If you are an independent consultant or a new consulting firm, one of the most important decisions you need to make is how much you are going to charge for your services. You want to get it as right as you can from the get-go so that you make what you are worth and so you don’t have to change it later, which isn’t impossible but can be tricky. Since many consultants, especially consultants just starting out, will charge an hourly rate, that’s what we’ll cover in this blog.
Now, you don’t have to charge hourly rates. There are multiple options for how you can get paid for your services. See my links at the bottom of this blog for different types of fee structures/ways to get paid that are more about value and less about time.
Start with You
How do you figure out what you should charge? Well, there’s a lot of information on the web about calculating what you should charge based on your previous salary and other inputs. That’s not how I would ever tell anyone to do it! Start with you and your life and then adjust the rate based on other inputs. I encourage that mainly because work is a part of your life, not your whole life, so your desired income or number of hours you are able or willing to work may change based on your life circumstances and aspirations. Either of those variables—income and hours—will change your price. So you have to know those first. Then you will have to add other inputs to get to a price that matches your life goals with market realities. That way you will develop a price that supports the life you want or is realistic.
Underpricing Traps
Many consultants just starting out fall into an trap of underpricing themselves. Sometimes people underprice because they think the only way they’ll get business is to be the cheapest. Sometimes they lack the confidence in the value of what they offer. Other times it’s because they haven’t done their homework about what others are charging in the market. Underpricing is also easy when you build your price based on how you and your job positions have previously been valued and not what value you offer a client. You’ll need to avoid those traps to get to the right price. So let’s start with important principles about pricing that are critical for you to know as you build your price.
Price communicates value. Yes, many clients are price sensitive and want a deal, but most people believe on some level that you get what you pay for. Few clients want the cheapest consultant because they think that means they would be settling for the bargain bin/least valuable consultant. And they are often right!
Don’t trust your lack of confidence. If you are someone who tends to lack confidence or are so nervous about becoming a consultant that your confidence is taking an unusual dive, then there is no reason you should believe yourself about your value. At least not now. Get input from people who know you and what you do, know the value of what you do, and will be completely honest with you. (Hint: Don’t ask people who lack confidence because you’ll likely get an answer filtered through their confidence issues.)
Know thy market. This requires exploration. Any unverified assumptions can send your price in the wrong direction. Don’t assume you already know the market, even if you have hired consultants before. There can be a big range in what other consultants charge and what they offer for the price. The more you know, the better you’ll be able to set your price.
Your past is not your value today. When you were employed, there are many reasons that your salary and other compensation were what they were. Many of those reasons have nothing to do with your value. So don’t equate your past salary with your value today. In consulting, value is defined by what you can do for a client that is valuable to them, not the cost for you to work in a specific position for an organization.
Overpricing Traps
Yes, some new consultants also overprice themselves. I see it happen less often than underpricing, but it can still be a problem for some folks. Sometimes it is because they inflate the value that they offer clients. Other times it’s because they did not do their market research to know that their price was too high. This is where a mix of honest self-reflection, feedback from knowledgeable and honest people, and market research can come in handy.
Of course, these types of problems tend to self-correct one way or another. Generally, overpriced consultants don’t get business because of their price—in which case, the market has spoken—or, if they got someone to pay their price, they don’t get repeat business because the value they provided did not equal or exceed the price.
Building Your Price
Now that you know which traps to avoid, you are ready to build your price. Remember, we are starting with you and your life.
1. Life Thresholds
The first step is to find a balance between your work hours and income. The two key questions for you to answer are:
How many annual hours do you want to spend working versus in other areas of your life?
What is the lowest annual income you want to make?
Hours. This question is really about making choices about what proportions you want or need different aspects of your life to have. There is no single answer. There is only the answer that works for you in your particular life circumstance. When you calculate how many hours you want to work, I would not do that in isolation. I suggest calculating how you will spend all of your time. Include all your work hours—whether they are billable or not. That includes time to do business development, tracking hours, invoicing, conferences, revenue projections, etc. It also should include assumptions about hours or days you do not plan to work. This will be an iterative process so don’t worry about the implications of the hours you picked yet.
Income. Now calculate the lowest annual income you want to make. I am not saying that is what you should make. This is just a threshold—a not-to-dip-below amount. This amount should pay for your living expenses, savings, and lifestyle, plus some percentage cushion on top for unexpected expenses and/or an enhanced lifestyle. Remember, this is the minimum income threshold, not the upper threshold. Include assumptions about changes to your taxes, benefits, and other expenses that you will now incur directly.
2. Play Price
Once you have those two numbers, you can calculate a price to start applying other inputs to. I call this the “play price” because you are going to play with it until you get to a final price. Don’t get attached to it! It’s just a place to start.
The calculation is pretty easy:
Minimum Income Threshold divided by Annual Work Hours equals Your Play Price
3. Other Price Inputs
Now you’re going to go back and adjust your minimum income threshold or annual work hours based on other considerations. Here are some of the key price inputs to consider when adjusting your price.
Market. This is where that market research you did comes in. Look at the hourly price range for consultants who do things similar to what you will offer. Where does your price fall along that range? Is it in the range? If not, get it in there. If it’s at the bottom, I would move it up. Does it fall along the range where you think it should? This last question is a judgement call based on what you now have learned about the market and your honest assessment of your value. Other price inputs may change where your price lands so keep coming back to look at your pricing position in the market range.
Overhead and expenses. You may want to adjust your minimum income threshold based on assumptions about nonbillable expenses related to work. Will you work out of an office or need to lease or buy equipment? Bake those into your minimum income threshold (or if you want to get really precise with how to do this, ask an accountant).
Bad debt. Unfortunately, you should also include some assumptions about the percentage of earned income that you won’t pocket because some clients don’t pay you what they owe you. I have only had this happen once. A client only paid a portion of what they owed. I know other consultants who have had this happen more often so it’s worth including in your calculation. I generally would include an assumption of 5% to 10% of unpaid income, depending on what you know about your market. If you aren’t sure, take another consultant out for drinks and ask them about it. Don’t ask them to name names, but get them to spill the beans so you can get a sense of how often it happens in your market.
Profit. You are a for-profit consultant, so always include a percentage profit you want to make. You have to check back on the market range to make sure you don’t fall into an overpricing trap, but always include some assumption about profit. If you don’t, you’ll likely be stuck in an underpricing trap.
Price increases. If you are doing a multi-year calculation, include some assumptions about increases in your price. You may do this annually to adjust for cost of living increases or cost of doing business increases. Note that this is not the same as the federal cost of living increases. This is set by you based on your circumstances and market changes. Often it can be between 2% and 5% but that’s not a hard and fast rule. It’s good to decide a maximum ahead of time and include language about it in your contracts so your client can anticipate it.
You may increase your price for certain engagements that require more of you. For example, if a client wants you to be onsite and away from your home for extended periods of time, you may charge more for assuming that extra burden and any extra expenses associated with that arrangement, such as child care or pet care.
You also may increase your prices when you can offer more value based on new knowledge, expertise, or methods. If you know that you are going to increase your value, consider how that might increase your price in the future.
4. Final Price
Using these inputs, play around with the price until you get it to a place where you feel comfortable. Keep in mind that adjusting your price based on these and other considerations is as much art as it is science. Given that, I suggest having other knowledgeable and honest people give you feedback on your assumptions and price before you finalize it. Of course, once you are out in the market, you can always adjust it more if you have good reason to.
Fee Structures
Regardless of what you picked for your hourly rate, you have to decide which pricing model or fee structure to propose for each client. This will define how you will be paid. You can get more information on the different types of fee structures by clicking on the links below.
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