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When we started our consulting business, one area we struggled with was pricing. Deciding how to set fees for our services was challenging.
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But we tried several routes: First, we charged a project rate – a set price for a pre-determined work product. However, we found that too often, the client would ask us for additional work or change the scope of the project in midstream. That led to our suffering what might be called scope creep. Several times, the price we had originally set was no longer appropriate for the hours needed to complete the work desired by the client.
Perhaps because we new to freelancing, we took on the extra work without pushing back on the client or explaining that the changes would necessitate an extra charge.
Our second strategy, which we switched to within months, was an hourly billing rate, and we have continued this way of charging to this day. We can give clients an estimate of the number of hours it will take to complete a work product so that they know what fees to expect. Charging by the hour also makes it easy to explain that changing or adding work will increase the number of hours needed.
The downside of this billing method, however, is that we need to keep track of all of our time. However, we find that that discipline is worth the simplicity of our fee structure.
Still, determining what hourly rate to charge remains a challenge. You don't want to overcharge your client or set your fees so high that you can't get work. On the other hand, you want to be fairly compensated for your time. Below are five factors we used when considering how to set our hourly billing rate.
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Size of the opportunity
Bain Consulting, McKinsey & Company and the Boston Consulting Group are all able to charge millions of dollars for an engagement because the projects on which they work hold the realistic possibility of yielding benefits to their clients worth hundreds of millions, if not billions, of dollars. This, of course, means that they can typically serve only the largest companies in the world.
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Unless you have an unusually strong pedigree, you yourself won't be able to work on opportunities of this magnitude or charge these fees. Nevertheless, think about the size of the opportunities on which you will work. Our rough rule of thumb is that the expected upside for the client should be on the order of ten times our fees or more.
One of our core values is that our clients should receive a level of value from our services that swamps our fees. Using this rule of thumb will help ensure that this is the case for you, too.
Ability of the client to pay
Even if you are working on an opportunity with $10 million worth of potential upside for the client, an unfunded start-up won't be able to pay fees of $1 million. The client company just won't have the cash. In such situations, there are three options: 1) Pass on the work; 2) Accept lower-than-normal fees (probably much lower); or 3) Negotiate fees that will be large only if the upside is realized.
From our perspective, the third option is the most attractive. This often means accepting equity, some form of convertible debt or a share of future profits for your services. Structuring fee arrangements in these situations can require experience and creativity. And it's advisable to seek help. Of course, if the client has been funded by angel investors or venture capitalists, he or she will be more likely able to afford your normal fees.
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Existing competition
The free market will set the cap for your fees. If prospective clients can hire equally qualified competitors at half of your rate, you'll likely be unable to bill many hours. So, it's worth asking people who are doing what you plan to do how they set their rates. If you are uncomfortable approaching local competitors, ask out-of-town consultants with whom you are unlikely to compete.
Google, LinkedIn and other social media platforms make it easy to find these people.
Your financial needs/goals
Your wants and needs will not affect a client's ability or willingness to pay. However, they should affect what you charge. Recognize that you are very unlikely to be able to bill eight hours in a typical workday (unless you are working as a fractional employee). Time spent on administrative tasks, marketing and personal issues will make this an impossibility.
We find it challenging to bill more than about 100 hours per month. If you are just starting out, this is likely an aggressive target for you, so you may want to adjust the number downward. In chatting with colleagues, we find that many consultants bill less than 25 hours per week. Nevertheless, you can get a floor for your fees by taking your aspirational fee income and dividing by 1,200 (12 months X 100 hours per month).
If you set your fees at the level you need to achieve your income objectives, you will find out whether your business model is viable.
Setting your fees too high rather than too low
Once you have established a billing rate with a client, it is difficult to raise fees significantly. On the other hand, it is much easier to lower your billing rate. Therefore, our advice is to err on the high side.
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Setting fees always involves an element of judgment. However, considering the five factors above will put you on the road to setting prices that are appropriate.
