for your professional services as a freelance developer, designer, consultant?

That’s a recurrent question that first-time and even longtime entrepreneurs always have to work hard on getting an answer to. It’s extremely important to get it right, maybe not on the first time, but as you work on more and more projects it’s important to refine and learn how to set your prices to a level that makes sense for your cost structure, desired profit margins and the nature of the market where you conduct business at.

Let’s ask the MBAs

When I was taking a “Pricing Strategies” course at a business school we got to the class where we would discuss the specifics of how to set the right price for products. We learned a lot about economics models, formulas and processes that use fixed costs, variable costs, marginal costs, competitive and complementary products, supply and demand, economies of scale and other considerations to come up with an ideal price for consumer goods or manufactured products.

The whole point of going to business school for me was to learn more about how to run my software development company, so when I saw that the professor was about to wrap up and opening to questions, I asked:

“That is great for products… but how about services. If I am selling consulting services or software development for hire… how can I set my prices?”

I was disappointed with the immediate answer from my professor (an economist):

“Like every economist will answer any question… it depends.”

Well… you don’t need an MBA to come to that conclusion on your own. However, as the course progressed and as I took other courses related to business (negotiation, game theory, marketing) a lot of the concepts have been very helpful to defining a price strategy for my business, but none have provided a definitive answer to the question.

Let’s ask the hustlers

If you ask natural born hustlers and entrepreneurs, those who have learned by doing and have been selling things since they were kids, they will probably tell you that price is irrelevant and they can sell anything at any price, it just depends on who they are selling it to.

You can sell the same thing (let’s say… a pen) for $1 or $500 … it all depends on who you are dealing with as a client (how much money do they have, how much are they willing to pay, how desperate are they to get what you are selling), how you position your product and your ability to persuade and close the sale.

Setting a price is part art / part science, so you have to combine all of the economics and cost based hard numbers with the more subjective, psychological and behavioral aspects of your specific business case.

So what does “it depends” really mean

Whether you learn this from a business school, sales workshop or from experience running your own consulting business or freelance gig, you will end up considering at least these two elements when setting a price for professional services:

1) Your Costs

If you want to make a living by selling your professional services and make enough money to buy a house, a car, pay for vacations, support a family and eventually retire, the first thing you have to take care of are you basic costs of living and business operation expenses.

So the first thing to consider and have a clear understanding of are your costs. How much do you need to make each month to cover all of your costs?

If you can’t cover your costs with the revenue you generate from selling your services, then you will fail and give up once the stress and debt levels are too high and you will end up shutting down and looking for a job (become an employee so coming up with the money is not your problem… it’s your employer’s problem).

2) Your Capacity (comparable to a factory’s production capacity)

When you sell services, your raw materials are basically two things:

1. Time (hours on a day)
2. Your talent (programming, designing, drawing, etc)

These two raw materials, when combined determine your “throughput”.

Time is limited and it exists in the same quantity for all humans on the planet. We only have 24 hours in a day and there is nothing you can do to make days have more hours than that. In those 24 hours you have to fit enough time blocks to eat, sleep, work, learn, have fun, take care of your kids, your dog, your cat, or anything you want to do and makes you happy.

You have to be able to work with that limitation. So, if you decide that as a freelancer (or small consulting business) you will work 8 hours per day, then your talent will determine how much you can get done on that time.

Talent is tricky… you can be “a natural born _(whatever)_” (let’s use UI Designer as an example) and be very talented at it. Or you could be someone who is “not a natural” but through years of study, practice and persistence becomes a professional at it (UI Designer).

Depending on how junior or senior you are at your skill you will be able to do a lot or little progress on each 8 hour work days.

Extremely talented UI Designers can create amazing user interfaces in one single work session… others, with less talent or those who are still learning will take three or more sessions, requiring more feedback and revision cycles with the client.

Let’s stop here for an example of these two elements in play

We haven’t even started listing all of the other factors and we already have an ambiguity regarding the prices of what a UI Designer produces.

Let’s use a hypothetical scenario where a startup founder needs the UI design for his new app idea.

How much does the UI design of the app cost? Is there a defined price for this out there? Should this founder set apart $1,000 or $10,000 for the user interface of the app?

Well, the answer is: “It depends!”

Not only it depends on the scope of the project (how many screens, how many elements on the screen, etc), in the end all of those quantitative specifications will need to be evaluated by you, the freelancer that will work on the project and will become a specific quantity of billable hours.

And remember that your talent or skill level determines how much or little you can do on each hour you work. Then the total time required for the “app UI design” is already ambiguos and depends totally on who is hired for the job.

The app founder can go out and ask for quotes and estimates for the project and get estimates ranging from 10 to 100 hours of billable hours.

Not only that, but the price the designers will charge per hour of work could range from $15 to $250 (for example).

The startup founder (the client) might end-up with options like:

• Senior UI Designer, extremely talented and fast will spend only 10 hours on it, charges $250/hour = $2,500.
  The client gets the result, exceeding expectations in 2 days.
• Senior UI Designer, not that talented nor fast will spend 25 hours with two feedback sessions and revisions, charges $120/hour = $3,000.
  The client gets the expected result in 1 week.
• Junior UI Designer, very talented and fast, spends 10 hours on initial draft then a feedback session with client (2 hours), revised version of the design in 10 more hours = 22 hours at $50/hour = $1,100
  The client gets the result, exceeding expectations in 1 week.
• Junior UI Designer, not that talented nor fast will spend 15 hours on a draft, then a feedback session (2 hours) where the client discards the draft completely, then another option in 15 hours, feedback session (2 hours), revised version of design (15 hours) = 49 hours at $45/hour = $2,205
  The founder gets the expected result in 2 weeks… not that happy with the results but, will have to go with that since all that money was already spent.

Just with those four options, the startup founder has to decide who to hire based only on their Junior/Senior designation, their portfolio and their hourly rate (and maybe a ballpark estimate of how many hours it might take).

If the only thing the client sees is the hourly rate, the options are: $45, $50, $80 or $250. Easy… right? go with the cheapest… $45/hour

We know that is the wrong answer, but only because we know how much time it will take for each option to complete the deliverable.

Also, remember that time is money… it is much better to get this done in two days (what the most expensive option will do for $250/hr) than having to wait two weeks and go through a lot of back and forth with the cheapest option ($45/hr).

In this case there are two right answers… depending on how urgently the client needs the UI design to be completed:

1. Need it ASAP: the best option is the most expensive one ($250/hour) because you end up paying a total of $2,500 and only wait 2 days… compared to what the cheapest option ($45/hour) will end up costing you $2,205 but take 2 weeks to complete (and will not look as amazing as the work of the super talented senior designer).
2. It can wait a week: the best option is the “very talented and fast Junior UI designer” who charges $50/hr. This will cost only $1,100 and will probably look close to (or even better) to what the $250/hour will produce.

How did the designers decide who much to charge?

Each case is different, based on their personal cost structure, life style, etc. Some of these designers might have done a very complex analysis to come up with their billable rate, others just went with the flow and shopped around the market to see how much others were charging… who knows what each of them did to come up with their price. But in the future I can walk you through the mechanics of what can be done to come up with your prices (at least what I have been doing and refining over the years).

Is that all?

No, no, no, no… We haven’t even started. This is how complex it gets with only two factors in play: talent + time = throughput.

We still have to consider other factors like:

• Competition and Market forces (supply and demand)
• Urgency (we touched a little bit on this, but there is more)
• Opportunity costs (both on the clients and the freelancer side)
• Your branding (are you perceived as Premium or Commodity?)
• Value added (do you provide more than just the service)
• Geographical Location of the client (is the client in New York or in Perú)
• Geographical Location of the freelancer (do you live on a low cost or high cost of living city)
• Others…

A full book can be written about this (and many have been published already), so I am not going to pretend this blogpost is comprehensive. In fact, we’ll leave it here for now and continue analyzing the topic on future posts.