
How to calculate your hourly rate - mipapage
http://makaluinc.com/blog/2012/11/how-to-calculate-an-hourly-rate.html
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philiphodgen
Note the inherent flaw in "by the hour" billing: if you want to increase your
income you either must work more hours or raise your rates. In other words,
hourly billing guarantees a built-in cap to your annual income. You have a
maximum, but no minimum income. This is a world that I do not want to live in:
a voluntary upper limit on my achievements.

Hourly billing is a method of setting prices by looking at the cost of the
product you are selling. In fact a customer does not care what it costs for
you to deliver a product or service. You could be delivering a product that is
made of diamonds and unicorn horns. It doesn't matter.

What matters is the value of your product or service to the customer. Your
job, as a business owner, is to set your price based on the customer, not
based on your costs.

Set your price based on the value that you deliver. Then adjust the inputs
(hours of worker time, etc.) until you can deliver the value at that price.
Mercedes Benz adjusts the inputs for a C-class car until it hits the target
price. It adjusts the inputs differently for an E-class or S-class car.

There is a lot of information out there in the wide world about this. It is
not "fixed pricing." Call it "value pricing." Fixed pricing is just computing
the cost of your inputs, adding a margin, and declaring a price. Value pricing
is a matter of working backwards from the customer's value desires to set the
price.

For you math people, this is an "area beneath the curve" problem.

I'm an international tax lawyer. I make far more money (and have happier
customers) when I charge a declared price than when I bill by the hour.

All that being said, one of the points in the article is exactly right: raise
your prices and you will get better quality customers.

Go see www.verasage.com as a jumping-off point for discussions of pricing in
professional service firms. All business are alike. Don't think that advice to
an accounting firm is inapplicable to you. It's not. It's all "delivery of a
service to a human being in exchange for money".

~~~
bguthrie
Measuring value in software development is difficult. If you can tie your
activities directly to either higher revenue or lower cost, that's great. As
an international tax lawyer, I'd think you have a relatively straightforward
way to demonstrate value: it's proportional to the money your clients save on
their taxes. patio11 has the same advantage: consulting time spent optimizing
conversions through A/B testing can be directly tied back to increased
revenue.

But what if you end up working on a product for a company that never makes
them any money at all? You haven't provided any direct business value,
although you may have done quite a lot of work--maybe months or years. Are you
going to charge them nothing?

Rates are a proxy for value that accounts at least in part for the risk of
project failure. High-risk individuals might account for this by trading
equity for hourly rate or accepting some other form of in-kind compensation,
as many startup employees do. But you have to be a strong believer in the
project in order to do so, and most freelancers, to put it bluntly, aren't.
Otherwise they'd be employees.

Nonetheless, don't start at the bottom by calculating costs. There's a market
value for your services in the area where you live. If you can, start by
asking other freelancers and consulting firms. The value of a good is what
people will pay to get it, not what it costs to make.

~~~
philiphodgen
The value to my clients comes in two forms: (1) amount of tax saved and (2)
stress and fear eliminated.

The first is easy to quantify. It also means there is an upper cap on your
income. The upper cap is the amount of tax saved. As your price approaches
that number, the likelihood of a "yes" decreases.

Do not set your pricing based on easily quantifiable criteria, unless you're
working on huge deals where you can take a small fraction of the value as
compensation. (By small I mean low single digit percentages).

The second is where the true value sits. People are willing to exchange money
for a peaceful brain. People are willing to exchange money in exchange for
more time in their lives. It is here that personal value choice
discontinuities work in your favor. Set your pricing based on intangibles.

A business owner is willing to throw money at a problem to not have to think
about the problem at all. This frees up the owner's brain to think about stuff
that really matters and will make money.

An hour spent by a CEO looking at tax returns could be an hour taken away from
making a deal that brings in $1 million for the company. It's worth spending
$1,000 to make the problem go away. You are happy to take the $1,000 because
it takes you $125 of time input to solve that problem.

I have seen this with very large companies. There is a reason why their
compensation packages include "your employer will pay for a lawyer,
accountant, and personal financial planner." You don't want an executive with
10,000 employees under him/her to be sweating credit card payments, or "Is my
will up to date?" or any trivia like that.

Moreso, however, I see this with entrepreneur-driven companies. The owner is
the manager and this person's time is incredibly valuable and should not be
spent on trivia, especially emotion-laden trivia.

~~~
gregpilling
> A business owner is willing to throw money at a problem to not have to think
> about the problem at all. This frees up the owner's brain to think about
> stuff that really matters and will make money.

Yes I am. As a business owner, I completely agree with this statement. After a
while of running a business, one day you will calculate how many dollars per
minute your expenses are and it will scare the hell out of you. Then you will
understand why you throw money at problem X to make it go away, because you
need to focus on opportunity Y to bring in more revenue.

------
TamDenholm
Like others have mentioned, charge by the value you provide. I know a few
parables that illustrate my point that i often tell people, this is one,
excuse my terrible paraphrasing.

"Guy walks along and sees Pablo Picasso chilling in a cafe watching the world
go by, the man goes up to him and asks, 'Wow nice to meet you, can you draw me
a sketch on this napkin? I'll pay you for your time!' Picasso scribbles on the
napkin for a minute or two and hands it to the man, the man asks 'Thats great,
how much?' Picasso replies '$5,000', astounded the man says, 'but it only took
you a few minutes! I'm not paying that much!', Picasso says 'Yes, but it took
me decades to be able to do that in a few minutes, you're paying for the
decades of experience, and in decades to come, that drawing will be worth a
lot more.'".

My point being that you shouldnt be leasing your time, you should be providing
$100k worth of value and charging $20k for it, regardless of how long it
takes.

And if i'm the customer and i know that you can provide $100k of value to my
company, then i'll happily pay you $20k to do it.

~~~
rwhitman
In my experience its been much easier to pitch clients by quoting an hourly
rate, every time I've tried to do a project rate it falls flat. I can't tell
if its sticker shock or my presentation of the value isn't very good.

Love to hear if there are tips out there for the sales pitch when doing these
kinds of bids...

~~~
ams6110
What kind of projects?

~~~
rwhitman
Usually web development, sometimes design + dev

------
artumi-richard
The rule of thumb I was told is 1000 billed hours per year. If you want to
earn £40k, and are billing by the hour, charge £40 per hour.

That gives you the room to be flexible.

The original article adds extra in as they have a different structure, but
they start with $75k and year and end up with $85 an hour. Which seems to me
to be close enough.

I used it when I started by company. I think it was good advice.

~~~
tome
One thousand billable hours per year seems reasonable, but if you want to earn
equivalently to someone who's on a £40k salary you should aim for
substantially higher than £40k of revenue.

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dools
The advice that everyone trots out on HN whenever someone mentions hourly
rates of BILL BY VALUE CREATED!!1 goes beyond being trite: it's confusing and
damaging.

One of the most important things I ever did was work out my hourly rate, using
exactly the method outlined in this post.

If you're early in your career, you can't just waltz in and say you're going
to charge someone $4,000 to write them an email responder sequence.

By working out the _inelastic_ base hourly rate at which you need to work in
order to earn a level of salary you ensure that:

1) You know exactly what your opportunity cost is versus getting a job (ie.
you are making a conscious decision to work for $40k/year instead of the
$90k/year you could earn if you went and got a job somewhere)

2) You know that when it's time to scale, what you'll have to be able to
charge in order to hire someone at "market rates"

3) It makes your negotiating position much much stronger - when people try to
screw you down on price you know precisely where your "bottom line" is - at
what point am I losing money here?

If you want to bill based on value created, that's great and it's something
you can achieve once you've developed a strong position in the market and a
bit of a track record.

Up until that point (and even afterwards) it's vitally important to know the
base cost of an hour of your (or your employees time).

Saying that someone shouldn't work out their base hourly rate because we
should all be billing based on value created is like saying that you should
run a retail shop and sell everything according to the maximum you think
people should pay, but never look at the cost of purchasing the stock in the
first place.

------
dworin
Enough people have pointed out the importance of value pricing over hourly
billing that I don't have anything to add there.

But I will bring up a neglected point, which is that this formula assumes that
all employees hours are equal, or at least indistinguishable enough that you
can take an average, and completely ignores the idea of leverage in
professional services. Leverage is how you make a professional services firm a
profitable, growing business, and not just a series of contractors that you
farm out.

To start thinking about leverage, you need to realize that not all of your
employees are the same, so a globally blended rate doesn't make sense. Some of
them are junior level employees who are smart and capable, but still learning
the ropes. They benefit from your firm's intellectual property, so they're
able to add value greater than their salary would indicate. At the top, you
have the firm's principals or partners, who tend to have less time to spend
doing work, because they're busy trying to market the firm and win new
business. So even though their rate may be higher, it's spread across fewer
hours. In the middle are either technical experts or managers who are able to
command a higher rate, and can mentor others, but aren't quite ready to bring
in new business on their own.

As your employees learn and become capable of better work, they also become
more valuable to you, which means you should pay them more, which means their
rates should go up accordingly. But now you need them to do more valuable
work, so you also need to find new junior people to replace them. This is how
you help your employees grow, and it's how you help your firm grow.

Your firm's profitability comes from the fact that you can charge greater than
an employees costs to your clients. That's the basic idea behind a services
business, otherwise you're all just independent contractors. So your source of
profits is the amount you charge on top of your employee costs, and that could
vary by level.

The number of people at each level, and the amount you charge for them,
depends on the nature of your work and your firm. Figuring out the rate
balance and the right growth rate is one of the most important parts of
managing your firm (probably second to creating a great culture, although the
two are related).

The reason that the firm in the article is able to raise more revenue by
raising prices is because they've been undervaluing their own work this whole
time. Once the price starts to better reflect value, the way you grow is by
sustainably hiring in new people and growing them with the firm - the price
mechanism is money that's currently being left on the table, it's not a growth
mechanism.

~~~
DougWebb
My father-in-law and I had a discussion about this in relation to my company,
which charges different rates for a few different roles on our projects. We've
had trouble with this as people shift from project to project or work is
shifted from one role to another (eg: junior to senior developer) which
changes the amount of time available for the fixed budget we had planned. I
was interested in his input since he has a lot of experience running large
Enterprise departments.

He told me that he had tried different approaches over the years, and the best
approach was to charge the maximum rate for all roles on the project. The
working assumption is that senior workers will tend to do the work faster and
on their own, but junior developers will require oversight from senior
developers. That justifies the higher rate for juniors; it offsets the time
that seniors have to spend mentoring them, which also ensures that the same
quality of work is produced whether it's done by a senior or junior.

Charging the same rate for everyone greatly simplifies budgeting, especially
if some parts of the project turn out to be over-estimated while others were
under-estimated when the initial budget is put together. If all hours are the
same price, you can shift them freely where they're needed as reality starts
to beat up your plan. When hours have different prices, it's a lot more
complicated to do that.

------
Jabbles
patio11 has good advice on this:
[https://training.kalzumeus.com/newsletters/archive/consultin...](https://training.kalzumeus.com/newsletters/archive/consulting_1)

------
richeyrw
I've also done it by working backwards. This can be useful particularly in
smaller consulting firms. Say you have three tech guys who want to start
consulting, you start by saying how much do you want to make each year? How
many hours do you want to work a week? Then how many people do you want to
hire to help? How much would you have to pay them? From this you have some
variables you can tweak to see what various numbers of subordinates and
various annual salaries get you as an hourly rate.

------
lazyjones
That's a good approach before you take into account the effects of
marketing/positioning. Customers will not always hire the cheapest freelancer,
they will often (irrationally?) believe that successful developers with a high
hourly rate must be particularly good.

When I founded my company (with a different business, i.e. not around web
development for clients) in 2000 after a year of freelancing, I set my hourly
rates ridiculously high (about 18 times my previous rates) because I didn't
really want to do any development for clients at that time and to my surprise,
I still got some clients who felt that I must be particularly good. So while
you cannot generelly expect to make more money on average by setting your
rates very high, it's foolish to set them based on your cost calculation and
general demand only.

------
pnathan
One thing I always wonder is how to break into the consulting business.

The earning potential looks considerably above the salary employee potential.
My current skills & expertise are very much "backend", and I don't have
networking connections with people who could offer significant amounts of cash
for the solutions I could offer. (Put another way, I only know very small
business owners, as they are the dominant employer in the area).

It seems as if the best way in is to get hired at a consulting firm and really
understand how tech can drive business value. Am I off?

~~~
scarecrowbob
Personally, I just found built up some savings to give myself a runway, found
two small-ish but workable projects/clients, and quit my job...

It was a bit easier because I was not making a lot at the job anyhow-- I
basically had to sell one small project a month to replace the income on the
job (maybe 3 or 4 days of work), but after that I simply tried to be nice to
folks, super available, and really knowledgable. Your situation may be
different.

It doesn't hurt that I'm 90mi outside of Austin, so there are a) no jobs here
to tempt me, and b) a whole lot of possible work within a small drive.

But I also have to have a lot more going on than just my specific tool chain
of computer skills-- I have to do a lot of business strategy and networking
things, even if that usually just means eating lunch with folks I've worked
with just to keep in touch.

------
juanpdelat
Please correct me if I'm wrong.

So, in order to make the same $75k/year the employee makes in the example, the
manager would have to hire around 6 employees with the same structure and have
at least 6 projects per year.

~~~
jtbigwoo
Most consulting companies that I've worked with don't have very many non-
billable employees. For a company of under 50, you probably only need a
handful of sales and support folks. For billable employees, that other 30% is
supposed to cover management and business development tasks.

Once a company got the size of needing non-billable managers, I assume that
you'd add a fraction of that person's salary to the overhead numbers.

------
ruswick
My first thought when reading this was "Jesus Christ are Germany's PTO
policies generous."

In nations that are more work-centric (eg. the US) the possible billable hours
will be nontrivially higher and thus the hourly rate will be significantly
lower.

For instance, I know people who get only 10 days off per year minus holidays,
meaning that they take a maximum of 10 days per year total. This also entails
working ~8 Saturdays per year, which comes out to roughly 1850 hours per year.

It seems as though this type of calculation will vary widely based on
location.

~~~
Spooky23
That's crazy. One of the incredibly attractive things about my job now is that
I get 40 days of discretionary PTO. Sick time is separate.

I took a reasonable paycut to get the gig, but its totally worth it.

10 days off a year is a joke.

------
kalid
I made a calc to crunch the numbers, here:

<http://instacalc.com/10103>

[Shameless plug since it's my own pet project :)]

