Business Owners Toolbox Blog Discussions and articles to help the small business owner solve the challenges they face as they grow their business.

For consultants, contractors, and other professionals

How much money do you leave on the table? . . . how many jobs do you lose? . . . by the way you price your work?

This is a regular issue of discussion at our Business Group meetings. I’ve pulled together notes from several such discussions.

I would love your questions and feedback on this topic.

Hourly or fixed fee?

You should never work on a fixed fee for a poorly-defined project or one of unknown scope.

When to use an hourly rate (e.g., time and materials):

– At the beginning of a job, before you have a handle on it

– For parts of the job that inherently cannot be defined (e.g., for landscapers, “rocks and roots;” for remodelers, dry rot; for bookkeepers and programmers, repairing the goofy things your predecessor did).

An hourly rate with a cap on fees acts as a fixed price where you accept the downside risk but have no upside opportunity.

When to accept fixed fee basis, monthly fee or retainer:

– For a routine continuing task, where the scope is known and agreed upon

– For a definable new task

– If your fee is fat enough to cover contingencies.

Define the scope of the job. Answer these questions for each job: Exactly what will you do? What are the deliverables? What is not included? What do you charge for extras?

Specify the add-on services you can make available (at an extra price, of course).

Here are other terms of your client agreement that affect pricing and billing:

– Duration of agreement or contract.

– Payment terms. How much up-front deposit? When you will invoice and how soon they must pay. (Can you get payment upon completion of service? Do you accept payment by credit card?)

– Their responsibilities and timing. They must do what and by when?

– With whom you will interface and how?

– How the contract can be terminated by either party?

– When do you have the right to raise your rates?

Monthly Retainers?

Sometimes the term “retainer” scares clients. It looks to them like an ongoing contractual commitment. (Have you seen the computer commercial where the consultant says with a sheepish grin, “We are contractually entangled”?) Instead, ask for a standard monthly commitment. “For a business your size, for your needs, you probably need about ________hours per month.”

Specify your regular scope of work under the retainer. “For this many hours we can probably handle the following tasks: ______.”
These tasks probably fall into the following categories:

1. Right now problems to be solved, work to be done. This is what you’re being hired to do.

2. Ongoing follow-up and support to ensure implementation.

3. Proactive projects to be handled when other requirements are completed for the time being. (I.e., non-time-sensitive things you do when urgent tasks are handled so that they don’t think you are twiddling your thumbs and billing them.)

List and describe all these carefully, so that you will know when some request falls outside the agreed-upon scope.

Specify extra charges. For what things will the billing level be increased? Some examples:

– Tasks outside the specified scope; special projects

– Handling crises, emergencies

– Delays and extra work caused by the client not meeting their agreements with you (!!)

– Rush work that requires you (or your employees) to work evenings or weekends or shift around scheduled work with other clients

Your monthly billing must include time spent preparing reports, phone calls, attending periodic meetings and reviews, managing the project, and doing research.

Different billing rates?

You may be tempted to charge different rates for:

a) Working a greater number of hours. Suppose your hourly rate is $150 for a small number of hours. For a larger number of hours, you may legitimately give a discount because your cost of marketing and administration is reduced as a percentage of the billing on that job. But it’s also fine to keep it at $150.

b) Different tasks, e.g. tasks that require a different level of skills. For example, you may think you should charge a lower rate when you are doing lower-skilled tasks. But if so, you should also charge a much higher rate when you do your highest-skilled tasks. Often, thinking things through and coming up with excellent solutions to problems is the highest value you bring. Your rate should be $500 or $1,000 per hour at such times.

If you are tempted to charge a lower rate for lower-skilled parts of the work, then it’s time to consider hiring or assigning a lower-skilled person to do that part and pay them half to a third of what you bill them out for.

If the entire job seems worthy of only a lower rate, then it is probably not a good job for you.

Should you bill for thinking? What if you wake up at 3:00am with the million-dollar solution to your client’s problem? How much do you bill them? This could be the most valuable thing you do for them. (Make sure you turn the light on and write it down!) This shows the difficulty of billing by the hour. What would you say on your invoice, “Million dollar idea: 10 seconds”?

Should you bill for research? Some consultants say, “I’m the expert; they expect me to already know all this stuff, so how can I bill them for researching things for their job?” I question this belief. Are they hiring you because you already know everything, or for your ability to efficiently find out what they need to know? Ask your attorney: do they bill you for the time they spend researching case law in all those books that line their office walls? You betcha! Obviously you must know the basics of your profession, but beyond that, bill for research. You might tell your client up-front about how much time you expect to spend on research. A rule of thumb: the more you are expected to know without looking it up, the higher your rate should be.

Should you bill for travel time? To keep your business profitable, you have two choices: a) bill for travel time (yours and your employees’), or b) set rates high enough to incorporate unbilled travel time. Options:

– Don’t bill for travel time to nearby clients: only when travel miles are greater than, say, 30 minutes.

– Don’t bill for travel time if you spend more than _____ hours per day on site.

– Have clients come to you. Charge a lower rate if they come to you.

– Conduct some meetings via phone or do some work online.

What’s your hourly rate?

What is the proper pay rate for a lead consultant? One consultant found that competitors charge $180–$210 per hour. $160 seemed too low: she wouldn’t be taken seriously. Perhaps $185 is right. Recommendation to her from other consultants: “Make the first digit 1 rather than 2.”

Other ways of looking at pricing:

– Value-added pricing approach. What is this job worth to them? What does it cost them not to have it done? Set your price based on this.

– What do the big guys charge? If the client doesn’t hire you, how much will they have to pay someone else for work of equal quality? If your rate is too much below this, they probably won’t hire you, because you don’t seem credible.

Negotiate your rate?

Should you leave som­e negotiating room on the price? Some say “yes,” but I am against it. Don’t cut prices unless you also cut scope. However, you might say,

– “I can reduce the hourly rate by 10% if you commit to using us for at least ______ hours per month.”

– “The rate for hiring a Principal is $185, and our lead consultant bills at $165.”

– Reduce the scope: “For the price you want to pay, here’s what we can provide.”

– Or resell them on value. Why are you worth your rate?

Billing vs. pay rates

Profitable companies bill out their skilled employees for (at least) three times their pay rate. Thus if you pay an employee $50 per hour, bill them for $150. If you can only bill $120, then you should pay no more than $40.

For an independent subcontractor, this ratio should be at least 2 to 1.

Why should you get 2/3 of the money, you filthy capitalist pig? Here’s why:

– To contribute to your direct employees’ benefits, their pay for unbillable hours, their pay for work that goes over budget

– Overhead. Contribution to facilities cost, insurance, administration, marketing, etc.

– You must pay employees (and even subs) on time, regardless of when you collect the receivable. You are the banker.

– Marketing cost. You brought in the job. You must recoup the cost of time spent on all the jobs you didn’t get. For example, if you get one out of three of the jobs you bid on, then the one you get must cover the bidding cost of the two you didn’t get.

– Management cost. You may have to devote some unbillable time to managing their work.

– Entrepreneurial risk. You take the risk for business reverses and interruptions, the risk of not getting paid by the client, the liability for lawsuits, the obligation for leases, etc.

– Profit from operations. You are supposed to make money on every aspect of your business.

– Return on your investment. You put the company together and built it up. Your organizational skill, teambuilding, training, and creativity are essential and deserve an ongoing return.

All this is in addition to the amount you pay yourself for time spent on the job.

I assert that if you bill for less than twice what you pay your people, you actually lose money out of your pocket for each hour they work.

At the very least, this practice is a sign that your business model needs tuning: you are estimating poorly, underpricing, overpaying, or going after the wrong kinds of jobs or customers.

Exceptions. Pay a larger proportion of billings for valuable extraordinary contributions, e.g.:

– Rainmaker. Someone who brings in good clients or generates extra business with current ones

– Creator. Someone who develops new intellectual property that allows you to bring in increased billings.

Raising rates

It’s easiest to raise rates for new clients. But if there is a large disparity in rates between new and old clients, then you will begin to resent the lower-paying ones. It’s then time to raise your rates, or fire these customers. If your rate is below market, and your client leaves you because you raise rates, then they will end up paying even more, so why would they leave you? You know it’s time to raise your rates if your clients tell you you’re under-priced.

Should you take jobs on commission?

Have a sliding scale? Give a lower rate for non-profits or start-ups? Before you do any of these, make sure you have enough full-rate work to maintain a viable business that pays you well. Then, if you wish, set a certain percentage of your projects that you will do at a different rate. But beware! These projects are time eaters. If you are working for me on spec or for a very low rate, I have no compunctions about asking you to do just a little more.

And finally, here is my Rule #1 for pricing:

“Never subsidize anyone wealthier than you are!”